UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
☒ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended June 30, 20192020
OR
☐ Transition report pursuant to Section 13 of 15(d) of the Securities Exchange Act of 1934
For the transition period from fromto _________ to__________
Commission File Number: 000-23329
Charles & Colvard, Ltd.
(Exact name of registrant as specified in its charter)
| North Carolina | | 56-1928817 |
| (State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
170 Southport Drive Morrisville, North Carolina | | 27560 |
| (Address of principal executive offices) | | (Zip Code) |
(919) 468-0399
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common Stock, no par value per share | CTHR | The Nasdaq Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☐ |
| | | | |
| Non-accelerated filer | ☒ | Smaller reporting company | ☒ |
| | | | |
| | | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes☐ No☒
As of December 31, 2018,2019, the aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates of the registrant was $15,818,991$36,362,504 based on the closing sales price as reported on The Nasdaq Capital Market.
As of August 29, 2019,28, 2020, there were 28,983,06928,965,660 shares of the registrant’s common stock, no par value per share, outstanding.
DOCUMENT INCORPORATED BY REFERENCE
Certain portions of the Proxy Statement for the registrant’s 20192020 Annual Meeting of Shareholders to be held on November 21, 201919, 2020 are incorporated by reference into Part III of this Annual Report on Form 10-K.
CHARLES & COLVARD, LTD.
FORM 10-K
For the Fiscal Year Ended June 30, 20192020
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| PART I | | |
Item 1. | | 2 |
Item 1A. | | 2117 |
Item 1B. | | 29
27 |
Item 2. | | 29
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Item 3. | | 29
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Item 4. | | 29
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| PART II | | |
Item 5. | | 30
28 |
Item 6. | | 3028 |
Item 7. | | 31
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Item 7A. | | 52
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Item 8. | | 5348 |
Item 9. | | 8381 |
Item 9A. | | 8381 |
Item 9B. | | 8482 |
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| PART III | | |
Item 10. | | 8482 |
Item 11. | | 8482 |
Item 12. | | 8482 |
Item 13. | | 8482 |
Item 14. | | 8482 |
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| PART IV | | |
Item 15. | | 8583 |
Item 16. | | 88
86 |
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Statements expressing expectations regarding our future and projections relating to products, sales, revenues, and earnings are typical of such statements and are made under the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, representations, and contentions and are not historical facts and typically are identified by use of terms such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “continue,” and similar words, although some forward-looking statements are expressed differently.
All forward-looking statements are subject to the risks and uncertainties inherent in predicting the future. You should be aware that although the forward-looking statements included herein represent management’s current judgment and expectations, our actual results may differ materially from those projected, stated, or implied in these forward-looking statements as a result of many factors including, but not limited to, (1) our dependence onbusiness, financial condition and results of operations could continue to be adversely affected by an ongoing COVID-19 pandemic and related global economic conditions; (2) our future financial performance depends upon increased consumer acceptance, growth of sales of our products, and operational execution of our strategic initiatives; the impact of(3) the execution of our business plans oncould significantly impact our liquidity; (4) our ability to fulfill orders onbusiness and our results of operations could be materially adversely affected as a timely basis; intense competition in the worldwide jewelry industry;result of general and economic conditions; (5) the financial difficulties or insolvency of one or more of our major customers andor their lack of willingness and ability to market our products; dependenceproducts could adversely affect results; (6) we face intense competition in the worldwide gemstone and jewelry industry; (7) we are subject to certain risks due to our international operations, distribution channels and vendors; (8) 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; (9) we are currently dependent on a limited number of distributor and retail partners in our Traditional segment; dependence on our exclusive supply agreement with Cree, Inc., or Cree,segment for the supplysale of our silicon carbide, or SiC, crystals for the foreseeable future; general economic and market conditions, including the current economic environment; risks of conducting business in foreign countries; inaccuracies inproducts; (10) we rely on assumptions, estimates, and data we use to calculate certain of our key operating metrics;metrics and real or perceived inaccuracies in such metrics may harm our abilityreputation and negatively affect our business; (11) our failure to maintain compliance with The Nasdaq Stock Market’s continued listing requirements;requirements could result in the delisting of our common stock; (12) we may experience quality control challenges from time to time that can result in lost revenue and harm to our brands and reputation; (13) seasonality of our business may adversely affect our net sales and operating income; (14) our operations could be disrupted by natural disasters; (15) our loan, pursuant to the potential impactPaycheck Protection Program, or the PPP Loan, under the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, as administered by the U.S. Small Business Administration, or the SBA, may not be forgiven or may subject us to challenges and investigations regarding qualification for the loan; (16) we may not be able to adequately protect our intellectual property, which could harm the value of seasonality onour products and brands and adversely affect our business; (17) negative or inaccurate information on social media could adversely impact our brand and reputation; (18) we depend on an exclusive supply agreement, or the impactSupply Agreement, with Cree, Inc., or Cree, for substantially all of natural disasters and other events beyond our control onsilicon carbide, or SiC, crystals, the raw materials we use to produce moissanite jewels; if our operations;supply of high-quality SiC crystals is interrupted, our business may be materially harmed; (19) sales of moissanite jewelry could be dependent upon the pricing of precious metals, which is beyond our control; (20) our current customers’ potential perception ofcustomers may potentially perceive us as a competitor in the finished jewelry business; (21) if the impact of significante-commerce opportunity changes in dramatically or if e-commerce opportunities, technology or models; the riskproviders change their models, our results of operations may be adversely affected; (22) a failure of our information technology infrastructure or a failure to protect confidential information of our customers and our network against security breaches;breaches could adversely impact our ability to protect our intellectual property; the potential adverse impact of negative or inaccurate information on social media; the failurebusiness and operations; (23) if we fail to evaluate, implement, and integrate strategic opportunities; possible adverse effects ofacquisition or disposition opportunities successfully, our business may suffer; (24) governmental regulation and oversight;oversight might adversely impact our operations; and the impact of(25) some anti-takeover provisions included inof our charter documents may delay or prevent a takeover of our company, in addition to the other risks and uncertainties described in more detail in “Risk Factors” in Part I, Item 1A, of this Annual Report on Form 10-K. Forward-looking statements speak only as of the date they are made. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur except as required by the federal securities laws, and you are urged to review and consider disclosures that we make in the reports that we file with the Securities and Exchange Commission, or SEC, that discuss other factors relevant to our business.
EXPLANATORY NOTE REGARDING THIS ANNUAL REPORT
As previously reported, we changed our fiscal year end to June 30 from December 31, effective July 1, 2018. This annual report is for the twelve-month period from July 1, 2018 to June 30, 2019. References in this report to “fiscal year” refer to the year ended June 30. References in this report to “transition period” refer to the six-month transition period from January 1, 2018 to June 30, 2018. References in this report to “calendar year” refer to the year ended December 31.
PART I
Overview
Our Mission
At Charles & Colvard, Ltd., we believe luxurythat fine jewelry can be bothaccessible, beautiful, and conscientious. With innovative technology and sustainable practices, our goal is to lead a revolution in the jewelry industry – delivering a brilliant product at extraordinary value balanced with environmental and social responsibility.
About Charles & Colvard
Charles & Colvard, Ltd., a North Carolina corporation founded in 1995 (which may be referred to as Charles & Colvard, we, us, or our), manufactures, markets and distributes Charles & Colvard Created Moissanite® (which we refer to as moissanite or moissanite jewels) and finished jewelry featuring our proprietary moissanite gemstone for sale in the worldwide jewelry market. Our unique differentiator, moissanite – The World’s Most Brilliant Gem® – is core to our ambition to create a movement around beautiful, environmentally and socially responsible fine jewelry and fashion jewelry. Charles & Colvard is the originator of lab-created moissanite, and we believe that we are leading the way in delivering the premium moissanite brand through technological advances in gemstone manufacturing, cutting, polishing, and setting. By coupling what we believe to be unprecedented lab-created gemstones with responsibly-sourcedresponsibly sourced precious metals, we are delivering a uniquely-positioneduniquely positioned product line for the conscientious consumer.consumer.
Our strategy is to build a globally revered and accessible brand of gemstones and finished jewelry that appeals to a wide consumer audience and leverages our advantage of being the original and leading worldwide source of moissanite. We believe a direct relationship with consumers is important to this strategy, which entails delivering tailored educational content, engaging in dialogue with our audience, and positioning our brand to meet the demands of today’s discerning consumer. In June 2019, we successfully 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 total gross proceeds of approximately $11.01 million, before deducting the underwriting discount and fees and expenses of approximately $1.02 million. The timing of this financing event iswas critical given the growing worldwide acceptance of lab-created gemstones with emerging generations of consumers. These proceeds, which we intend to use are using for marketing and for general corporate and working capital purposes,, will enable us to focus efforts on expanding the Charles & Colvard global brand awareness with our target consumer and further develop our global omni-channel sales strategy with a primary focus on top line growth. For more detailed information about our planned use of targeted funds for reinvestment into our business, see Marketing to the Online Channels Segment below.
We sell loose moissanite jewels and finished jewelry through two operating segments: our Online Channels segment, which encompasses our digital properties components, comprises our charlesandcolvard.com website, e-commerce outlets, including marketplaces, drop-ship customers, and other pure-play, exclusively e-commerce customers; and our Traditional segment, which consists of domestic and international distributors and retail customers.
We report segment information based on the “management” approach. This segment reporting approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of our operating and reportable segments. For more information about our operating segments, see Note 3 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
We believe our expanding application of an omni-channel sales strategy across the jewelry trade and to the end consumer with accessible gemstones and value branded finished jewelry featuring Charles & Colvard moissanite positions our goods at the many touchpoints where consumers are when they are making their buying decisions – thereby creating greater exposure for our brand and increasing consumer demand.
COVID-19 Update
As COVID-19 continues to spread throughout the world, the ongoing global pandemic continues to prompt governments and businesses to maintain and, in some cases, extend unprecedented measures in response. Such measures have included federal, state, county and local governments, and public health organizations and authorities around the world implementing a variety of measures intended to control the spread of the virus, including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing and hygiene requirements.
During February 2020, following the initial outbreak of the virus in China, the COVID-19 pandemic and related governmental and business responses began to have an adverse effect on our operations, supply chains, distribution channels, and consumer buying behaviors. Cumulatively, these things also impacted the net realizable value and marketability of our legacy inventory, which was subsequently written-off during our fiscal quarter ended March 31, 2020.
Governments in many parts of the world have begun to relax some of the previously imposed COVID-19 related measures and restrictions, and these areas have seen businesses and activities beginning to reopen, with the lives of those citizens beginning to return somewhat to pre-pandemic levels. However, many other parts of the world, including the U.S., are seeing signs that the virus is continuing to spread rapidly with unprecedented rates of infection and illness, and the cessation and relaxing of previously imposed business, travel, and social restrictions by these affected governments are, in some cases, being halted. Accordingly, in many parts of the U.S. we are seeing the reopening trends of our businesses, factories, schools, and retail outlets slowing and, in many instances, reversing altogether. We are also seeing significant and strict social distancing and public safety requirements, including facial coverings, imposed throughout the country. The COVID-19 pandemic and these ongoing measures and restrictions continue to adversely affect workforces, customers, economies, and global supply chains, and further result in significant travel and transport restrictions – all of which have combined to further lead to an ongoing worldwide economic downturn and a decrease in demand for our products. These actions and events continue to disrupt the normal operations of many businesses, including ours.
While we are gradually resuming operations, we are meeting consumer demand through our transactional website charlesandcolvard.com and across our omni-channel sales outlets including drop-ship partners such as Macys.com, Helzberg.com, Belk.com, and Overstock.com, through marketplaces such as Amazon.com, and supplying global wholesaler product needs. Consequently, we have begun seeing a rebound in demand for our products during our fourth fiscal quarter ended June 30, 2020. However, the COVID-19 pandemic has had a significant adverse impact on our business, results of operations, financial condition, and liquidity during the fiscal year ended June 30, 2020, or Fiscal 2020.
A detailed description of the actions we have taken, and are taking, in response to the COVID-19 pandemic is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Our Market Opportunity
According to an August 2020 study by Forbes Magazine, the COVID-19 pandemic has caused an historical shift in e-commerce during 2020. While traditional retail sales have declined, e-commerce has seen a 129% growth year-over-year in the U.S. and Canada as of April 2020, with a 146% growth in all online retail orders. Substantially all brick-and-mortar stores have migrated retail sales online in order to survive the ongoing COVID-19 pandemic. As a result, Forbes projects that U.S. e-commerce sales are estimated to hit approximately $710 billion for the calendar year ending December 31, 2020, or about 15% of total U.S. retail sales, up from approximately $602 billion, or 11%, of total retail sales, as compared to 2019.
By 20202025, the global onlineluxury fashion jewelry market is expected to drive $45approximately $480 billion in worldwide sales which is expectedaccording to represent 15%a February 2020 report from Statista, a leading global provider of the global jewelryretail market and global online fine jewelry is projected to represent a staggering $30 billion of the global jewelry market according to Forbes.com and McKinsey & Company.consumer driven data. We believe thisthe convergence of the online jewelry shopper and the emergence of lab-created gemstones as a solution to the underserved, ethically-minded valueethically minded consumer shapespresents a bright and sizeable future opportunity for Charles & Colvard and jewelry designed with our exceptional gemstone.
Our Strategic Transformation
As consumers, and particularly those in the Millennial and emerging Gen-Z generations, have shifted to significant levels of online shopping and buying patterns, we transformed our go-to-market strategy in a relatively short period. Our historical business was that of a gemstone manufacturer, and as such, we created gemstones, and leveraged our distributor network as the primary method for delivering our goods to market. That meant relying on our Traditional segment partners to generate interest and sales for our gemstone, while they were doing the same for other gemstones and jewelry across the industry. Consequently, we believe there was a substantial lack of market awareness for moissanite and the Charles & Colvard brands.
In February 2016, we made the strategic decision to explore a potential divestiture of our direct-to-consumer home party business previously operated through our Charles & Colvard Direct, LLC (dba Lulu Avenue®) subsidiary. After careful analysis of our core competencies, market strategies, and intent to advance toward profitability, we determined a divestiture of this distribution channel to be in our best interest and that of our shareholders. In March 2016, we and Charles & Colvard Direct, LLC, entered into an asset purchase agreement with Yanbal USA, Inc., or Yanbal, under which Yanbal purchased certain assets related to our direct-to-consumer home party business for $500,000 and assumed certain liabilities related to such assets.
In October 2016, we re-launched Charles & Colvard with the intent to position both Charles & Colvard and its innovative moissanite products as a premium gemstone and jewelry brand. During this pivotal time, we launched the charlesandcolvard.com website as our primary storefront, established our brand across key social media properties, and began a significant digital marketing campaign. The purpose of this strategy was to gain exposure, build brand awareness, and begin the journey of establishing a lifetime relationship with consumers that are seeking an alternative luxury brand that aligns with their buying preferences.
The calendar year ended December 31, 2017, was a year of growth and optimization of our branding initiatives. Over the course of 2017, we executed our strategic plan with new innovations in our Forever OneTM product line and finished jewelry offerings. We invested in key retail and online partnerships, as evidenced by our brick-and-mortar expansion into nearly all Helzberg Diamonds stores and our achievement of the authorized Seller-Fulfilled Prime status on Amazon.com. We believe that we improved the charlesandcolvard.com customer’s experience with our brand by offering free shipping and introducing a 60-day free returns policy.
During the transition period ended June 30, 2018, we delivered on several key initiatives that we believe helped create a strong underpinning for our business. Among these achievements, we entered into an amendment to our exclusive Supply Agreement with Cree for the supply of SiC materials that extends the agreement by five years with our unilateral option, subject to certain conditions, for renewal for an additional two-year period. The amendment also allows us under certain conditions to purchase alternative SiC material whose standards fall outside of Forever OneTM specifications. We also introduced Moissanite by Charles & Colvard®, a value line of gemstones that offers the cost-conscious consumer a competitively-priced option for moissanite jewels. We expanded key retail relationships that we believe will be instrumental in expanding the Charles & Colvard brand and positioning our products with other luxury brand options. We invested in new cooperative marketing relationships that we believe will be essential for proliferating the Charles & Colvard brand into new and innovative marketing channels. Finally, we signed new international e-commerce agreements that will make it easier for us to sell and ship our products globally. Finally, we significantly expanded our media exposure into nationally-recognized fashion-related print media.
During June and July 2018, we negotiated and entered into a $5.00 million asset-based revolving credit facility with White Oak Commercial Finance, LLC, or White Oak. The annual borrowing fees associated with this credit facility are lower than those in connection with our previous credit facility with a commercial bank, and moreover, we believe the borrowing terms and financial covenants underlying this credit facility are less restrictive than those under our previous credit arrangement. Accordingly, we believe our current credit facility will continue to enable us to be more nimble when executing our strategic plans.Colvard.
In June 2019, as described above, we successfully completed an underwritten public offering of 6,250,000 shares of our common stock at a price of $1.60 per share, which, together with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July, resulted in net proceeds of approximately $9.99 million, net of underwriting discount and fees and expenses. We intend to use these proceeds for marketing and for general corporate and working capital purposes. As evidenced by what we believe is a vote of confidence by our shareholders and the financial success of our underwritten public offering, we will continue to execute our digital marketing strategy to build and reinvest in our business.
During the fiscal year ended June 30, 2019, we achieved four consecutive quarters of net income. We believe this strong financial performance positions us with a strong foundation on which to apply and achieve the maximum benefit from the net proceeds of our recent public offering. We finished fiscal 2019 with more than half of our business derived from our Online Channels segment, which serves our direct-to-consumer customer, or DTC, presence. We believe this growth continues to establish our leadership position as a DTC brand. Also, during fiscal 2019, we forged new inroads into numerous international markets, where we believe that we have key growth opportunities. Accordingly, we launched several marketplaces including but not limited to Amazon sites in Australia, Germany, Italy, France, Spain and, Japan. Concurrently, we continued to support cross-border trade, or CBT, efforts to drive international customers to our U.S.-based website with enhanced international shopping features. Lastly, we leveraged our regional distribution network in certain international regions, such as China, that will require a significant local presence and use of resources. We feel confident in our agile international growth model and plan to continue these efforts into fiscal 2020.
Throughout fiscal 2019, we expanded our product selections to meet market demand, including expanding the footprint of our Moissanite by Charles & Colvard® product line and introducing our Signature Collection, a patent-pending line of exclusive jewelry featuring our unique floret logo. We saw strong sales performance of these new product lines, which we believe is an indication of the recognition and adoption of our brand by consumers. Finally, we continued to grow our presence with key retail partners, such as with Helzberg Diamonds stores with the addition of incremental product styles and an expanded case line presence in nearly all doors. In October 2018, we announced the establishment of a new relationship with Macy’s, with whom we continue to build a significant and growing online presence. We plan to continue evolving our retail strategy as we optimize our strategic partnership arrangements.
A more detailed description of our achievements during the fiscal year ended June 30, 2019, the transition period ended June 30, 2018, and the calendar year ended December 31, 2017, is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Our Strategic Outlook
Our focusThe full extent of the impact of the COVID-19 pandemic on our operational and financial performance is currently uncertain and will depend on many factors outside of our control, including, without limitation, the timing, extent, trajectory and duration of the pandemic, the development and availability of effective treatments and vaccines, the imposition of protective public safety measures, and the impact of the pandemic on the global economy and demand for consumer products. We expect the COVID-19 pandemic will continue to have an adverse impact on our business, results of operations, financial condition, and liquidity during the fiscal year ending June 30, 20202021, or Fiscal 2021.
Our strategic focus for Fiscal 2021 is centered on the expansion of Charles & Colvard’s brand on a global scale.scale and to increase the size of our business through top-line growth. As lab-created gemstones are being embraced by emerging generations, we believe our ability to establish moissanite and the Charles & Colvard brand directly with consumers is key to our future success and ability to fuel our growth. We will execute on our key strategies with a continued commitment to spending judiciously and generating sustainable earnings improvement.
Our key strategiesstrategic goals for fiscal 2020Fiscal 2021 are as follows:
Expansion of Brand AwarenessDigital Presence. We plan to utilize digitalcontinue focusing on conversion-based advertising channels and other marketing strategies such as influencer marketing programs involving brand advocates to drive messaging to larger marketscampaigns by way of large social media followings,capitalizing on our existing digital platform and Over-the-Top, or OTT, advertising platforms that include subscription video-on-demand, or SVOD, services like Netflix and Hulu. Through these channels, we believe that we will find new and compelling ways to engage the target consumer that is not yet familiar with our brand. We plan to expand our brand footprint on a global scale – engaging the consumer everywhere she shops.
International Sales Reach.transactional website, charlesandcolvard.com. We intend to balance our omni-channel sales strategy with regional-specific marketing programs, online channels growth initiatives, and through relationships with select retail and distribution partners. We believe that expanded product offerings will ensure a variety of goods to meet the demands of today’s discerning consumers. We also plan to deploy distribution channels, marketing programs, and geographically-aligned curations to attract consumers and drive regional sales. Additionally, cross-border trade promotions will remain a key strategy that we believe will drive global customers to Charles & Colvard’s corporate transactional site where we can offer the most comprehensive and brand-immersive experience.
Product Evolution. Being responsive to customer preferences has played a pivotal role in the rise of our Online Channels segment as the high-growth component of our business. We employ what we believe to be an agile product development philosophy that ensures a swift and fluid stream of new finished jewelry and gemstones that are responsive to customer demand. As we expand our reach to international locations – and as our Millennial and Gen-Z audiences mature – we will listen intently to market demand, measure carefully the costs and opportunities for our business, and strive to deliver the products that are responsive to our audiences’ choices.
Enhanced Customer Experience. We plan to evolve our technology platform and services to support a continually-enhanced customer experience. We will use analytics to make data-driven decisions that offer deeper personalization and more immersive shopping experiences. We plan to drive customer engagement, encourage repeat buyers,improve and grow our customer loyalty program, all of which we believe will support our ability to deliver an exemplary worldwide customer service experience.
Corporate Social Responsibility.online presence and properties. We believe that we have the ability to utilize new functionality to engage our captive social media audience on Facebook, Instagram, and YouTube, among others, by showcasing our products in real time through available existing online video streaming and live stream broadcasting platforms. In addition, we plan to develop and roll-out a new transactional website, moisssaniteoutlet.com. We believe this new platform will provide us a more targeted opportunity to sell some of our more accessible and market value-branded inventory. We also believe in the power of community. Accordingly, we plan to continue our work with locally based companies and organizations through our existing corporate outreach and social responsibility programs as well as our soon-to-be implemented corporate alliance program. We believe these programs will incrementally expand our digital footprint and product reach.
Enhanced Customer Engagement. We intend to befurther develop and evolve our existing technological platform and customized virtual services for our customers. We intend to expand our existing virtual shopping consultation service beyond our current offering in order to engage with more customers in a good corporate citizen, and in practice, to have a business model that helps us be socially accountable to our stakeholders. During fiscal 2019, we elevated our use of recycled precious metals in more than 95% of all the finished jewelry we sourced. Going forward, we are working toward utilizing only recycled precious metals in our production lines.personal way. We also plan to carefully measure the environmental impact of our business operations withdevelop a goal toward improving our overall environmental footprint. We also want to positively impact the communities where we work and live – which wenew digital consumer engagement program that will continue to support through philanthropic programs that advocate positive social change. We plan to create a higher level of transparency regarding these corporate social responsibility practices so that ourincentivize existing customers and stakeholders will be ableloyal brand advocates to track our efforts and hold us accountable to be an even better corporate citizen.
Our Guiding Principles
Onebecome digital ambassadors of the most critical factors in implementing our strategies and achieving success is our team of employees. We carefully develop, support and reward our team members, making sure they know our fundamental mission, which is to lead a revolution in the jewelry industry – delivering a brilliant product at an extraordinary value balanced with environmental and social responsibility. We have set forth Guiding Principles that set the tone for everything we do – from structuring our interactions with strategic partners, customers and shareholders to the way we operate our business, and the products we bring to market.
Following are the principles that guide our actions:
Catalyze. Build positive momentum with customers and influencers by being thoughtful and trustworthy in every interaction;
Innovate. Disrupt the jewelry industry through use of technology – in gemstone and jewelry design, business processes and engagement with our audience;
Aspire. Be socially conscious, economically informed and environmentally responsible. Strive to build a sustainable business and give back through community acts;
Obsess. Think like a consumer, act like a friend. Constantly seek ways to reduce friction between the brand and our audience;
Achieve. Focus attention on the interdependent successes of individual, brand and shareholder; and
Enrich. Promote personal growth and the ability to effect positive change in the business by cultivating a culture of critical thinking and creativity.
Our Audience
Our consumer audience is in transition. Prior to our product brand re-launch in 2016, our audience largely comprised Baby Boomers and Generation X – which we consider an older set of consumers. Today, our market research, which is based on charlesandcolvard.com customer analytics, indicates that more than half of our audience comprises Millennial and emerging Gen-Z consumers. Regardless of demographic, our research indicates that our audience is driven by three distinct motivating factors: (i) Beauty – the innate brilliance of our gemstone and jewelry selection; (ii) Value – the “bang for the buck” possible with moissanite, and the ability to buy luxury items while saving money for other things in life; and (iii) Conscientiousness – having a positive impact on the world by buying a brand that is ethically-oriented and socially responsible.
While these common motivating factors transcend demographics, we believe that we are seeing trends that lend themselves to highly targeted marketing programs. Most distinctly, conscious consumerism has become a reality in today’s competitive retail environment. Increasingly, consumers are seeking brands that do business for good and are making a conscious effort to control their impact on the environment. This is a common characteristic among Millennial and Gen-Z audiences, whom we believe are more socially and ethically minded than previous generations.
In addition to moving toward conscientious consumerism, it is becoming increasingly evident that today’s consumer desires a direct and more personal relationship with the brands from which he or she chooses to purchase. According to a recent market research study cited by the Interactive Advertising Bureau, a trade group that empowers the media and marketing industries to thrive in today’s digital economy, two-thirds of consumers expect direct brand connectivity. Further, according to a recent survey by Astound Commerce, a global digital commerce agency, 59% of respondents preferred to do research directly on brand sites, with 55% preferring to buy directly from brands. With more than half of our fiscal year 2019 revenue being generated from our Online Channels segment, we believe it’s clear that our customers are responding positively to our direct connection with consumers. This benefits the Charles & Colvard brand and to encourage their friends and families to make purchases.
| • | Product Development. We intend to elevate our Forever OneTM brand and our patented Signature Collection as well as expand our product selection. Our transactional website, charlesandcolvard.com, is the premier platform where we market and sell our finished jewelry products set with Forever OneTM gemstones. However, charlesandcolvard.com is also the ideal stage where we are able to tell our story and to educate consumers about our brand. This is where consumers will be able to find a more robust collection of educational content and visual media assets to learn about the premium quality of our Forever One™ gemstones and jewelry. Additionally, we plan to develop and bring new products to market that align with our core values and overall strategic vision. |
Disciplined Growth. We are aware of the challenges facing the U.S. and global economies as it empowers usa result of the COVID-19 pandemic. However, we intend to control our brand message and voice withdevelop a strategic acquisition growth strategy that over time is based on creating sustainable long-term value. In the consumer. For these pointed reasons,meantime, we plan to continue our focus on direct-to-consumer outreach and deep customer engagement. Our marketing programs will be driven by the above understanding of our audience and their motivating factors. Their mindset will drive the segmented messages we deliver, define the partners and kindred brands we select and co-promote with, and determine the channels and means by which we engage our audience.
In summary, we believe our beautiful, high value, ethically-sourced product aligns directly with the principles and purchasing requirements of our primary target – the Millennial and Gen-Z audiences.
Marketing to the Online Channels Segment
Driven by continuously updated knowledge of our audience, through e-commerce and web analytics as well as research through social media and customer service channels, we proactively engage our consumersan organic growth strategy through a multi-channel digital marketing strategy. Our goal is to continue growing our direct relationship with the consumer, which we believe will drive interest across all of our selling channels. Despite capital constraints in recent years, we have successfully built a growing consumer following and an effective marketing engine that combined have contributeddedication to our recent growth. Targeted application of proceeds from our recent public offering will be focused on digital marketing efforts, which we believe will ultimately drive topline growth dueexisting core product market, and providing exemplary customer service. We also plan to expanding brand awareness across the globe.
Our approach for marketing directly to the consumer includes the following types of communication channels and content types:
Communication Channels
Following are the myriad of connected channels we use to promote our brand and products:
Organic Social Media. To reinforce and support our position as the leading source of ethically-sourced, lab-created moissanite, our marketing team manages several social media initiatives that target current and future jewelry consumers to support the promotion and sale of Charles & Colvard Created Moissanite®. Our campaigns are focused on driving a consistent message emphasizing the socially responsible aspects of our jewels and finished jewelry, their everlasting beauty, and overall value. Our social media efforts include owned posts and engagements (our own profiles and activities). We concentrate on the following six main social media platforms based on the demographics and psychographics of their users: Facebook, Instagram, Pinterest, Twitter, YouTube and LinkedIn.
Paid Advertising (Including, But Not Limited To, Search Engine Marketing, Display Ads, Video Ads, and Social Media Advertising). Approximately 81% of consumers begin their buying journeys by using a web search to discover new products and services, according to a recent research study by Synchrony Financial, formerly known as GE Capital Retail Bank. In short, we believe the typical buyer’s journey is a digital one. Digital marketing encompasses the myriad of ways we can be a part of that journey from resources such as Search Engine Marketing (based on keyword buys and ads), digital display (banner ads and product re-targeting ads), video pre-roll (ads playing before and during third-party YouTube videos), native advertising (long-form content produced in conjunctionexplore strategic alliance partnership relationships with digital-media and entertainment outlets), and social media advertising (specifically on social media platforms such as Facebook, Instagram, and Pinterest). We are using and continually optimizing available digital marketing channels. And we will also continue to monitor new forms of paid media as they arise – assessing whether they will be effective in helping us connect with our target audiences.
Email. We know that people who subscribe to our emails are 35% more likely to purchase than visitors to our website who are not subscribed (based on analytics from Google and Marketo, an Adobe Company, a global marketing analytics firm). Therefore, we target some of our paid advertising on specifically driving email subscriptions, and we have used technology to incorporate website elements that encourage signing-up. In addition, when potential customers do subscribe, we have much better data with which to personalize communications with these customer prospects through direct email and our website content.
Public Relations. Earned brand mentions – cultivated by a comprehensive outreach program and powerful connections within beauty, fashion and cultural media outlets – is highly important to our brand-building efforts. By inclusion in articles, gift guides, and other pieces in known online magazines like InStyle, Town & Country, Refinery29, and others, we reach our target audiences in a way that allows us to “borrow” the authority of the media outlet. During the calendar year that ended December 31, 2018, we generated a meaningful number of mentions in consumer-related publications and blogs. Each of those mentions generated new online traffic to our website, sparked social media mentions, and grew our overall consumer audience.
Influencers. According to a recent study by the Digital Marketing Institute, a global digital marketing research firm, almost half of all consumers depend on influencer recommendations for product and brand purchases. Similarly, according to the Influencer Marketing 2020 report published by Influencer Intelligence, in association with Econsultancy, a leading U.S. influencer marketing authority, up to 61% of Millennial consumers say they have been swayed in their purchasing decisions by digital marketing influencers. This is a clear indicator of what marketers have already come to accept, which is that people trust other people’s opinion more than they trust a brand’s advertising. However, we believe there is a caveat – the influencers with whom a brand partners must truly be aligned together in mindset. We do not believe that we can simply find someone with millions of followers, pay them to post about our brand and product, and expect to see results. Instead, we believe we must find influencers who embody the same mindset as our brand and believe as we dobusinesses in the products that we bring to market. This kind of long-term influencer reach takes timeretail and commitment to develop and we plan to continue to build this type of influencer network throughout fiscal 2020.
Our Website. Along with the primary purpose of making sales, our website is a critical communication channel within the buyers’ journey. We use our site to educate new visitors on the origin, benefits, and beauty of moissanite. We create specific landing pages to support our different buyers’ journeys – whether through an engagement ring buyer’s guide or assistance with gift buying for men. It is the home for information on how we give back to our local community and other organizations.
Content Types
Following are the varied mediums that we use across the communication channels listed above:
Photography. We believe in the importance of amazing photography when marketing a visually-driven product such as jewelry. We are continually creating new photos to support our ecommerce channels and to keep our marketing on all channels targeted and fresh. We create lifestyle photography for use in advertising, organic social media posts and more. Those photos also allow shoppers on our site to see the product in context, which illustrates style and scale far better than product shots on white background. We plan to continually explore new styles of photography to better market our products and engage our audiences in conversation.
Videos. According to Cisco Systems, Inc., more than 80% of all content consumed on the Internet is expected to be video by 2020. In addition, according to Simply Measured, a Sprout Social company that empowers enterprises to do more with their social media strategy, video social media posts generate 12-times the shares as a post with text and images combined. Accordingly, we have dramatically increased our use of video on all channels mentioned above. Over the past year, we have created an educational Style Guide video series that gives tips on how to pair certain engagement and wedding bands, to mix different metals, or to detail the distinctions in our different gemstone cuts. We have also created a Q&A Video series, giving customers easily communicated answers to commonly asked questions. We have also released multiple video ad series during this past fiscal year for the Calendar Year-End Holidays, Valentine’s Day, and Mother’s Day to drive higher sales. Within a few months of release, these video series were viewed thousands of times. Accordingly, we believe the video medium will be a growing communication channel across all of our lines of business and we intend to continue focusing on video-related resources going forward.
Interactive and Immersive Experiences. Throughout fiscal 2019, we expanded our use of custom landing pages, featuring immersive experiences, focused on highly specific audiences (e.g., men exploring engagement rings), campaigns (e.g., Mother’s Day) and partnerships (e.g., our sponsorship of the North Carolina Courage, a professional women’s soccer team based in Raleigh, North Carolina, a member of the National Women’s Soccer League, or NWSL, and the reigning NWSL 2018 National Champions). These landing pages allow us to target specific messages to audiences looking for specific information, which drives them to spend more time on our website and increases the shopper’s chance to purchase and return to our website more often. As we increase our ability to personalize content through today’s technology, we intend to expand the use of landing pages featuring interactive and immersive content to drive consumer engagement.
User Generated Content. We believe that our greatest sales people are our satisfied customers – our fans. The more content our fans create – in the form of reviews or feedback on our website and social media posts on their own profiles – the more brand awareness we generate. When we engage with people who have posted, and then re-post their images and stories,jewelry industry where we believe that we receive the highest levelwould be able to capitalize on existing market synergies and likeminded product brands for market growth. To accomplish our long-term acquisition growth strategy, we intend to seek appropriate acquisition opportunities of social media engagement. Along with cultivating those posts through one-on-one engagement withcompanies to expand our satisfied customers on social media,operations, seek new or leading brand positions, and leverage our renewed Loyalty Programexisting sales, marketing, and distribution infrastructure. We plan to prudently pursue strategic acquisitions that was launchedare both complementary and accretive in July 2019 will encourage morepursuit of our plans for long-term value and more people to post their positive personal reviews and stories.
Distributing to the Online Channels Segment
Driven by continuously updated knowledge of our audience, through e-commerce and web analytics as well as research through social media and customer service channels, we proactively engage our consumers through a multi-channel digital marketing strategy. Our goal is to continue growing our direct relationship with the consumer, which we believe will drive interest across all of our selling channels.
Our approach for marketing directly to the consumer in our Online Channels segment includes the following types of communication channels: (i) organic social media; (ii) paid advertising (including, but not limited to, search engine marketing, display ads, video ads, and social media advertising); (iii) email; (iv) public relations; (v) influencers; and (vi) our own website. In addition, our marketing approach comprises the following types of content types: (i) photography; (ii) videos; (iii) interactive immersive experiences; and (iv) user-generated content.
Equally as important to us as marketing to our direct consumer audience is moving our customers through the process of engaging with our brand – and eventually converting them into a lifetime customer. Throughout the aboveour marketing tactics, we employ calls to action that drive the consumer to the many places where they can view our products and complete their purchase. We utilize a centralized distribution and fulfillment facility in Morrisville, North Carolina, to fulfill Online Channels segment orders.
Following are our primary online transactional channels:
charlesandcolvard.com. Throughout the transition period ended June 30, 2018 and fiscal year ended June 30, 2019, weWe believe that we significantly enhancedcontinue to enhance our transactional website to optimize for the mobile consumer and to reduce friction betweenimprove our brand and the shopper.customers’ experience. Programs such as free shipping, a 60-day returns policy, and an enhanced and optimized shopping experience werehave been rolled out.out over time. With data collected through web analytics, and through user surveys that reveal how consumers use the site, we are in a continual state of optimizing the buying experience – making it easier for shoppers to browse, sort and compare. We utilize these data to inform the selection of new, leading-edge technologies to further enhance our users’ experience, including technologies provided by such partners as Amazon Pay, Affirm, Inc., and PayPal Holdings, Inc., or PayPal, for financing purchases, Braintree, a service of PayPal, for ease of transfer, and Flow, which is a company that specializes in facilitating cross-border global trade and e-commerce services. Our goal is to remain continually focused on improving our customers’ experience.
Cross-Border Trade. With 84% of global e-commerce sales predicted to take place outside of Europe and North America by 2020, according to statistics from Statista.com (based on data from Shopify Inc., a global cloud-based, multi-channel commerce platform), we are combining regionalized marketing efforts in new geographies with promotional campaigning to drive international consumers to our charlesandcolvard.com web property. Through the application of market-leading cross-border trade, or CBT, technology, such as building our relationship with Flow, we believe CBT to be a significant opportunity in fiscal 2020Fiscal 2021 and beyond. For example, Flow Commerce, Inc., or Flow, is widely considered the next-generation for CBT e-commerce transactions and is known worldwide to be revolutionizing how merchants go global. Flow’s platform helps such global enterprises create a positive and localized shopping experience for their international customers while helping to ensure a complete and accurate record of CBT transactions for the enterprise.
| • | Marketplaces. A large majority of buyers start their online shopping experience with a web search. In fact, according to jumpshot®, a global content management and digital intelligence firm that tracked marketplace data, more than 50% of those web searches begin on Amazon. That number skews even higher within the Millennial demographic in that Amazon is the web search brand Millennials identify as most relevant based on a finding by the Pew Research Center, a renowned nonpartisan fact think tank. Therefore, we have made a point to be prominent on Amazon, achieving Seller-Fulfilled Prime status in 2017, which means we have the option of fulfilling orders with the same benefits of Amazon Prime. This enables us to be positioned more prominently in Amazon’s search platform and to take advantage of their negotiated shipping rates and service levels that, in turn, lower our overall shipping costs. This status is available by Amazon to only those sellers who have a history of fulfilling orders quickly and maintaining appropriate levels of stock. InDuring the fiscal year ended June 30, 2019, or Fiscal 2019, we expanded our relationship with Amazon to include many international locations, including websites in Europe, Australia, and Japan. We also have a market presence on eBay and a multitude of other specialty marketplaces, allowing us to meet our customers when and where they want to buy. Our goal is to continue to optimize our presence on these marketplaces and to expand into new regions and platforms where we have identified cost-effective opportunities. |
Pure-Play E-tailers. FTI Consulting, a global business advisory firm, estimates that 25% of total retail sales will become e-commerce centric by 2030. As consumers become more digitally savvy, new businesses have gained traction by tailoring their product, services and experiences to specific consumer preferences. We believe that these pure-play e-tailers offer unique opportunities for Charles & Colvard to feature our gemstones and connect with their loyal audiences. As our fiscal 2020 strategy evolves, we plan to focus on expanding these relationships and forge new partnerships that enable us to reach broader audiences.
Drop Ship Retail. In an effort to smartly expand their assortments, many retailers utilize direct fulfillment from their vendors to their consumers, or drop-ship, as it enables them to offer a more robust assortment online without having to physically take ownership of the goods in their warehouse. These retailers are consistently seeking socially responsible brands to serve the growing demand for conscientious product selection from their audiences. Since we began drop-shipping products in 2013, we have refined our information technology and operations capabilities to support these partnership arrangements in multiple ways, including fully integrated electronic data interchange, or EDI, solutions for inventory management, order processing, and invoicing. Operationally, we maintain in-stock rates and leverage our centralized distribution and fulfillment facility to meet partner service-level agreements, or SLAs, for shipments and returns. We plan to continue seeking new partnership arrangements as well as optimize existing arrangements throughout fiscal 2020Fiscal 2021 and beyond.
MarketingDistributing to the Traditional Channels Segment
The Traditional Channels segment is our legacy segment – represented by such outlets as manufacturers, distributors, and brick-and-mortar retailers. Going forward, these market channels remain important avenues for Charles & Colvard to drive product to market and be present in the many places the consumer takes his or her shopping journey.
| • | Trade Advertising. Throughout the transition period ended June 30, 2018 and the fiscal year ended June 30, 2019, we continued to target the trade with print advertisements featuring moissanite, with specific emphasis on our Forever OneTM moissanite jewels and finished jewelry featuring the Forever OneTM jewel in leading trade publications. We intend to continue to deliver meaningful promotion of Forever OneTM as we further expand this product line into the distribution network within our Traditional segment. In May 2018, we introduced a new grade of moissanite, Moissanite by Charles & Colvard®, which delivers to the trade a price-sensitive moissanite product that competes with other comparable value-based products making their way to market. Additionally, we utilize a Partner Portal on our website into which authorized distributor and retail partners can gain secured access to our logos, branding materials, and other marketing-related guidelines.
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Our approach for marketing to customers and strategic partners within our Traditional segment includes the following types of communication channels: (Industry Associations. iWe maintain relationships with major jewelry) trade advertising; (ii) industry organizationsassociations; (iii) trade shows; and jewelry trade publications as an opportunity to communicate with our peers on a consistent basis through media coverage, trade shows, and charitable events, among others.
(Trade Shows. ivOur attendance at leading jewelry trade shows as a sponsor, an exhibitor, or a participant has helped us extend our outreach to customers. During the transition period ended June 30, 2018 and the fiscal year ended June 30, 2019, we attended major domestic and international jewelry industry trade shows including JCK, North America’s largest annual jewelry trade event in Las Vegas, and the Hong Kong Gem and Jewellery Fair. We intend to continue investing in these important industry events in fiscal 2020.
Cooperative Advertising. We sometimes participate in the) cooperative advertising programs of our distributor and retail partners, subject to the customer adhering to our branding guidelines and other conditions. In these programs, we subsidize a portion of their marketing costs in order to create awareness of and exposure for our gemstones and jewelry.
Distributing to the Traditional Channels Segmentadvertising.
We utilize a centralized distribution and fulfillment facility in Morrisville, North Carolina, to fill bulk orders to manufacturer, distributor, and retail customers.
Retail. In order to create awareness and exposure for our gemstones, jewelry, and brands, we sell loose moissanite jewels and finished jewelry featuring moissanite at wholesale prices to nationally recognized and emerging retail customers through a broad range of channels including jewelry chains and department stores. Wholesale orders are received by way of purchase orders and fulfilled from our centralized fulfillment center. In many cases, we have placed loose moissanite jewels and finished jewelry inventory in stores on a consignment basis. Under this consignment model, in accordance with our revenue recognition accounting policy, we recognize the revenue for these transactions after the retail partner has sold an item to a consumer or other contractual conditions are met. In other cases, a retailer purchases the goods, or a portion of the goods, under what we call an asset purchase model. Under the asset model, we recognize the sale and related revenue upon transfer of the goods to the retailer. Due to the maturity of certain retail relationships, we have recently migrated select brick-and mortar partners to a blended asset and consignment model account structure, which affords us more favorable customer payment terms that result in more favorable cash flow. We will continue to evolve our retail channel strategy as we optimize our methods and partnership arrangements.
Domestic Manufacturers and Distributors. In order to service the vast number of independent jewelers, jewelry stores, and smaller jewelry chains, we sell our loose moissanite jewels and finished jewelry to domestic wholesale distributors and finished jewelry manufacturers at distributor prices, that in turn resell the loose jewels or finished jewelry at a markup to independent jewelers and jewelry stores – whether brick-and-mortar, online, or both. In limited circumstances, we have placed loose moissanite jewels and finished jewelry inventory with select domestic distributors on a consignment basis. We continue to evaluate our channel strategy for domestic distributors, which may result in a change to our historical domestic distributor methods and partners.
International Manufacturers and Distributors. In order to create global awareness and exposure for our gemstones, jewelry, and brands, we sell loose moissanite jewels and finished jewelry featuring moissanite to international wholesale distributors and finished jewelry manufacturers at distributor prices, that in turn sell the actual loose jewels or set the loose jewels in mountings and sell the finished jewelry to brick-and-mortar and online retailers. We currently have numerous international wholesale distributors based in Australia, Canada, Hong Kong, India, Japan, the Netherlands, Russia, Singapore, South Africa, and the United Arab Emirates. Some of these distributors typically sell into neighboring countries and the extended geographic regions where they may be located. Additionally, from time to time, we have placed loose moissanite jewels and finished jewelry inventory with select international distributors on a consignment basis. We continue to evaluate our channel strategy for international distributors, which may result in a change to our historical international distributor methods and strategic partners. A portion of our international sales consists of finished jewels sold internationally that may be re-imported to U.S. retailers.
For a discussion of our largest customers for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017,2019, see Note 13 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Seasonality
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 advanced planning and production our customers undertook. However, the effect of seasonality on our business is also impacted by the timing of orders we receive to support new or expanded distribution and the level of current inventory positions held by our customers. In recent years, we have experienced a higher degree of seasonality in the fourth calendar quarter than we have experienced in prior years primarily as a result of the holiday season sales to end consumers through our Online Channels segment. In future periods, as sales of our finished jewelry increase to retailers and directly to consumers, both in dollars and as a percentage of total sales, we anticipate a seasonality trend more typical with the retail jewelry industry, and these factors may significantly affect our results of operations in a given quarter.
In connection with the change in our fiscal year-end, the results of our fiscal quarters (three-month periods ended March 31, June 30, September 30 and December 31 of each year) are expected to reflect the same effects of the seasonal trends on jewelry industry-related revenues discussed above, except that fiscal year-end periods beginning after June 30, 2018, are expected to reflect increased distributor, manufacturer and retailer sales activities relating to the calendar year-end holiday season impacting our results more predominately during our first and second fiscal quarters. Due to this change in our fiscal year-end, the effect of seasonality, particularly with respect to the effects of the year-end holiday season, on our business was less pronounced during the transition period ended June 30, 2018.
Moissanite
Over 120 years ago, Nobel Prize-winning chemist, Henri Moissan, Ph.D., first discovered the extremely rare mineral SiC in a meteorite crater in Arizona. Over a century after the discovery of SiC, and after years of experimentation, researchers from the Research Triangle Park in North Carolina developed and patented a thermal growing process for creating pure SiC crystals in a controlled laboratory environment. This long-sought-after breakthrough made possible the world’s first lab-created moissanite gemstone – posthumously named after its discoverer. With hardness rivaling any mineral on earth, and optical properties exceeding all mined and created gemstones, we believe moissanite is a brilliant jewel that is free from environmental and ethical issues, and capable of disrupting traditional definitions of fine jewelry.
Naturally-occurringNaturally occurring moissanite is generally very small in size, dark green or black in color, and not a commercially viable source of gemstone material. Therefore, in order to create high quality moissanite material in desirable colors and across a range of carat sizes that will appeal to a consumer audience, we expect only lab-grown SiC crystals to provide a sustainable source of moissanite for gemstones. In addition to carat size, important characteristics of a gemstone are beauty, durability, and rarity. The beauty of a colorless or near-colorless gemstone is characterized by its color, brilliance, and fire. The brilliance of a gemstone is measured by its refractive index, or the extent to which, when coupled with the facet design, the gemstone reflects light. The fire of a gemstone, or the breaking of light rays into spectral colors, is measured by its dispersion. Durability is determined by a gemstone’s hardness, or resistance to scratching and toughness, or resistance to chipping or cleaving. Rarity is the availability or perceived availability of a gemstone. Moissanite jewels have a unique combination of brilliance, fire, durability, and rarity.
Moissanite’s beauty is objectively derived from its refractive index, which is higher than any other gemstone, including diamond. And its hardness is greater than all minerals, and all known gemstone materials with the exception of diamond. As a result, moissanite jewels, like diamond, can be cut with sharp, well-defined, and highly polished facets that accentuate their brilliance and fire. The cutting specifications (facet arrangement and proportions) for moissanite jewels are different than any other gemstone and designed to maximize the brilliance and fire of the raw material.
We evaluate the finished jewels to exacting standards with automated video-imaging equipment using internal and independent third-party certified gemologists. Due to the rare natural occurrence of moissanite and both the proprietary and technical limitations in producing mass quantities of gem-grade moissanite, we believe that moissanite is among the rarest of jewels.
The following table compares the physical properties of moissanite jewels with other fine gemstone materials:
| Description | | Refractive Index | | | Dispersion | | | Hardness (1) | | Toughness | | Refractive Index | | Dispersion | | Hardness (1) | | Toughness |
Charles & Colvard Created Moissanite® | | 2.65-2.69 | | | 0.104 | | | 9.25 – 9.5 | | Excellent | | | 2.65-2.69 | | | | 0.104 | | | | 9.25 – 9.5 | | Excellent |
| Diamond | | 2.42 | | | 0.044 | | | 10 | | Good to Excellent (2) | | | 2.42 | | | | 0.044 | | | | 10 | | Good to Excellent (2) |
| Ruby | | 1.77 | | | 0.018 | | | 9 | | Excellent (3) | | | 1.77 | | | | 0.018 | | | | 9 | | Excellent (3) |
| Sapphire | | 1.77 | | | 0.018 | | | 9 | | Excellent (3) | | | 1.77 | | | | 0.018 | | | | 9 | | Excellent (3) |
| Emerald | | 1.58 | | | 0.014 | | | 7.50 | | Poor to Good | | | 1.58 | | | | 0.014 | | | | 7.50 | | Poor to Good |
(1) For purposes of this table, “hardness” is based on the Mohs Scale, which is a relative scale only. Quantitative comparisons of different gemstone materials cannot be made directly using the Mohs Scale. Moissanite jewels, while harder than all other known gemstones, are approximately one-half as hard as diamond.
(2) In cleavage direction, toughness is “good”.
(3) Except twinned stones
Sources: Gemological Institute of America, Gem Reference Guide for GIA Colored Stones, Gem Identification and Colored Stone Grading Courses 32-35, 65-82, 87-90 (1995); Cornelius S. Hurlburt, Jr. & Robert C. Kammerling, Gemology 320-324 (2d Ed. 1991); Kirk-Othmer, Encyclopedia of Chemical Technology 524-541 (5th Ed. 2004); Institution Of Electrical Engineers, Properties of Silicon Carbide (Gary L. Harris, Ed., 1995); Robert Webster, Gems: Their Sources, Descriptions and Identification 889-940 (5th Ed. 1994); W. von Muench, “Silicon Carbide” in Landolt-BöLandolt-Börnstein Numerical Data and Functional Relationships in Science and Technology, New Series, Group III, Vol. 17C, pp. 403-416 and 585-592 (M. Schultz and H. Weiss, Eds., 1984); Kurt Nassau, Shane F. McClure, Shane Elen & James E. Shigley, “Synthetic Moissanite: A New Diamond Substitute”, Gems & Gemology, Winter 1997, 260-275; Kurt Nassau. “Moissanite: A New Synthetic Gemstone Material”, Journal of Gemmology, 425-438 (1999); Mindat.org, “Moissanite” (https://www.mindat.org/min-2743.html); and Wikipedia, “Moissanite” (https://en.wikipedia.org/wiki/Moissanite).
Products and Product Development
Moissanite Jewels
Historically, Charles & Colvard primarily sold legacy moissanite jewels including Forever ClassicTM and Forever Brilliant®. We continue to offer these legacy products in limited shapes and sizes, and only when available, through our Traditional segment as well as through our Online Channels segment through drop ship retail, and direct-to-consumer e-commerce marketplace outlets. In 2015, we announced availability of our premier product, the first colorless moissanite jewel, Forever OneTM, which grades from colorless (D-E-F) to near-colorless (G-H-I) using the Gemological Institute of America’s, or GIA’s, color grading scale. Our limited launch was met with great enthusiasm from channel partners and consumers. In response to this demand, we continue to expand our Forever OneTM product line with additional shapes and sizes. Today, we offer Forever OneTM in 27 cuts, and a multitude of sizes ranging from melee accent stones as small as .0020.002 carats to gemstones up to 6.13 carats, and our Exotics line of products that are as large as 15.55 carats diamond equivalent weight, or DEW.
In May 2018, we announced the availability of a new grade of gemstone, Moissanite by Charles & Colvard®. We believe that, with the exception of our own colorless moissanite jewel, Forever OneTM, our new gemstone is a cut above other moissanite on the market. Created from the same patented SiC material that offers unparalleled clarity, we believe that Moissanite by Charles & Colvard® is truly a revolutionary value. The distinction between Forever OneTM and Moissanite by Charles & Colvard® is made through our applied expertise throughout the design and manufacturing process summarized below and described in more detail in “Manufacturing and Quality Assurance”. We believe that due to the discerning approach we take to ensure the quality of Forever OneTM, it remains far above any other offering available today. By closely evaluating clarity, color, and cut, we are able to determine which gemstones meet our exemplary standards for Forever OneTM, and those that fit within one of our multiple grade Moissanite by Charles & Colvard® gemstones.
Our manufacturing process starts with SiC material primarily manufactured by Cree through its patented process. This proprietary growing process creates a SiC material that is nearly free of micropipes – a type of inclusion sometimes found in lab-grown SiC material. However, based on the terms of the amended Supply Agreement with our strategic partner, we are permitted to purchase certain amounts of SiC materials from third parties under limited conditions. Either way, the SiC material comes to us as a boule, or a formed mass, that has the atomic structure of a single crystal. After beginning our manufacturing process, each boule is carefully inspected by our certified gemologists to ensure it meets our minimum standards for Charles & Colvard Created Moissanite® gemstones, including those for clarity and color grades. The products that meet appropriate minimum quality standards move forward on the journey to become our Charles & Colvard Created Moissanite® gemstones. From this point, as the product continues to move through our manufacturing process, it is subjected to further processing steps, such as cutting, faceting, and finishing. At the end of our manufacturing process, it’s the clarity and color designation, coupled with further inspection by our certified gemologists regarding the quality levels of the cutting, faceting, and finishing processes, that will ultimately determine if the product becomes one of our premier Forever OneTM gemstones or one our multiple grade Moissanite by Charles & Colvard® gemstones.
Moissanite Finished Jewelry
We began selling finished jewelry featuring moissanite in 2010. Our core designs included stud earrings, solitaire and three-stone rings, pendants, and bracelets. We are now selling an expanded selection of fashion-oriented, designer-inspired moissanite jewelry that we offer as an expansion to the core line of jewelry. The primary ingredients of our moissanite finished jewelry are loose moissanite jewels that we have on hand as part of our finished goods inventory, precious metal settings, and labor to mount the jewels into the settings.
Source of Raw Material
Our moissanite jewels are made from gem-grade SiC crystals. Our primary supplier of SiC crystals is Cree with which we have certain exclusive supply rights for SiC crystals to be used for gemstone applications. In addition, based on the terms of the Supply Agreement, as amended, with Cree described below, we are permitted to purchase certain amounts of SiC materials from third parties under limited conditions. We source the metals used for our finished jewelry, including white, yellow, and rose gold, platinum, tantalum, and sterling silver, from a number of domestic and international manufacturers located in the U.S, China, India, Mexico, Hong Kong, Vietnam, or Portugal. In line with our goal of providing socially and ethically-sourced products, we require suppliers to adhere to our stringent supplier guidelines, as well as to certify that their gold isand tantalum are coming from conflict free sources and that all precious metals supplied to us are responsibly sourced.
Exclusive Supply Agreement with Cree
On December 12, 2014, we entered into an exclusive supply agreement with Cree, or the Supply Agreement, which superseded and replaced our prior 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. However, effectiveEffective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement was also amended to (i)(i) provide us with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following expiration of the initial term; (ii)(ii) establish 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; and (iii)(iii) 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 written 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.
We believe that our Supply Agreement with Cree, which holds the U.S. patent for micropipe-free silicon carbide material and the related method of manufacture, provides us a superior quality core material above all other moissanite and one that possesses an unrivaled level of gemstone clarity. We also believe that the terms and conditions contained within the amended Supply Agreement are overall more favorable when compared with those in the Supply Agreement prior to the amendment.amendments. Our total purchase commitment under the Supply Agreement, as amended, until June 20232025 is approximately $52.9$52.95 million, of which approximately $43.98$36.60 million remains to be purchased as of June 30, 2019.2020.
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.
Intellectual Property
We held a number of U.S. product and method patents for moissanite jewels that expired during 2015, under which we had broad, exclusive rights to manufacture, use, and sell moissanite jewels in the U.S. We held these same patents in 25 foreign jurisdictions, primarily across Asia and Europe, that expired in 2016, with one remaining in Mexico that expires in 2021. In addition, we have certain trademarks and pending trademark applications that support our moissanite branding strategy. Additionally, we have certain issued and pending design patents that if approved we believe will differentiate our products in the gemstone and jewelry industry. Since the expiration of our patents we have noted new providers of moissanite entering the market. We know how challenging it is to create high-quality moissanite and anticipate it will take emerging providers significant time and investment to bring meaningful and competitive products to market. As we experienced ourselves, achieving 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, in the foreseeable future, we do not anticipate significant direct moissanite competition in our superior quality gemstone ranges with consistent production volumes.
Our success and our ability to compete successfully depends in part upon our proprietary technology. In addition to our remaining international patent, we rely on trade secret laws and employee, consultant, and customer confidentiality agreements to protect certain aspects of our technology. We currently are not subject to any claims that our products or processes infringe on the proprietary rights of third parties. At the present time, we are also dependent on Cree’s technology for the production of SiC crystals.
Manufacturing and Quality Assurance
Moissanite Jewels
The production of Charles & Colvard Created Moissanite® jewels is an elaborate process developed over a number of years of collaborative research and development, acquired and learned knowledge from scientists, and considerable investment expense.
Following are the key manufacturing processes of our moissanite jewels:
Growing gem-grade raw SiC crystals;
Manufacturing rough preforms;
Faceting and polishing jewels;
Inspecting, sorting, and grading; and
Growing Gem-Grade Raw SiC Crystals. SiC crystal growth suitable for gem-grade usage at commercial quantities is proprietary both in design and in operational methodology. Cree has grown the majority of our SiC crystals in accordance with the terms of the Supply Agreement. We routinely evaluate the yield and quality of saleable moissanite jewels from SiC crystals. The yield of saleable jewels from each crystal is one of the most significant factors affecting the volume and cost of moissanite jewels available for sale. Yield is dependent on the quality of the crystals, and variations in crystal quality can adversely affect our gross margin percentage.
Manufacturing Rough Preforms. We have made considerable investment in the design, development, and customization of a proprietary manufacturing process that includes equipment, software, and procedures to maximize raw material yield. The result is production of intermediary shapes, called “preforms,” that vary depending upon the size and shape of the desired finished jewel. While we may not necessarily spend significant research and development funds during a specific operating period, we remain committed to invest research and development resources to improve raw material yield, including studying alternate preform shapes and cutting technologies, due to the dramatic effect such an improvement could have on our gross margin percentage.
Faceting and Polishing Jewels. Each preform is faceted and polished by our independent third-party gem-cutters to create what we believe to be our uniquely-faceteduniquely faceted Revolutionary Cut™ gemstones based on master designs with multiple quality control measures built into the process. Gem-cutter training is a regimented program involving several months of progressive hands-on bench training. As we continue to expand the assortment of Forever One™, we will continue the process of certifying additional cutters to ensure sufficient scalability of our production capabilities to meet anticipated demand for this premium finished jewel.
Inspecting, Sorting, and Grading. Similar to other gemstones, each faceted moissanite jewel greater than 3.5 millimeters in size is individually graded against established master standards using our specially trained personnel. Additionally, as part of our overall quality assurance program, a representative sample from each batch of jewels is submitted to an image analyzer to ensure critical angles and other attributes designed to maximize moissanite’s optical properties are consistently maintained. This phase of manufacturing is relatively labor-intensive and requires skills not readily available in the general work force. In the future, we may elect to outsource certain portions of this stage of the manufacturing process to independent third parties that we will require to adhere to our rigorous quality control and monitoring standards.
Engraving. For moissanite gemstones that are four millimeters and larger in size, with certain exceptions Charles & Colvard laser inscribes an identifying code on the girdle of each Forever One™ and Moissanite by Charles & Colvard® gemstone that includes the Charles & Colvard Floret logo. This identifier matches a grading standard and is an important element in protecting the integrity of Charles & Colvard Created Moissanite® and ensuring the customer an authentic Charles & Colvard gemstone.
Finished Jewelry
Our line of finished jewelry featuring moissanite is developed by a team of industry experts integrating our moissanite jewels into many forms of jewelry, generally made of precious metals, either designed or purchased by us utilizing a core group of suppliers, manufacturers, and finishers. In addition to our Limited Lifetime Warranty offered on our moissanite jewels, we provide a twelve-month Limited Warranty on all finished jewelry featuring our moissanite, and on jewelry designs that do not contain our moissanite gemstones, such as men’s wedding bands.
All procured finished jewelry components are sourced from our approved suppliers, and each finished jewelry item is jobbed and/or tracked by stock keeping unit, or SKU, utilizing our enterprise resource planning system. The components of moissanite finished jewelry comprised in each job are then manufactured into finished jewelry by assemblers either in the U.S. or internationally in China, India, Mexico, Hong Kong, Vietnam, or Portugal. We are continuously working with our existing manufacturing partners, as well as identifying new manufacturing partners, to expand our assortments and efficiencies.
All finished jewelry produced by Charles & Colvard undergoes a multi-point inspection process. A representative sampling of manufactured finished jewelry items undergoes stone and metals testing to ensure that the items for sale are of the quality that we strive to maintain. Also, in line with our goal of providing socially and ethically-sourcedethically sourced products, we require suppliers of our gold and tantalum to certify that the gold and tantalum is coming from conflict free sources and that all precious metals supplied to us are responsibly sourced. If required by government ordinance or requested by a customer, we facilitate the inspection of our finished jewelry by internationally recognized testing facilities to comply with legal requirements and to ensure consumer confidence.
Working Capital Practices
Our primary source of working capital is cash on hand and cash generated by operations. As global and U.S economic activity slowed in response to the COVID-19 pandemic, we experienced and anticipate ongoing constraints on our cash and working capital, including experiencing potential liquidity challenges. The impact of the pandemic has had – and is expected to continue having – an adverse effect on our operations and financial condition as revenues declined and, despite our cost-saving efforts, many business and operating expenses remained flat or continued to rise. Cash flow scrutiny will be crucial for our business in the months ahead as we anticipate seeing lower revenues resulting in less cash flow, along with delayed accounts receivable collections, as needs grow to step up payables to important suppliers. We expect to become more nimble in managing our inventory levels given the uncertainty in the supply chain, which may also place further demands on working capital. Because we have a quarterly minimum purchase commitment under the Supply Agreement, we may be required to purchase SiC materials in excess of our immediate needs from time to time, which may result in inventories that are higher than we might otherwise maintain.
We have an effective shelf registration statement on Form S-3 on file with the SEC that allows us to periodically offer and sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total of $25.00 million, 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. In June 2019, we completed an underwritten public offering of 6,250,000 shares of our common stock at a price of $1.60 per share, which, together with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July, resulted in aggregate net proceeds of approximately $9.99 million, net of the underwriting discount and fees and expenses.
Payment terms on trade receivables for our Traditional segment customers are generally between 30 and 90 days, though we may offer extended terms with specific customers and on significant orders from time to time. We extend credit to our customers based upon a number of factors, including an evaluation of the customer’s financial condition and credit history that is verified through trade association reference services, the customer’s payment history with us, the customer’s reputation in the trade, and/or an evaluation of the customer’s opportunity to introduce our moissanite jewels or finished jewelry featuring moissanite to new or expanded markets.
Our returns policy for consumers on our charlesandcolvard.com website provides for the return of purchases for any reason generally within 60 days of shipment. Our returns policy for all other 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 and finished jewelry 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.
Competition
As competitive moissanite and lab-created diamond expand and grow their market presence, there is no more important time than now to confirm Charles & Colvard’s leadership position as the premier worldwide moissanite provider and to further establish our presence in emerging markets. We believe our leadership position is a product of more than 2025 years of moissanite innovation, and is bolstered by the following strengths:
| • | With our Forever OneTM gemstones, we believe that we have achieved a level of perfection that is rarely seen in any gemstone – featuring colorless grades with an innovative cut that we believe reveals optical properties unrivaled by any other jewel. This pinnacle of production is the outcome of continual improvement and artisan craft. Additionally, we believe that with our Moissanite by Charles & Colvard® gemstones we have brought forward a price-conscious alternative to competitive moissanite that we believe exceeds the quality of competitive moissanite – specifically in terms of clarity, as well as in cut and polish. The distinction between Forever OneTM and Moissanite by Charles & Colvard® is made through our applied expertise throughout the design and manufacturing processes and the discerning approach we believe we take to ensure the quality of Forever OneTM remains far above any other offering available today. By closely evaluating clarity, color, and cut, we are able to determine which gemstones meet our exemplary standards for Forever OneTM and those that should bear the Moissanite by Charles & Colvard® name. |
With an exclusive SiC crystal Supply Agreement with Cree, which holds the U.S. patent for micropipe-free silicon carbide material and the related method of manufacture, we believe this core raw material empowers Charles & Colvard to rise above all other moissanite with an unrivaled level of gemstone clarity.
With our mature and innovative supply chain, while we have experienced instances of suppliers temporarily closing their operations, delaying order fulfillment or limiting their production as a result of the impact of the COVID-19 pandemic, we have utilized alternative supply arrangements with partners whose businesses are not under stay-at-home orders or whose production came back online. Accordingly, we believe that we arehave remained able to seamlessly manage the complex manufacturing process of both our moissanite gemstones and the varied jewelry options we deliver to a global audience.
With an established direct-to-consumer presence and supporting digital marketing capacity, we believe we are able to leverage established communication channels directly with our target audience.
With a global distribution network, and notwithstanding the impact of the COVID-19 pandemic, we continue to believe that we have optimized this network for timely delivery of everythingour products from unique consumer orders to bulk distribution orders.
With our significant inventory, we believe we are positioned to meet the just-in-time needs of our distribution partners. We believe having inventory quantities on the shelf is paramount to meeting the delivery requirements of our customers.
With our above strengths outlined, it is also important to note that our future competitive success is reliant, in part, on the following:
| • | Our continued success in developing and promoting the Charles & Colvard brands, such as Forever OneTM and Moissanite by Charles & Colvard®, which are used in finished jewelry featuring moissanite, resulting in increased interest and demand for moissanite jewelry at the consumer level; |
| • | Our ability to differentiate Charles & Colvard Created Moissanite® from competing products, including competitive moissanite and the rapidly-emergingrapidly emerging lab-created diamond industry; |
The ability to operationally execute our digital marketing strategy for our Online Channels segment;
Our continued ability and the ability of manufacturers, designers, and retail jewelers to select jewelry settings that encourage consumer acceptance of and demand for our moissanite jewels and finished jewelry;
The ability to understand our consumer market segment and effectively market to them a compelling value proposition that leads to converted customers;
Our ability to continue our relationship with Cree in order to sustain our supply of high-quality SiC crystals;
| • | The continued willingness and ability of our jewelry distributors and other jewelry suppliers, manufacturers, and designers to market and promote Charles & Colvard Created Moissanite® to the retail jewelry trade; |
| • | The continued willingness of distributors, retailers, and others in our distribution channels to purchase loose Charles & Colvard Created Moissanite®, and the continued willingness of manufacturers, designers, and retail jewelers to undertake setting of the loose jewels; |
Our continued ability and the ability of jewelry 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.
Competitive Gemstones and Jewelry
Gemstone materials can be grouped into three types:
Those found in nature, generally through mining techniques;
Synthetic gemstone, which has the same chemical composition and essentially the same physical and optical characteristics of natural gemstone but is created in a lab; and
Simulants, which are similar in appearance to natural gemstone but do not have the same chemical composition, physical properties, or optical characteristics.
Moissanite is a rare, naturally-occurringnaturally occurring mineral. Our lab-created gemstones, Charles & Colvard Created Moissanite®, are considered a synthetic version of the naturally occurring moissanite mineral. Our moissanite jewels compete with fine gemstones such as ruby, sapphire, emerald, and tanzanite as well as with mined diamonds. We also face competition from synthetic diamonds, synthetic diamond films, and other sources of moissanite gemstones. Some suppliers of diamonds and other fine gemstones, as well as the suppliers of synthetic and lab-created gemstones, may have substantially greater financial, technical, manufacturing, and marketing resources and greater access to distribution channels than we do.
Competing with Mined Diamonds
The worldwide market for large, uncut, high-quality mined diamonds is significantly consolidated and controlled by the De Beers Group of Companies, or De Beers, (headquartered in South Africa), Alrosa (Russia), Rio Tinto (Australia), and BHP (Canada). These companies have a major impact on the worldwide supply and pricing of mined diamonds at both the wholesale and retail levels. While moissanite trades at a fraction of the cost of mined diamonds, diamond producers may undertake additional marketing or other activities designed to protect the mined diamond jewelry market against sales erosion from consumer acceptance of competing goods such as moissanite jewels.
We believe these indicators from the mined diamond trade show a change in consumer confidence in the diamond trade. In addition, in 2018 De Beers entered into the lab-created diamond trade – stating their intent to address market interest.
Competing with Lab-Created (Synthetic) Diamond
Lab-created diamond material has been synthesized since the early 1940s and made its way into industrial processes by the 1950s. Common applications such as diamond-tipped drill bits and abrasive processes led the way, followed by uses in solid-state electronics. In more recent years, lab-created diamonds have become accepted as a form of gemstone with companies such as Diamond Foundry, Pure Grown Diamonds and Lab Diamonds Direct gaining notoriety in the market.
In June 2018, De Beers – one of the world’s largest mined diamond sight holders – announced its initiative to launch a line of fashion jewelry with lab-created diamonds. We believe this step is a validation of the market opportunity for providing a socially and environmentally conscientious, quality alternative gemstone at a reasonable price compared to mined gemstones.
Consumer demand is driving the charge behind this recent adoption of lab-created gemstones. Today’s discerning consumer is seeking ethically-sourcedethically sourced options, better price points, and authenticity in the brands they choose to engage. We believe the recent rise in interest for lab-created diamond is creating a halo effect for the moissanite gemstone market. While we are experiencing growing traffic and interest in Charles & Colvard from the ongoing attention around lab-created gemstones, we may face future price point and consumer related demand pressures from the lab-created diamond industry. With current moissanite pricing averaging approximately 5% of mined diamond gemstones and approximately 10% of lab-created diamond, we believe that for the foreseeable future we will continue to be able to address an underserved segment of the market.
Competing with Other Moissanite Producers
Although we believe that our moissanite jewels have a leadership market position, we are beginning to face competition from other companies that develop competing SiC material. These products are emerging primarily from Eastern countries and are making their way into the U.S. market. Our ongoing research of the competitive landscape has identified competing moissanite, primarily in the “E-F” and below color range, according to the GIA’s grading scale. However, we have not yet identified competing moissanite that exhibits a consistent level of color, cut, clarity and polish that is competitive with the quality of our Forever OneTM gemstone.
We also have not identified competitive sources that have exhibited the ability to supply a consistent and high volume of quality moissanite substantial enough to address the considerable consumption needs of distributors and retailers that serve the jewelry trade. Achieving 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.
However, we are seeing a grade of moissanite material reaching the market that exhibits a lower color rating and/or lesser cut, clarity and polish standard compared to our Forever OneTM gemstone. This inferior product is coming to market at competitive price points, and we have subsequently been experiencing downward pricing pressures from price-sensitive purchasing channels. In May 2018, we entered the market with a value line of moissanite to compete directly with these lower-grade moissanite products. This new value line, known as Moissanite by Charles & Colvard®, is a competitively-pricedcompetitively priced line of gemstones that is fashioned from the same core material as our other created moissanite products. Finished gemstones that do not meet our meticulous grading standards for Forever OneTM – but do meet our high specifications for gemstones worthy of carrying the Charles & Colvard name – will now be offered to the market at a value priced option. For the fiscal year ended June 30, 2019, 6%2020, approximately 13% of our revenue was generated from Moissanite by Charles & Colvard® gemstones and finished jewelry – we believe this percentage of revenue is validating the market for this value-priced product line.
Competing with Simulants
While moissanite is a synthetic gemstone (a lab-created version of the naturally-occurringnaturally occurring SiC mineral), we may also, to a lesser degree, face competition from simulant gemstones, including cubic zirconia and man-made crystals. Producers and sellers of these products may see the markets for these products being eroded by the market penetration of our moissanite jewels. We believe that the substantially lower price of these products is the primary basis upon which they will compete with our moissanite jewels; however, they are not considered fine gemstone or jewelry products.
Competing in the Finished Jewelry Space
The global fine jewelry market competition is fierce. Such well-known jewelry designers and manufacturers as James Allen, Brilliant Earth, and Blue Nile, among others, have a variety of jewelry collections featuring diamond and other precious and semi-precious gemstones, and enjoy strong brand recognition and a loyal consumer following. These companies also have greater financial resources than we do to develop and market their products.
We intend to expand our market share and compete with these well-known brands primarily on the basis of the combination of quality, design, and value, as moissanite is the highest quality, affordable alternative available to more expensive gemstones such as diamond. We believe that focusing on the clear advantages in moissanite’s retail price points, especially in the one-carat and larger sizes, will provide a key point of differentiation and value proposition to the end consumer who may not have had the opportunity to previously purchase fine jewelry due to limitations in discretionary spending income.
In addition, we believe that the Charles & Colvard Created Moissanite® suite, including moissanite jewels such as Forever OneTM and Moissanite by Charles & Colvard®, along with moissanite finished jewelry that we are developing pursuant to our marketing programs, may create a long-term competitive advantage for our products as we build brand recognition. We endeavor to partner with recognized designers and jewelry companies, in addition to developing our own proprietary brands of finished jewelry. While our finished jewelry business is still developing, our goal is to build multiple strong brands sought after by the end consumer. We propose to focus our marketing efforts on emphasizing our attractive designs, coupled with moissanite’s exceptional brilliance, fire, durability, and rarity, to establish moissanite as a primary consumer choice in fine jewelry.
Our design, manufacture and marketing of finished jewelry featuring moissanite for sale at wholesale pricing to distributors and retailers and at retail to end consumers through our charlesandcolvard.com and other Online Channels outlets may result in some of our current wholesale customers perceiving us as a competitor, despite our efforts to use primarily non-conflicting sales channels. As we continue to develop our finished jewelry business, we intend to increase distribution through new and existing channels similarly to how many other companies have executed cross-channel marketing and distribution strategies. Due to the size of the finished jewelry market, we believe that such sales channels can co-exist, with the overall end result being increased consumer and brand awareness of moissanite products and a corresponding increased demand for not only our products, but those of our distributor and manufacturer customers as well.
Government Regulation
We are subject to governmental regulations in the manufacture and sale of moissanite jewels and finished jewelry. In particular, in July 2018 the Federal Trade Commission, or FTC, issued updated guidelines governing the description of lab-grown diamonds and other gemstones that require such gemstones to be clearly identified as to the gemstone’s lab-grown origin in any promotional or marketing materials. In addition, the precious metal in our finished jewelry may be subject to requirements, which vary by country and by state, such as hallmarking and alloy content. While we have a policy to ensure compliance with applicable regulations, if our actions are found to be in violation of FTC or other governmental regulations, we may be required to suspend marketing of our products and could incur significant expenses in developing new marketing strategies and materials that would not violate governmental regulations.
Employees
As of August 29, 2019,28, 2020, we had a total of 6348 employees, all of whom were full-time and none of whom were part-time. None of our employees are represented by a labor union. We believe that our employee relations are good.
Directors and Executive Officers of Charles & Colvard, Ltd.
The members of our current Board of Directors are the following:
Neal I. Goldman
Chairman of the Board of Directors of Charles & Colvard, Ltd.; President of Goldman Capital Management, Inc., an investment advisory firm.
Anne M. Butler
Chief Executive Officer of Butler Advisors, a consulting firm specializing in strategic and operational advising to private equity, venture capital, and institutional investors on direct selling acquisitions and management.
Benedetta Casamento
Retail Consultant specializing in finance, business operations, and financial planning and analysis.
Jaqui Lividini
Chief Executive Officer and Founding Partner of Lividini & Co., a brand strategy company that specializes in brand development and marketplace positioning, engagement marketing, and retail strategy.
Suzanne MiglucciDon O’Connell
President and Chief Executive Officer of Charles & Colvard, Ltd.
Ollin B. Sykes
President of Sykes & Company, P.A., a regional accounting firm specializing in accounting, tax, and financial advisory services.
Our current executive officers are the following:
Suzanne MiglucciDon O’Connell
President and Chief Executive Officer
Clint J. Pete
Chief Financial Officer
Don O’Connell
Chief Operating Officer and Senior Vice President, Supply Chain
Available Information
Our corporate information is accessible through our website at https://www.charlesandcolvard.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available, free of charge, access on our website to all reports we file with, or furnish to, the SEC, including our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. A copy of this Annual Report on Form 10-K and our other reports are available without charge upon written request to Investor Relations, Charles & Colvard, Ltd., 170 Southport Drive, Morrisville, North Carolina 27560.
We operate in a dynamic and rapidly changing business environment that involves substantial risk and uncertainty, and these risks may change over time. The following discussion addresses some of the risks and uncertainties that could cause, or contribute to causing, actual results to differ materially from expectations. In evaluating our business, you should pay particular attention to the descriptions of risks and uncertainties described below. If any of these risks actually occur, our business, financial condition, or results of operations could be materially and adversely affected.
The COVID-19 pandemic and related global economic impacts have adversely affected our business and are expected to continue to adversely affect our business, financial condition and results of operations. The global outbreak of COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the U.S. Government in March 2020, and has negatively affected the U.S. and global economy. In response to this pandemic, federal, state, county and local governments and public health organizations and authorities around the world have implemented a variety of measures intended to control the spread of the virus including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing and hygiene requirements. These measures have adversely affected workforces, customers, economies and global supply chains, and resulted in significant travel and transport restrictions – all of which have combined to lead to an economic downturn. It has also disrupted the normal operations of many businesses, including ours.
As a result of the COVID-19 pandemic, state and local governmental mandates required a forced shutdown of our facility which may impact us for an extended period. In response, in April 2020 we furloughed approximately 50% of our employee base at that time, principally within our operations area. While most of our operations employees subsequently have been phased back into employment, these actions materially impacted our productivity. Effective June 1, 2020, we also enacted a significant reduction-in-force, or RIF, that reduced our active workforce by approximately 25% and included the elimination of senior-level sales, marketing, information technology, and operations personnel as well as executive-level sales and marketing positions. Since March 2020, a significant number of our executive and staff employees have been and continue to be working from home. The widespread outbreak of COVID-19 could also adversely affect our workforce in terms of serious health issues and absenteeism, which could further materially impact our productivity. The pandemic has also interfered with general commercial activity related to our supply chain, including our raw material and components sources. We have experienced widespread instances of suppliers temporarily closing their operations, delaying order fulfillment or limiting their production, impacting our ability to produce finished goods and deliver to our customers. In our Traditional segment, our brick-and-mortar customers began closing their stores to foot traffic in March, with tentative plans to re-open on a rolling schedule that may lead into the fall timeframe or later. We have also experienced widespread instances of distributors reducing or closing their operations, impacting our ability to maintain significant levels of sales through our wholesale sales customers. In addition, trade shows, industry events and product demonstrations have been preemptively cancelled for the critical production season leading up to the calendar year-end 2020 holiday season. As a result, our selling activities and our ability to convert those activities into sales have been, and we expect will continue to be, adversely impacted by the pandemic. In our Online Channels segment, our transactional website charlesandcolvard.com remains open, but is restricted to available stock and the limited production capacity of functioning suppliers. In addition, our ability to draw down from our existing credit facility with White Oak Commercial Finance, LLC, or White Oak, is currently restricted as a result of our diminished borrowing base, which is tied to our accounts receivable. While we are seeing business strengthen in both our Online Channels and Traditional segments, our business, financial condition, and results of operations are expected to continue to be adversely affected by the COVID-19 pandemic until business resumes to pre-pandemic levels.
The extent to which the COVID-19 pandemic impacts us will depend on numerous evolving factors and future developments that are uncertain and that we are not able to predict at this time. These factors include: the severity of the virus; the duration and scope of the pandemic; governmental, business, individual and other actions taken in response to the pandemic; the effect on our suppliers and distributors, and disruptions to the global supply chain; the impact on economic activity; the extent and duration of the impact on Traditional segment partner confidence and order placements; the effect on consumer demand and their buying patterns for our products; the effect of any closures or other changes in operations of our and our suppliers’ and distributors’ facilities; the health of and the effect on our employees and our ability to meet staffing needs in our manufacturing and distribution facility and other critical functions, particularly if employees become ill, are quarantined as a result of exposure or are reluctant to show up for work; our ability to sell our products worldwide and provide customer support, including as a result of travel restrictions, work from home requirements and arrangements and other restrictions or changes in behavior or preferences for interactions; restrictions or disruptions to transportation, including reduced availability of ground, sea or air transport; the ability of our distributors, retailers, third party customers and consumers to pay for our products; the effect of the fair value measurement of certain assets or liabilities; and the effect on our ability to access capital, including government stimulus funds, on favorable terms and continue to meet our liquidity needs. Even after the COVID-19 pandemic has subsided, we may continue to experience adverse impacts to our business as a result of any economic recession that has occurred or may continue for the foreseeable future. The COVID-19 pandemic could also exacerbate or trigger other risks discussed in this Annual Report on Form 10-K, any of which could have a material and adverse effect on our business, results of operations, and financial condition. We continue to monitor the pandemic, have actively implemented policies and procedures to address the current business and economic environment, and may adjust our current policies and procedures as more information and guidance become available to address the evolving situation.
Our future financial performance depends upon increased consumer acceptance, growth of sales of our products, and operational execution of our strategic initiatives. We believe that most consumers are not generally aware of the existence and attributes of moissanite jewels and that the consumer market for moissanite jewels and finished jewelry featuring moissanite remains in the early stages of development. The degree of future market acceptance and demand is subject to a significant amount of uncertainty. Our future financial performance will depend, in part, upon greater consumer acceptance of moissanite jewels as an ethically-sourced, affordable, luxurious alternative to other gemstones, such as diamond, and our ability to develop brands and execute strategic initiatives, in particular, our Online Channels segment, to grow our sales and operating income. As we execute our strategy to build and reinvest in our business, significant expenses and investment of cash will be required going forward and this may adversely affect our operating income. If we are unable to execute and achieve desired revenue levels, we may adjust our strategic initiatives in response to the results of our investments.
In addition, consumer acceptance may be affected by retail jewelers’ and jewelry manufacturers’ acceptance of moissanite jewels and finished jewelry featuring moissanite. The quality, design, and workmanship of the jewelry settings, whether manufactured by us or other manufacturers, could affect both consumers’ perception and acceptance of our products and costs incurred by returns and markdowns. Additionally, as other competitors enter the market, the lower quality of competitors’ gemstones could negatively impact consumer perception of moissanite, and in turn, acceptance of our jewels.
Thus, our future financial performance may be affected by:
| • | Our continued success in developing and promoting the Charles & Colvard brands, such as Forever OneTM and Moissanite by Charles & Colvard®, which are used in finished jewelry featuring moissanite, resulting in increased interest and demand for moissanite jewelry at the consumer level; |
| • | Our ability to differentiate Charles & Colvard Created Moissanite® from competing products, including competitive moissanite and the rapidly-emerging lab-created diamond industry; |
The ability to operationally execute our digital marketing strategy for our Online Channels segment;
Our continued ability and the ability of manufacturers, designers, and retail jewelers to select jewelry settings that encourage consumer acceptance of and demand for our moissanite jewels and finished jewelry;
The ability to understand our consumer market segment and effectively market to them a compelling value proposition that leads to converted customers;
Our ability to continue our relationship with Cree in order to sustain our supply of high-quality SiC crystals;
| • | The continued willingness and ability of our jewelry distributors and other jewelry suppliers, manufacturers, and designers to market and promote Charles & Colvard Created Moissanite® to the retail jewelry trade; |
| • | The continued willingness of distributors, retailers, and others in our distribution channels to purchase loose Charles & Colvard Created Moissanite®, and the continued willingness of manufacturers, designers, and retail jewelers to undertake setting of the loose jewels; |
Our continued ability and the ability of jewelry 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 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 $5.00 million asset-based revolving credit facility, or the White Oak Credit Facility, that we obtained from White Oak on July 13, 2018, failure to meet one or more of the following covenants could restrict our ability to draw on the White Oak Credit Facility: (i)(i) failure to provide White Oak with certain financial information; (ii)(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 $500,000 in excess availability (as defined under the White Oak Credit Facility). Our ability to draw down from the White Oak Credit Facility is currently restricted as a result of our diminished borrowing base, which is tied to our accounts receivable. In addition, we currently have an effective shelf registration statement on Form S-3 on file with the SEC that allows us to periodically offer and sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total of $25.00 million (approximately $13.99 million after giving effect to our June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option). However, we may offer and sell no more than one-third of our public float (which is the aggregate market value of our outstanding common stock held by non-affiliates) in any 12-month period. If we are not able to draw 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. The White Oak Credit Facility matures on July 13, 2021, and there is no guarantee of 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 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 jewels and manufacture finished jewelry settings 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 OneTM or Moissanite by Charles & Colvard®. In addition, we are currently dependent upon certain vendors for most 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.
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 mined diamonds, lab-created (synthetic) diamonds, other moissanite products,the COVID-19 pandemic has caused, and simulants. A substantial number of companies supply productsmay continue to the jewelry industry, many of whom we believe have greater financial resources than we do. Competitors could develop newcause, us or improved technologies, including those for lab-grown diamonds, that may render the price point for moissanite noncompetitive, which couldour distributors, vendors, and/or customers to temporarily suspend our or their respective operations and have an adverse effectimpact on our business, results of operations, and financial condition.ability to fulfill orders on a timely basis.
We 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). However, we have 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 and competitive products entering the market. However, as we experienced ourselves, achieving 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. In addition, today’s consumers demand transparency from and high visibility into the brands they choose to align with and purchase from. As our pending patent rights and other pending intellectual property rights are approved, we will continue to rely on these patents and our carefully-executed brand awareness and digital marketing campaigns to build our consumer relationships and maintain our competitive position going forward. If, however, we are unable to successfully build strong brands for our moissanite jewels and finished jewelry featuring moissanite or competition grows faster than expected, we may not have commercially meaningful protection for our products or a commercial advantage against our competitors or their competitive products or processes, which may have a material adverse effect on our business, results of operations, and financial condition.
The 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 amounts 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, 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 dependent on a limitedface 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 mined diamonds, lab-created (synthetic) diamonds, other moissanite products, and simulants. A substantial number of distributorcompanies 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 retail partnersfinancial condition.
We have previously relied on our patent rights and other intellectual property rights to maintain our competitive position. Our U.S. product and method patents for moissanite jewels expired in our Traditional segment for the sale2015 and most of our products.patents in foreign jurisdictions expired in 2016 with only one in Mexico remaining (which expires in 2021). However, we have 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. A significant portionNotwithstanding the foregoing, since the expiration of our patents we have noted new providers of moissanite and competitive products entering the market. However, as we experienced ourselves, achieving 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. As our pending patent rights and other pending intellectual property rights are approved, we will continue to rely on these patents and our carefully-executed brand awareness and digital marketing campaigns to build our consumer relationships and maintain our competitive position going forward. If, however, we are unable to successfully build strong brands for our moissanite jewels and finished jewelry featuring moissanite 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. During the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the calendar year ended December 31, 2017, our three largest customers collectively accounted for approximately 30%, 33% and 38%, respectively, of our 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 through our Traditional segment will continue to be to a limited number of distributors and retailers.
We depend on a single supplier for substantially all of our SiC crystals, the raw materials we use to produce moissanite jewels; if our supply of high-quality SiC crystals is interrupted, our business may be materially harmed.We are party to an exclusive supply agreement with Cree, which we depend on for the provision of substantially all of the SiC material we use to produce moissanite jewels. Under the terms and conditions of the Supply Agreement, we agreed to purchase from Cree, and Cree agreed to supply, all of our required SiC material, subject to terms and conditions that allow us to purchase certain amounts of SiC materials from third parties under limited conditions. The Supply Agreement is set to expire in 2023 and we have the option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following expiration of the initial term. If our supply of high-quality SiC crystals is interrupted, thenor competition grows faster than expected, we may not be able to meet demandhave commercially meaningful protection for moissanite jewels and our business may be materially and adversely affected. Cree has certain proprietary rights relating to its process for growing large single crystals of SiC and its process for growing colorless and near-colorless SiC crystals. There is no guaranty that we would be able to obtain similar quality SiC crystals from another provider. There can be no assurance that Cree will be able to continue to produce and supply us with SiC crystals of sufficient quality, sizes, and volumes that we desire or that we will be able to continue to negotiate future purchase commitments at acceptable prices that enable us to manage our inventories and raw material costs effectively
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 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.
Luxurya commercial advantage against our competitors or their competitive 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 thator processes, which may affect consumer spending or buying habits could materially and adversely affect demand for our products. In addition, volatility in the financial markets has had and may continue to have a negative impact on consumer spending patterns. A reduction in consumer spending or disposable income may affect us more significantly than companies in other industries and could have a material adverse effect on our business, results of operations, and financial condition.
We are subject to certain risks due 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 13%8% of total consolidated net sales during fiscal 2019.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 ability to expand and succeed internationally may also be limited by the demand for our products, the ability to successfully transact in foreign currencies, the ability of our brand to resonate with consumers globally and the 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 reliance on development of foreign markets and use of foreign vendors, we are subject to the risks of conducting business outside of the U.S.
These risks include the following:
the adverse effects on U.S.-based companies operating in foreign markets that might result from war; terrorism; changes in diplomatic, trade, or business relationships (including labor disputes); or other political, social, religious, or economic instability;
an outbreak of a contagious disease, such as COVID-19, which may cause us or our distributors, vendors, and/or customers to temporarily suspend our or their respective operations in the affected city or country;
the continuing adverse economic effects of any global financial crisis;
unexpected changes in, or impositions of, legislative or regulatory requirements;
delays resulting from difficulty in obtaining export licenses;
international regulatory requirements, tariffs and other trade barriers and restrictions, including the consequences of U.S. led tariff actions;
the burdens of complying with a variety of foreign laws and regulations, including foreign taxation and varying consumer and data protection laws, and other factors beyond our control, and the risks of non-compliance;
longer payment cycles and greater difficulty in collecting accounts receivable;
our reliance on third-party carriers for product shipments to our customers;
risk of theft of our 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 ongoing negotiations surrounding 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 higher costs to us, adversely affecting our operations, particularly as we expand our international presence.
Additionally, while substantially all of our foreign transactions are denominated in U.S. dollars, foreign currency fluctuations could impact demand for our products or the ability of our foreign suppliers to continue to perform. Further, some of our foreign distributors operate relatively small businesses and may not have the financial stability to assure their continuing presence in their markets. There can be no assurance that the foregoing factors will not adversely affect our operations in the future or require us to modify our 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 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 two separate occasions in the past five years,March 24, 2020, we have received a notification letter from Nasdaq Nasdaq’s Listing Qualifications Department indicating that we wereare not in compliance with listing requirementsNasdaq 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. However, In accordance with Nasdaq subsequently notified us in both instances thatListing Rule 5810(c)(3)(A), we had regainedhave 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 satisfy Nasdaq’s listingcontinue to meet all applicable Nasdaq Capital Market requirements in the future we expectand Nasdaq determines to take actions to regain compliance, but we can provide no assurance that any such action would preventdelist 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 andstock; adversely affect the market liquidity of our common stock;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.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 some of the faceting of our loose moissanite jewels are located in regions that are susceptible to tsunamis, flooding, and other natural disasters that may cause a disruption in our vendors’ operations for sustained periods and the loss or damage of our work-in-process inventories located at such vendors’ facilities. Damage or destruction that interrupts our ability to deliver our products could impair our relationships with our customers. Prolonged disruption of our services as a result of a natural disaster may result in product delivery delays, order cancellations, and loss of substantial revenue, which could materially and adversely affect our business, results of operations, and financial condition.
Our PPP Loan may not be forgiven or may subject us to challenges and investigations regarding qualification for the loan. We received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, or the Lender, a nationally licensed lender under the SBA on June 18, 2020 pursuant to the Promissory Note issued by us on June 15, 2020. Pursuant to Section 1106 of the CARES Act, we may apply for and be granted forgiveness for all or a portion of the PPP Loan. Such forgiveness will be determined, subject to limitations, based on the use of the loan proceeds for qualifying expenses, which include payroll costs, rent, and utility costs. We cannot provide any assurance that we will be eligible for loan forgiveness, that we will ultimately apply for forgiveness, or that any amount of the PPP Loan will ultimately be forgiven by the SBA.
Additionally, the PPP Loan application required us to certify that the current economic uncertainty made the PPP Loan request necessary to support our ongoing operations. While we made this certification in good faith after analyzing, among other things, our financial situation and access to alternative forms of capital, and believe that we satisfied all eligibility criteria for the PPP Loan and that our anticipated receipt of the PPP Loan is consistent with the broad objectives of the Paycheck Protection Program of the CARES Act, the certification described above does not contain any objective criteria and is subject to interpretation. In addition, the SBA has stated that it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith. The lack of clarity regarding loan eligibility under the program has resulted in significant media coverage and controversy with respect to public companies applying for and receiving loans. If, despite our good faith belief that we satisfied all eligibility requirements for the PPP Loan, we are found to have been ineligible to receive the PPP Loan or in violation of any of the laws or regulations that apply to us in connection with the PPP Loan, including the False Claims Act, we may be subject to penalties, including significant civil, criminal and administrative penalties and could be required to repay the PPP Loan. In the event that we seek forgiveness of all or a portion of the anticipated PPP Loan, we will also be required to make certain certifications which will be subject to audit and review by governmental entities and could subject us to significant penalties and liabilities if found to be inaccurate. In addition, our anticipated receipt of the PPP Loan may result in adverse publicity and damage to our reputation, and a review or audit by the SBA or other government entity or claims under the False Claims Act could consume significant financial and management resources. Any of these events could harm our business, results of operations and financial condition.
We may not be able to adequately protect our intellectual property, which could harm the value of our products and brands and adversely affect our business. We rely primarily on patent, copyright, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights, all of which provide only limited protection. We held U.S. product and method patents for moissanite jewels, which expired in 2015, under which we believed that we had broad, exclusive rights to manufacture, use, and sell moissanite jewels in the U.S. We had these same patents in 25 foreign jurisdictions primarily across Asia and Europe that expired in 2016 and one that will expire in Mexico in 2021. However, our patent expirations have enabled competitors and other businesses to duplicate and market a similar product and enter the marketplace. Without patent protection, we must rely primarily on our branding strategy and the Supply Agreement under which Cree supplies SiC crystals exclusively to us, as well as confidentiality procedures, to protect our proprietary rights, which may or may not be sufficient. In addition, at the present time, we are primarily dependent on Cree’s technology for the production of SiC crystals. There can be no assurance that any patents issued to or licensed by or to us will provide any significant commercial protection, that we will have sufficient resources to protect our respective patents and proprietary rights, that any additional patents will be issued in the future, or that any existing or future patents will be upheld by a court should we seek to enforce our rights against an infringer.
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 have 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. The success of our growth strategy may depend on our continued ability to use our existing brand names in order to increase consumer awareness and further develop strong brands around our moissanite jewels and finished jewelry collections. We cannot assure that any future trademark or other registrations will be issued for pending or future applications or that we will be able to obtain licenses or other contractual rights to use brand names that may infringe the proprietary rights of third parties. We also cannot assure that any registered or unregistered trademarks or other intellectual property or contractual rights will be enforceable or provide adequate protection of our proprietary rights. Our inability to secure proprietary protection with respect to our brands could have a material adverse effect on our business, results of operations, and financial condition.
We also cannot be certain that our products and brand names do not or will not infringe valid patents, trademarks, and other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business. Litigation to determine the validity of any third party’s claims could result in significant expense and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor. In the event of an adverse result of any such litigation, we could be required to expend significant resources to develop non-infringing technology or to obtain licenses for, and pay royalties on the use of, the technology subject to the litigation. We have no assurance that we would be successful in such development or that any such license would be available on commercially reasonable terms.
Negative or inaccurate information on social media could adversely affect our brand and reputation. We are actively using various forms of digital and social media outreach to accomplish greater awareness of our brand and the value proposition we offer. These social media platforms and other forms of Internet-based communications allow access not only by us, but by any individual, to a broad audience of consumers and other interested persons. Consumers value readily available information concerning goods that they have or plan to purchase; however, they may act on such information without further investigation or authentication. Many social media platforms, including those relating to recruiting and placement activities, immediately publish the content of their participants’ posts, often without filters or checks on accuracy of the content posted. While we actively monitor social media sites, we may be unable to quickly and effectively respond to or correct inaccurate and/or unfavorable information posted on social media platforms. Any such information may harm our reputation or brand, which could in turn materially and adversely affect our business, results of operations, and financial condition.
We depend on a single supplier for substantially all of our SiC crystals, the raw materials we use to produce moissanite jewels; if our supply of high-quality SiC crystals is interrupted, our business may be materially harmed.We are party to an exclusive supply agreement with Cree, which we depend on for the provision of substantially all of the SiC material we use to produce moissanite jewels. Under the terms and conditions of the Supply Agreement, we agreed to purchase from Cree, and Cree agreed to supply, all of our required SiC material, subject to terms and conditions that allow us to purchase certain amounts of SiC materials from third parties under limited conditions. The Supply Agreement is set to expire in 2025, but may be further extended upon mutual agreement of the parties to the Supply Agreement. If our supply of high-quality SiC crystals is interrupted, then we may not be able to meet demand for moissanite jewels and our business may be materially and adversely affected. Cree has certain proprietary rights relating to its process for growing large single crystals of SiC and its process for growing colorless and near-colorless SiC crystals. There is no guaranty that we would be able to obtain similar quality SiC crystals from another provider. There can be no assurance that Cree will be able to continue to produce and supply us with SiC crystals of sufficient quality, sizes, and volumes that we desire or that we will be able to continue to negotiate future purchase commitments at acceptable prices that enable us to manage our inventories and raw material costs effectively.
Sales of moissanite jewelry could be dependent upon the pricing of precious metals, which is beyond our control. Any increases in the market price of precious metals (primarily gold) could affect the pricing and sales of jewelry incorporating moissanite jewels. The majority of price increases in precious metals are passed on to the end consumer in the form of higher prices for finished jewelry. These higher prices could have a negative impact on the sell-through of moissanite jewelry at the retail level. From 2006 through 2019,2020, the price of gold has increased significantly, resulting in higher retail price points for gold jewelry. Accordingly, higher gold prices could have an adverse impact on both sales of moissanite finished jewelry and the jewelry industry as a whole.
Our current customers may potentially perceive us as a competitor in the finished jewelry business. As described above, we are currently dependent on a limited number of customers, including distributors and retailers, for the sale of our products in the Traditional segment. Our design, manufacture, and marketing of finished jewelry featuring moissanite for sale to distributors and retailers may result in some of these current customers perceiving us as a competitor, despite our efforts to use primarily non-conflicting sales channels. In response, these customers may choose to reduce their orders for our products. This reduction in orders could occur faster than our sales growth in this business, which could materially and adversely affect our business, results of operations, and financial condition.
If the e-commerce opportunity changes dramatically or if e-commerce technology or providers change their models, our results of operations may be adversely affected. As e-commerce emerges as one of our primary selling channels, our business model becomes more reliant on third-party platforms to achieve success. Should our products, product listings, or business not meet the requirements of certain third-party transactional channels such as marketplaces, comparison shopping engines, or social commerce sites, it may affect our ability to meet our revenue targets. Additionally, Amazon, eBay, Jet, Walmart.com, Gemvara, or other desirable e-commerce platforms may decide to make significant changes to their respective business models, policies, systems, or plans, and those changes could impair or inhibit our ability to sell our products through those channels. Further, a significant change in consumer online behavior or the introduction of new or disruptive technology could adversely affect overall e-commerce trends and diminish the value of investments we have made in select online channels. Any of these results could cause a significant reduction in our revenue and have a material adverse effect on our results of operations.
A failure of our information technology, or IT, infrastructure or a failure to protect confidential information of our customers and our network against security breaches could adversely impact our business and operations. We rely upon the capacity, reliability, and security of our IT infrastructure and our ability to expand and continually update this infrastructure in response to the changing needs of our business related to the deployment, integration, and management of new technology. For example, we regularly implement new IT systems and update payment gateways that support our Online Channels segment. As we implement and integrate new systems, as well as retire and de-integrate existing systems, the IT operating environment following such changes may not perform as expected. We also face the challenge of supporting our older systems and implementing necessary upgrades. If we experience a problem with the functioning of an important IT system or a security breach of our IT systems, the resulting disruptions could have an adverse effect on our business.
In addition, we and certain of our third-party vendors receive and store personal information associated with our sales operations and other aspects of our business. In connection with our e-commerce business, we rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including credit card numbers. Our disclosure controls and procedures address cybersecurity and include elements intended to ensure that there is an analysis of potential disclosure obligations arising from security breaches. We also maintain compliance programs to address the potential applicability of restrictions against trading while in possession of material, nonpublic information generally and in connection with a cybersecurity breach. The breakdown in existing controls and procedures around our cybersecurity environment may prevent us from detecting, reporting or responding to cyber incidents in a timely manner and could have a material adverse effect on our financial position and value of our Company’s stock. Despite our implementation of security measures, our IT systems and e-commerce business are vulnerable to damages from computer viruses, natural disasters, unauthorized access, cyber-attack, and other similar disruptions. An increasing number of websites and Internet companies have reported breaches of their security. Any such compromise of our security could damage our reputation, business, and brand and expose us to a risk of loss or litigation and possible liability, which could substantially harm our business and results of operations. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations, damage our computers or those of our customers, or otherwise damage our reputation and business. These issues are likely to become more difficult as we expand the number of countries in which our e-commerce website operates. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.
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, which became effective in May 2018, replaced previously existing regulations and thereby extended the scope of EU data protection law to all non-EU companies processing data of EU residents. The GDPR contains numerous requirements and changes from prior EU law, including more robust obligations on data processors, greater rights for data subjects, and heavier documentation requirements for data protection compliance programs. The GDPR also imposes strict rules on the transfer of personal data out of the EU, including to the U.S., and recent legal developments in Europe have created complexity and uncertainty regarding such transfers of personal data from the EU to the U.S. For example, in July 2020, the Court of Justice of the European Union, or 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.
We may not be able to adequately protect our intellectual property, which could harm the value of our products and brands and adversely affect our business. We rely primarily on patent, copyright, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights, all of which provide only limited protection. We held U.S. product and method patents for moissanite jewels, which expired in 2015, under which we believed that we had broad, exclusive rights to manufacture, use, and sell moissanite jewels in the U.S. We had these same patents in 25 foreign jurisdictions primarily across Asia and Europe that expired in 2016 and one that will expire in Mexico in 2021. However, our patent expirations have enabled competitors and other businesses to duplicate and market a similar product and enter the marketplace. Without patent protection, we must rely primarily on our branding strategy and the Supply Agreement under which Cree supplies SiC crystals exclusively to us, as well as confidentiality procedures, to protect our proprietary rights, which may or may not be sufficient. In addition, at the present time, we are primarily dependent on Cree’s technology for the production of SiC crystals. There can be no assurance that any patents issued to or licensed by or to us will provide any significant commercial protection, that we will have sufficient resources to protect our respective patents and proprietary rights, that any additional patents will be issued in the future, or that any existing or future patents will be upheld by a court should we seek to enforce our rights against an infringer. At this point, we cannot reasonably estimate the impact these patent expirations will have on our future results of operations.
The existence of valid patents does not prevent other companies from independently developing competing technologies. Existing producers of SiC crystals or others may refine existing processes for growing SiC crystals or develop new technologies for growing large single crystals of SiC or colorless SiC crystals in a manner that does not infringe any patents issued to or licensed by or to us. Accordingly, existing and potential competitors have 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. The success of our growth strategy may depend on our continued ability to use our existing brand names in order to increase consumer awareness and further develop strong brands around our moissanite jewels and finished jewelry collections. We cannot assure that any future trademark or other registrations will be issued for pending or future applications or that we will be able to obtain licenses or other contractual rights to use brand names that may infringe the proprietary rights of third parties. We also cannot assure that any registered or unregistered trademarks or other intellectual property or contractual rights will be enforceable or provide adequate protection of our proprietary rights. Our inability to secure proprietary protection with respect to our brands could have a material adverse effect on our business, results of operations, and financial condition.
We also cannot be certain that our products and brand names do not or will not infringe valid patents, trademarks, and other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business. Litigation to determine the validity of any third party’s claims could result in significant expense and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor. In the event of an adverse result of any such litigation, we could be required to expend significant resources to develop non-infringing technology or to obtain licenses for, and pay royalties on the use of, the technology subject to the litigation. We have no assurance that we would be successful in such development or that any such license would be available on commercially reasonable terms.
Negative or inaccurate information on social media could adversely affect our brand and reputation. We are actively using various forms of digital and social media outreach to accomplish greater awareness of our brand and the value proposition we offer. These social media platforms and other forms of Internet-based communications allow access not only by us, but by any individual, to a broad audience of consumers and other interested persons. Consumers value readily available information concerning goods that they have or plan to purchase; however, they may act on such information without further investigation or authentication. Many social media platforms, including those relating to recruiting and placement activities, immediately publish the content of their participants’ posts, often without filters or checks on accuracy of the content posted. While we actively monitor social media sites, we may be unable to quickly and effectively respond to or correct inaccurate and/or unfavorable information posted on social media platforms. Any such information may harm our reputation or brand, which could in turn materially and adversely affect our business, results of operations, and financial condition.
If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer. From time to time we evaluate strategic opportunities available to us for product, technology, or business acquisitions or dispositions. If we choose to make acquisitions or dispositions, we face certain risks, such as failure of an acquired business to meet our performance expectations, failure to recognize cost savings from a disposition, diversion of management attention, retention of management and existing customers of our current and any acquired business, and difficulty in integrating or separating a business’s operations, personnel, and financial and operating systems. We may not be able to successfully address these risks or any other problems that arise from future acquisitions or dispositions. Any failure to successfully evaluate strategic opportunities and address risks or other problems that arise related to any acquisition or disposition could adversely affect our business, results of operations, and financial condition.
Governmental regulation and oversight might adversely impact our operations. We are subject to governmental regulations in the manufacture and sale of moissanite jewels and finished jewelry. In particular, in July 2018 the FTC issued updated guidelines governing the description of lab-grown diamonds and other gemstones that require such gemstones to be clearly identified as to the gemstone’s lab-grown origin in any promotional or marketing materials. In addition, the precious metal in our finished jewelry may be subject to requirements, which vary by country and by state, such as hallmarking and alloy content. We may be under close scrutiny both by governmental agencies and by competitors in the gemstone industry, any of which may challenge our promotion and marketing of our moissanite jewels and finished jewelry products. While we have a policy to ensure compliance with applicable regulations, if our production or marketing of moissanite jewels and/or finished jewelry is challenged by governmental agencies or competitors, or if regulations are issued that restrict our ability to market our products, our business, results of operations, and financial condition could be materially adversely affected.
Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our company. A number of provisions of our articles of incorporation and bylaws impact matters of corporate governance and the rights of shareholders. Certain of these provisions have an anti-takeover effect and may delay or prevent takeover attempts not first approved by our Board of Directors (including takeovers that certain shareholders may deem to be in their best interests). These provisions also could delay or frustrate the removal of incumbent directors or the assumption of control by shareholders. We believe that these provisions are appropriate to protect our interests and the interests of all of our shareholders.
| Item 1B. | Unresolved Staff Comments |
Not applicable.
We currently lease approximately 36,350 square feet of office, storage, and light manufacturing space in the Research Triangle Park area of North Carolina from an unaffiliated third-party that is used by both of our current operating and reportable segments.
The majority of all U.S. personnel, including our executive offices, sales offices, administrative personnel, and production facilities are housed in the current space.
There are no material pending legal proceedings to which we are a party or to which any of our property is subject.
| Item 4. | Mine Safety Disclosures |
Not applicable.
PART II
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market for Registrant’s Common Equity
Our common stock is traded on the Nasdaq Capital Market under the symbol “CTHR.” As of August 29, 2019,28, 2020, there were 229223 shareholders of record of our common stock.
We did not pay any dividends on our common stock during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 2018, or the calendar year ended December 31, 2017.2020 and 2019. We will regularly review and consider the best policies and practices for our company, including the dividend policy. The payment of future dividends will be dependent on the facts and circumstances at the time of that review.
| Item 6. | Selected Financial Data |
Not applicable.
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussionManagement’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, is intended to provide a better understanding of our consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. This information should be read in conjunction with Item 1A, “Risk Factors” and our consolidated financial statements and the notes thereto included in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. Historical results and percentage relationships among any amounts in the consolidated financial statements are not necessarily indicative of trends in operating results for future periods.
Change in Fiscal YearBusiness Overview
In January 2018, our Board of Directors approved 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 of each year and ending on June 30 of the following calendar year. The change to the fiscal year reporting cycle began July 1, 2018. As a result of the change, we reported our financial results for the transition period ended June 30, 2018 on our Transition Report on Form 10-KT filed with the SEC on September 7, 2018, and we are reporting our results for the first full fiscal year ended June 30, 2019 in this Annual Report on Form 10-K.
In this Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, when financial results for the fiscal year ended June 30, 2019 are compared to financial results for the prior year period, the results compare the twelve-month period ended June 30, 2019 to the unaudited results for the twelve-month period ended June 30, 2018. When financial results for the transition period ended June 30, 2018 are compared to financial results for the prior year period, the results compare the six-month period ended June 30, 2018 to the unaudited results for the six-month period ended June 30, 2017. In the opinion of management, while we adopted new revenue recognition guidance, as required, on January 1, 2018, the unaudited results for the twelve months ended June 30, 2018 and the six months ended June 30, 2017 are comparative for purposes of this analysis since there was no change in the timing or measurement of revenues. Additionally, management believes these unaudited results for the periods presented reflect all adjustments necessary to present the financial position and results of operations as of and for both periods in accordance with the accounting principles generally accepted in the United States of America, or U.S. GAAP. A detailed discussion of our financial results for the calendar year ended December 31, 2017 is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, in our Transition Report on Form 10-KT filed with the SEC on September 7, 2018.
The following table shows the months included within the various comparison periods in our MD&A:
Fiscal Year-End 2019 Results Compared With Prior Year Period 2018 Results |
2019
(twelve-month, audited)
| | 2018
(twelve-month, unaudited)
|
July 2018 – June 2019 | | July 2017 – June 2018 |
Transition Period Ended June 30, 2018 Results Compared With
Prior Year Period 2017 Results
|
Transition Period Ended June 30, 2018
(six-month, audited)
| | Prior Year Period 2017
(six-month, unaudited)
|
January 2018 – June 2018 | | January 2017 – June 2017 |
OverviewOur Mission
At Charles & Colvard, we believe luxurythat fine jewelry can be bothaccessible, beautiful, and conscientious. With innovative technology and sustainable practices, our goal is to lead a revolution in the jewelry industry – delivering a brilliant product at extraordinary value balanced with environmental and social responsibility.
About Charles & Colvard
Charles & Colvard, Ltd., a North Carolina corporation founded in 1995 (which may be referred to as Charles & Colvard, we, us, or our), manufactures, markets and distributes Charles & Colvard Created Moissanite® (which we refer to as moissanite or moissanite jewels) and finished jewelry featuring our proprietary moissanite gemstone for sale in the worldwide jewelry market. Our unique differentiator, moissanite – The World’s Most Brilliant Gem® – is core to our ambition to create a movement around beautiful, environmentally and socially responsible fine jewelry and fashion jewelry. Charles & Colvard is the originator of lab-created moissanite, and we believe that we are leading the way in delivering the premium moissanite brand through technological advances in gemstone manufacturing, cutting, polishing, and setting. By coupling what we believe to be unprecedented lab-created gemstones with responsibly-sourcedresponsibly sourced precious metals, we are delivering a uniquely-positioneduniquely positioned product line for the conscientious consumer.
We sell loose moissanite jewels and finished jewelry through two operating segments: our Online Channels segment, which encompasses our digital properties components, comprises our charlesandcolvard.com website, e-commerce outlets, including marketplaces, drop-ship customers, and other pure-play, exclusively e-commerce customers; and our Traditional segment, which consists of domestic and international distributors and retail customers. For moreWe report segment information aboutbased on the “management” approach. This segment reporting approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of our operating segments,and reportable segments.
We operate in an environment characterized by both complexity in global markets and continuing economic pressures in the U.S. and internationally. Our strategy is to build a globally revered and accessible brand of gemstones and finished jewelry that appeals to a wide consumer audience and leverages our advantage of being the original and leading worldwide source of moissanite. We believe a direct relationship with consumers is important to this strategy, which entails delivering tailored educational content, engaging in dialogue with our audience, and positioning our brand to meet the demands of today’s discerning consumer. A significant component of our strategy in this environment is to focus on our core products, improving the quality and predictability of the delivery of our products and services, and placing those products quickly into the hands of our U.S. and international customers at affordable prices. Moreover, recognizing today that our customers and vendors are resource constrained, we are endeavoring to develop and extend our portfolio of products in a disciplined manner with a focus on domestic markets close to our core capabilities, as well as growing our global marketplace sales. We continue to focus on affordability initiatives. We also expect to continue to innovate and invest in technologies to fulfill product requirements for our customers and invest in our people so that we have the technical and production skills necessary to succeed without limiting our ability to build financial return to our investors.
Highlights of the Fiscal Year Ended June 30, 2020
COVID-19 Update
In March 2020, the novel strain of coronavirus, known as COVID-19, was declared a pandemic by the World Health Organization and declared a national emergency by the U.S. Government, and has negatively affected the U.S. and global economies. In response to this pandemic, federal, state, county, and local governments and public health organizations and authorities around the world have implemented a variety of measures intended to control the spread of the virus, including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing, and hygiene requirements. These measures have adversely affected workforces, customers, economies, and global supply chains, and resulted in significant travel and transport restrictions – all of which have combined to lead to an economic downturn. It has also disrupted the normal operations of many businesses, including ours. In early 2020 in the Asia Pacific region and during our quarter ended March 31, 2020 globally, the pandemic and related governmental and business responses began to have an adverse effect on our operations, supply chains, distribution channels, and consumer buying behaviors. Cumulatively, these circumstances also impacted the net realizable value and marketability of our legacy inventory, which was subsequently written-off.
The overall impacts of the COVID-19 pandemic include the following:
Across our supply chain, we experienced instances of suppliers temporarily closing their operations, delaying order fulfillment, or limiting their production. Where applicable, we utilized alternative supply arrangements with strategic partners whose businesses were not under stay-at-home orders or whose production came back online. During the quarter ended June 30, 2020, many of our suppliers began returning to normal operating and production levels. However, we and our suppliers remain subject to ongoing changes to governmental closure requirements that may have a long-term impact on our supply chain and ability to produce gemstones and finished jewelry for sale.
In our Online Channels segment, our transactional website charlesandcolvard.com remained open under restricted fulfillment capabilities. However, a quickly rising unemployment rate combined with consumer uncertainty and lack of confidence began reducing website traffic and conversions in March 2020. Beginning in March 2020, we maintained limited shipping functions with support from third-party production and fulfillment partners. We were also able to support only a certain level of active products on marketplaces and drop-ship partner websites such as Macys.com, Helzberg.com, Overstock.com, ShopHQ.com, and more. This ongoing e-commerce presence was restricted to available stock and the limited production capacity of functioning suppliers. During the quarter ended June 30, 2020, we began seeing orders in our transactional website, along with orders in our marketplaces and drop-ship partner websites, increase as consumer confidence strengthened and our operating and shipping functions began to return to normal activity levels. However, until business resumes to pre-pandemic levels across our entire supply chain, our Online Channels segment is expected to continue to be adversely impacted by the pandemic.
In our Traditional segment, brick and mortar customers began closing their stores to foot traffic in March 2020, with tentative plans to re-open on a rolling schedule that may lead into the fall timeframe or later. We also experienced instances of distributors, whose businesses rely on sales into retail organizations, reducing or closing their operations. These adverse effects impacted our ability to maintain significant levels of sales through our wholesale customers. In addition, trade shows and industry events have been preemptively cancelled for the critical production season leading up to the calendar year-end 2020 holiday season. As a result, our selling activities in our Traditional segment were significantly modified, and our ability to convert those activities into sales have been adversely impacted by the pandemic. Consistent with the trends we are experiencing in our Online Channels segment, we have begun seeing business strengthen with our brick and mortar customers as these customers begin to move forward with their re-opening plans following their closures in March 2020, but until business resumes to pre-pandemic levels, our Traditional segment is expected to continue to be adversely impacted by the pandemic.
As global and U.S economic activity slowed in response to the COVID-19 pandemic, we experienced and anticipate ongoing constraints on our cash and working capital, including experiencing potential liquidity challenges. The impact of the pandemic has had – and is expected to continue having – an adverse effect on our operations and financial condition as revenues declined and, despite our cost-saving efforts, many business and operating expenses remained flat or continued to rise. Cash flow scrutiny will be crucial for our business in the months ahead as we anticipate seeing lower revenues resulting in less cash flow, along with delayed accounts receivable collections, as needs grow to step up payables to important suppliers. We continue to focus on being more nimble in managing our inventory levels given the uncertainty in the supply chain, which may also place further demands on working capital.
The COVID-19 pandemic has had a significant adverse impact on our business, results of operations, financial condition, and liquidity during Fiscal 2020. The full extent of the impact of the COVID-19 pandemic on our operational and financial performance is currently uncertain and will depend on many factors outside of our control, including, without limitation, the timing, extent, trajectory and duration of the pandemic, the development and availability of effective treatments and vaccines, the imposition of protective public safety measures, and the impact of the pandemic on the global economy and demand for consumer and wholesaler products.
We believe that our management has taken – and continues to take – swift and appropriate action designed to hedge against the overall impact that the pandemic may have on our business, to prepare for a potential recessionary environment, and to efficiently manage the business while maintaining adequate liquidity and maximum operating flexibility. We remain focused on three critical areas of wellbeing, including safeguarding the health and safety of our employees, implementing senior managerial changes and streamlining operations while ensuring support of our brand and customers, and maintaining our financial strength and stability. Notwithstanding these challenges, we believe that we further solidified the global Charles & Colvard brand during Fiscal 2020.
Since the onset of the pandemic domestically, we have implemented the following measures:
We deployed a work-from-home option for our employees on March 13, 2020, and effective March 27, 2020, instituted a mandatory work-from-home policy for all, but essential, employees due to mandated stay-at-home orders by the State of North Carolina and local governmental authorities;
We temporarily suspended all hiring of employees starting April 13, 2020 and we furloughed approximately 50% of our employee base at that time, principally within our operations area. While most of our operations employees returned to full-time status as we moved forward with our phased reopening plans during May 2020, these actions materially impacted our productivity;
We extended new benefits to assist employees who participate in our 401(k) plan with additional distribution and new borrowing terms;
We implemented temporary salary and wage reductions for all employees, including a 25% reduction in salary for the President and Chief Executive Officer and a 15% reduction for each of the Chief Financial Officer and Chief Operating Officer. All employee salaries and wages were returned to pre-reduction levels in July 2020;
We reorganized our management and reduced our workforce. Effective June 1, 2020, Suzanne Miglucci, our former President and Chief Executive Officer, resigned and Don O’Connell was appointed as our new President and Chief Executive Officer. At the same time, we enacted a significant reduction-in-force, or RIF, that reduced our active workforce by approximately 25%. Included in the RIF were the elimination of senior-level sales, marketing, information technology, and operations personnel as well as executive-level sales and marketing positions. These RIF actions resulted in our recognition of severance-related expenses during the fourth quarter of Fiscal 2020 in the amount of approximately $427,000. The liability for the unpaid portion of our severance-related accrual in the amount of approximately $338,000 is included in accrued expenses and other liabilities in the accompanying consolidated balance sheet as of June 30, 2020;
We instituted a temporary 50% reduction in fees paid to our Board of Directors, which were also returned to pre-reduction levels in July 2020;
We successfully applied for and received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The loan in the principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, a nationally licensed lender under the SBA, on June 18, 2020 pursuant to a Promissory Note issued by us on June 15, 2020. As provided under the CARES Act, we intend to use the proceeds from this loan to enhance cash flow, to help maintain operations and fund current payroll requirements, and to assist us with the reopening phase of our business as we navigate the COVID-19 pandemic recovery efforts. There can be no assurance that such PPP Loan will be forgiven; and
We reduced non-payroll operating expenses, including decreased digital marketing spend and significantly reduced product development investments and travel expenditures.
We are continuing to take the following steps to further address the impact of the COVID-19 pandemic:
We are actively renegotiating contracts with vendors and suppliers to amend commitments to size our supply with current demand and delivery terms with others to reduce our cost of goods and services;
We are negotiating extended payment terms with select partners;
We are continuing to align variable expenses to match current sales trends as we continue to move forward with our phased reopening; and
We are currently continuing to offer the flexibility of a work-from-home option for our employees who are able to perform full-time duties effectively from home as the State of North Carolina continues to reopen through its predetermined phased reopening plan.
During the fiscal year ended June 30, 2020, we delivered on several key initiatives, which we believe leaves us well poised for future growth as we move forward into the fiscal year ending June 30, 2021. These accomplishments in fiscal year ended June 30, 2020, include the following:
Digital Marketing Refocus/Redirection. During June 2020, we ceased all top-of-funnel digital marketing campaigns and strictly refocused our digital marketing advertising strategy toward higher-converting, low marketing funnel activities. We believe that targeting consumers with whom we have already engaged and who have expressed interest in our products is a more effective use of our digital advertising spend. We believe this shift in our marketing strategy provides a more rapid financial return on our marketing investment, which is critical to our top line growth during the ongoing COVID-19 pandemic and going forward as we move into Fiscal 2021;
Enhanced Customer Experience. We developed and launched an improved technological e-commerce platform and offered user-friendly consumer services to support an enhanced customer experience. In June 2020 we launched our digital Charles & Colvard Virtual Bridal Ring Consultation program. This is a personal shopping concierge service where we are offering a customized virtual experience designed to simplify the ring buying process for our customers. This new customer support service offers deeper personalization and a more immersive shopping experience for our consumers. With our improved platform we believe that we are driving stronger customer engagement, encouraging repeat buyers, and growing our customer loyalty program, all of which we believe supports our ability to deliver an exemplary worldwide customer service personal shopping experience. We believe that offering this enhanced customer experience is an integral component of our overall marketing strategy. We believe that this enhanced customer interaction featuring a virtual personal shopping experience is important for our brand, but we also believe that it is even more relevant and important to our customers currently during these unprecedented times when social distancing practices remain in place throughout the U.S. and much of the world;
| • | E-Commerce Capabilities. In spite of the adverse impact that the COVID-19 pandemic has had on our Online Channels segment, we launched an online presence with the iconic Canadian department store Hudson’s Bay in May 2020. We believe this relationship gives us the ability to market our assortment of fine jewelry featuring Moissanite by Charles & Colvard® gemstones to this retailer’s robust digital audience on TheBay.com; |
Presence with Key Brick-and-Mortar Partners. Notwithstanding the adverse effect that the COVID-19 related closures had on our Traditional segment during the period these retailers were closed, in the months prior to the business interruption, we continued to broaden our relationship with Helzberg Diamonds stores with the addition of incremental product styles and expanded case line presence in nearly all doors during the early part of Fiscal 2020. We will continue to evolve our retail channel strategy as these stores reopen and businesses resume to pre-pandemic levels and when we are once again able to optimize our partnership arrangements; and
Corporate Social Responsibility. In these unprecedented times more than ever, we continue to believe that we have the responsibility to be a good corporate citizen, and in practice, to have a business model that helps us be socially accountable to our stakeholders. During Fiscal 2020, we elevated our use of responsible precious metals in substantially all the finished jewelry we sourced. We also want to positively impact the communities where we work and live and for the benefit of the world in general – which we intend to continue supporting through philanthropic programs that advocate positive social change. This is evidenced by our participation in a Coronavirus related giving-back program that contributes 40% of net proceeds from one of our top selling finished jewelry items to the Duke University Research Foundation’s Duke Health COVID-19 Research Fund that will help support the development of vaccines and treatments for COVID-19.
The continued spread of COVID-19 has led to ongoing disruption and volatility in the global and U.S. economies, and, depending on future developments, could continue to adversely impact our operations and financial position. Our focus as we move into Fiscal 2021 is centered on the health of our brand on a global scale. As lab-created gemstones are being embraced by emerging generations, we will continue our quest to establish moissanite and our jewelry brand directly with consumers. We will execute on our key strategies with a continued commitment to measured spending and generating sustainable earnings improvement.
As we manage through these challenging and unprecedented times, we plan to remain highly focused on prudently managing the reach of our brand – both domestically and internationally – through select digital marketing initiatives that align with consumer engagement and demand. However, in response to the global economic impact of the COVID-19 pandemic and its effect on consumer confidence and spending levels, we have narrowed our digital advertising spend toward higher-conversion marketing activities. We believe that our long-term mission will ultimately be accomplished through our ability to remain fluid and shift brand awareness strategies that are sensitive to these ever-changing times.
Our MD&A generally discusses Fiscal 2020 and Fiscal 2019 items and year-to-year comparisons between Fiscal 2020 and Fiscal 2019. Discussions of Fiscal 2019 items and year-to-year comparisons between Fiscal 2019 and the fiscal year ended June 30, 2018, or Fiscal 2018, that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results or Operations” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019 filed with the SEC on September 6, 2019.
The following table sets forth certain consolidated statements of operations data for the fiscal years ended June 30, 2020 and 2019:
| | | Year Ended June 30, | |
| | | 2020 | | | 2019 | |
| Net sales | | $ | 29,189,020 | | | $ | 32,244,109 | |
| Costs and expenses: | | | | | | | | |
| Cost of goods sold | | | 21,200,207 | | | | 17,352,167 | |
| Sales and marketing | | | 9,443,244 | | | | 7,983,506 | |
| General and administrative | | | 4,861,297 | | | | 4,640,810 | |
| Research and development | | | - | | | | 2,069 | |
| Total costs and expenses | | | 35,504,748 | | | | 29,978,552 | |
| (Loss) Income from operations | | | (6,315,728 | ) | | | 2,265,557 | |
| Other income (expense): | | | | | | | | |
| Interest income | | | 158,091 | | | | 11,022 | |
| Interest expense | | | (884 | ) | | | (2,198 | ) |
| Loss on foreign currency exchange | | | (1,829 | ) | | | (344 | ) |
| Other expense | | | - | | | | (13 | ) |
| Total other income, net | | | 155,378 | | | | 8,467 | |
| (Loss) Income before income taxes | | | (6,160,350 | ) | | | 2,274,024 | |
| Income tax (expense) benefit | | | (1,733 | ) | | | 1,443 | |
| Net (loss) income | | $ | (6,162,083 | ) | | $ | 2,275,467 | |
Consolidated Net Sales
Consolidated net sales for the fiscal years ended June 30, 2020 and 2019 comprise the following:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 16,777,628 | | | $ | 15,457,343 | | | $ | 1,320,285 | | | | 9 | % |
| Loose jewels | | | 12,411,392 | | | | 16,786,766 | | | | (4,375,374 | ) | | | -26 | % |
| Total consolidated net sales | | $ | 29,189,020 | | | $ | 32,244,109 | | | $ | (3,055,089 | ) | | | -9 | % |
Consolidated net sales were $29.19 million for the fiscal year ended June 30, 2020 compared to $32.24 million for the fiscal year ended June 30, 2019, a decrease of $3.06 million, or 9%. The decrease in consolidated net sales for the fiscal year ended June 30, 2020 compared with consolidated net sales for the prior fiscal year was primarily due to 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 June 30, 2020, we saw increased seasonal sales for both the calendar year-end holiday and Valentine’s Day. We also witnessed increased consumer awareness for our moissanite products throughout these holiday periods. Our transactional website, charlesandcolvard.com, was flat compared with the prior fiscal year due to the strength of demand during the COVID-19 pandemic. Net sales through our cross-border trade, or CBT, platform increased 34% versus the prior fiscal year. Despite the sales pressures we have been experiencing during the COVID-19 pandemic, our results have provided evidence that we had strong finished jewelry product net sales during the fiscal year ended June 30, 2020 in both our Online Channels segment and Traditional segment.
Sales of finished jewelry represented 57% and 48% of total consolidated net sales for the fiscal years ended June 30, 2020 and 2019, respectively. For the fiscal year ended June 30, 2020, finished jewelry sales were $16.78 million compared to $15.46 million for the fiscal year ended June 30, 2019, an increase of $1.32 million, or 9%. This increase in finished jewelry sales was due primarily to higher finished jewelry retail sales in our Online Channels segment as well as increased sales of Forever One™ and Moissanite by Charles & Colvard® products in our Traditional segment during periods prior to the COVID-19 pandemic. Net sales of our Forever One™finished jewelry and loose jewels represented 81% of total net sales for the fiscal year ended June 30, 2020.
Sales of loose jewels represented 43% and 52% of total consolidated net sales for the fiscal years ended June 30, 2020 and 2019, respectively. For the fiscal year ended June 30, 2020, loose jewel sales were $12.41 million compared to $16.79 million for the fiscal year ended June 30, 2019, a decrease of $4.38 million, or 26%. The decrease for the fiscal year ended June 30, 2020 was primarily due to the adverse impact of the COVID-19 pandemic and the resulting impact on consumer confidence and spending. The decrease was also due to lower levels of loose jewel sales in our Online Channels segment and, in particular, lower levels of loose jewel sales through the international distribution network in our Traditional segment.
U.S. net sales accounted for approximately 92% and 87% of total consolidated net sales during the fiscal years ended June 30, 2020 and 2019, respectively. Notwithstanding the adverse impact of the COVID-19 pandemic, U.S. net sales increased during Fiscal 2020 as a percentage of net sales, principally resulting from the significant decrease in international sales as discussed below. The decrease in U.S. net sales during the fiscal year ended June 30, 2020 compared to the prior year was offset somewhat by increased sales to U.S. customers during periods prior to the impact of the COVID-19 pandemic in both our Online Channels segment and Traditional segment.
Our largest U.S. customer during the fiscal years ended June 30, 2020 and 2019 accounted for 13% and 14% of total consolidated net sales during each respective period. Our second largest U.S. customer during the fiscal years ended June 30, 2020 and 2019 accounted for 12% and 10% of total consolidated net sales during each respective period. We expect that we will remain dependent on our ability, and that of our largest U.S. customers, to maintain and enhance retail and domestic distributor programs. A change in or loss of any of these customer or retailer relationships could have a material adverse effect on our results of operations.
International net sales accounted for approximately 8% and 13% of total consolidated net sales during the fiscal years ended June 30, 2020 and 2019, respectively. International net sales decreased to $2.37 million, or 44%, during the fiscal year ended June 30, 2020 compared to $4.26 million in the fiscal year ended June 30, 2019. International sales decreased due to lower demand in our international distributor market resulting from the adverse impact of the geopolitical unrest in Hong Kong and the COVID-19 pandemic affecting the distributors we serve in the China and Hong Kong markets. Prior to the effects of the COVID-19 pandemic, the lower demand in our international distributor market was offset somewhat by growth in our direct-to-consumer presence internationally, along with an increase in the number of CBT transactions in these periods reflecting increased direct-to-consumer sales from our Online Channels segment in international markets. In light of the ongoing global economic conditions, we continue to evaluate these and other potential distributors in international markets to determine the best long-term partners. As a result, and in light of the ongoing worldwide pandemic and international trade challenges, we expect our sales in these markets to continue to fluctuate significantly each reporting period.
We did not have an international customer account for 10% or more of total consolidated sales during the fiscal years ended June 30, 2020 and 2019. A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Finished jewelry | | $ | 7,469,790 | | | $ | 6,859,112 | | | $ | 610,678 | | | | 9 | % |
| Loose jewels | | | 6,062,186 | | | | 8,242,830 | | | | (2,180,644 | ) | | | -26 | % |
| Total product line cost of goods sold | | | 13,531,976 | | | | 15,101,942 | | | | (1,569,966 | ) | | | -10 | % |
| Non-product line cost of goods sold | | | 7,668,231 | | | | 2,250,225 | | | | 5,418,006 | | | | 241 | % |
| Total cost of goods sold | | $ | 21,200,207 | | | $ | 17,352,167 | | | $ | 3,848,040 | | | | 22 | % |
Total cost of goods sold was $21.20 million for the fiscal year ended June 30, 2020 compared to $17.35 million for the fiscal year ended June 30, 2019, a net increase of approximately $3.85 million, or 22%. Product line cost of goods sold is defined as product cost of goods sold in each of our Online Channels segment and Traditional segment excluding non-capitalized expenses from our manufacturing and production control departments, comprising personnel costs, depreciation, rent, utilities, and corporate overhead allocations; freight out; inventory write-offs; and other inventory adjustments, comprising costs of quality issues, and damaged goods.
The increase in total cost of goods sold for the fiscal year ended June 30, 2020 as compared to the fiscal year ended June 30, 2019 was primarily driven by a write-off during the third quarter of Fiscal 2020 of approximately $5.26 million representing the carrying value of our legacy loose jewel 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.10-K.
We believeSales 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 expanding applicationJune 2019 underwritten public offering that we deployed to expand brand awareness; a $217,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; a $58,000 increase in professional services fees principally comprising consulting services for cybersecurity and merchandise imaging; a $46,000 increase in compensation-related expenses; and a $41,000 increase in general office-related expenses, which is primarily related to increased sales and use taxes. These increases were partially offset by a $52,000 decrease in travel expenses as a result of COVID-19 cost control measures.
The increase in digital and social media marketing expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 was primarily due to a $623,000 increase in Internet marketing; a $524,000 increase in outside agency fees; a $110,000 increase in cooperative advertising; and a $9,000 increase in promotional expenses, primarily related to sponsorship of a local professional sports team. These increases were partially offset by an omni-channel sales strategy across$89,000 reduction in trade show expenses resulting from the cancelation of the jewelry tradeindustry’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 end consumer with gemstonesCOVID-19 pandemic, management drastically reduced advertising and branded finished jewelry featuring Charles & Colvard moissanite positions our goods atdigital 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 many touchpoints where consumers are when they are making their buying decisions – thereby creating greater exposure for our brand and increasing consumer demand.last month of Fiscal 2020.
HighlightsCompensation expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 increased primarily as a result of a $201,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $71,000 increase in severance accrual related to our June 2020 management reorganization and workforce reduction; and a $9,000 increase in employee stock-based compensation expense. These increases were partially offset by cost control measures implemented by management as a result of the Fiscal Year EndedCOVID-19 pandemic and its effect on our operations that led to a $235,000 decrease in bonus expense.
General and Administrative
General and administrative expenses for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| General and administrative | | $ | 4,861,297 | | | $ | 4,640,810 | | | $ | 220,487 | | | | 5 | % |
General and administrative expenses were $4.86 million for the fiscal year ended June 30, 2020 compared to $4.64 million for the fiscal year ended June 30, 2019, an increase of approximately $220,000, or 5%.
The increase in general and administrative expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 was primarily due to a $250,000 increase in compensation expenses; a $236,000 increase in professional services fees; and a $6,000 increase in equipment-related rental expense. These increases were partially offset by an $84,000 decrease in business franchise taxes and licenses; a $49,000 decrease in board retainer fees as a result of COVID-19 cost control measures; a $48,000 decrease in bank fees as a result of lower credit card sales transactions during the COVID-19 pandemic; a $31,000 decrease in travel expenses as a result of COVID-19 cost control measures; a $24,000 decrease in insurance expenses; an $18,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy reflecting lower customer accounts receivable balances during the COVID-19 pandemic; a $12,000 decrease in general office-related expenses, which is primarily related to lower software maintenance agreement-related expenses; and a $6,000 net decrease in all other general and administrative expenses.
Compensation expenses increased for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 primarily due to a $282,000 increase in severance accrual related to our June 2020 management reorganization and workforce reduction; a $128,000 increase in salaries and related employee benefits in the aggregate; and a $33,000 increase in employee stock-based compensation expense. These increases were offset in part by cost control measures implemented as a result of the COVID-19 pandemic and its effect on our operations that led to a $193,000 decrease in bonus expense.
Professional services fees increased for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 primarily due to a $158,000 increase in legal fees associated with corporate governance matters; a $38,000 increase in accounting services related to higher annual audit and tax fees, as well as fees associated with tax consulting services; a $30,000 increase in investor and public relations expenses; and a $10,000 increase in consulting and other professional services primarily in connection with nonrecurring accounting and financial reporting related consulting fees.
Loss on Foreign Currency Exchange
Loss on foreign currency exchange related to foreign sales transacted in functional currencies other than the U.S. dollar for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | 1,829 | | | $ | 344 | | | $ | 1,485 | | | | 432 | % |
During the fiscal year ended June 30, 2019,2020, we delivered on several key initiatives, which we believe further solidifiedhad international sales transactions denominated in currencies other than the Charles & Colvard brand. We also believeU.S dollar that we are well poisedresulted in foreign currency exchange net losses. The increase in these losses for future growth as we move forward into the fiscal year endingyears ended June 30, 2020.
These accomplishments2020, reflects changes in foreign currency fluctuation during the fiscal year ended June 30, 2019, include2020 compared with the following:prior fiscal year.
Interest Income
Interest income for the fiscal years ended June 30, 2020 and 2019 is as follows:
Completed an Underwritten Public Offering of our Common Stock –
| | | 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, at a price of $1.60 per share, which together with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July 2019, resulted in aggregate net proceeds of approximately $9.99 million. The net proceeds from this offering have been deposited into an interest-bearing account with a federally insured commercial bank. Accordingly, during the full fiscal year ended June 30, 2020, we earned interest income from cash on deposit in this interest-bearing account.
Provision for Income Taxes
We recognized a net income tax expense of approximately $1,700 and a net income tax benefit of approximately $1,400 for the fiscal years ended June 30, 2020 and 2019, respectively. Our income tax provisions in these periods primarily relate to estimated tax, penalties, and interest associated with uncertain tax positions. During the fiscal year ended June 30, 2019 we recognized a federal income tax benefit in the amount of approximately $23,000 that related to the realization of the recoverable portion of the alternative minimum tax, or AMT, deferred tax credit carryforwards being reclassified from a deferred tax asset to that of an income tax receivable.
As of each reporting date, we consider new evidence, both positive and negative, that could impact our view with regard to future realization of deferred tax assets. Beginning in 2014, we determined that negative evidence outweighed the positive and established a full valuation allowance against our deferred tax assets. We maintained a full valuation allowance as of June 30, 2020 and June 30, 2019.
Our statutory tax rate as of the fiscal year ended June 30, 2020 is 22.11% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.11%, net of the federal benefit.
For discussion of the effects of the Tax Cuts and Jobs Act, or the Tax Act, the CARES Act, and the State of North Carolina General Assembly Senate Bill 704: COVID-19 Recovery Act, or the NC COVID-19 Relief Act, on our provision for income taxes and deferred tax assets, see Note 12 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Certain Operating Metrics
We believe that certain metrics are key to our business, including but not limited to average order value, or AOV, average advertising spend per customer, and repeat customers. The following operating 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 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 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, whichexpenses. 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 intendissued 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 use 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. Accordingly, with these funds we plan However, in response to expand our brand’s reach primarily throughthe COVID-19 pandemic and its impact on consumer confidence and spending, management drastically reduced related advertising and digital marketing efforts. We believe that investmentsexpenditures in top-of-funnel marketing activities, such as social media advertising, influencer marketing programs, and international campaigns, will increase the overall awareness of Charles & Colvard. We also intend to expand our opted-in target market and drive top line growth. We believe that with these funds being secured in the June and July timeframe, this opportunity provides us the ability to positively impact the 2019 calendar year-end holiday season and ultimately accelerate our growth potential.
As discussed above, on June 18, 2020 we received a PPP Loan in the principal amount of Net Income – With four consecutive quarters$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 profitability duringthe 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 2019, we believe30, 2020, our financial performance for this fiscal year was strong. We believe that we have right-sizedworking 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 operations, balanced our resources, and understand the puts and takesallocation of runninginventory from long-term to short-term, a healthy business. We believe that this performance positions us with a strong foundation on which to apply and achieve the maximum benefitdecrease in accounts receivable, an increase in short-term operating lease liabilities resulting from the net proceedsadoption 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 recent public offering.
Established Our Position as a Direct-to-Consumer Brand – Our legacy is that of a moissanite gemstone manufacturer. This traditional business waslong-term debt. These factors were offset partially by an increase in our focus until October 2016, when we re-launched the business model with the intent to establish a direct-to-consumer, or DTC, presence. We finished our fiscal year-end 2019 with more than half of our business derivedcash, cash equivalents, and restricted cash resulting from our Online Channels segment, which serves our DTC customer. More than half of our Online Channels segment’s business is generated from our own transactional website, charlesandcolvard.com, where we can offercash provided by operating and financing activities and an exceptionalincrease in prepaid expenses and direct customer experience while controlling our brand and commanding high product margins. Delivering on our direct-to-consumer vision and our Online Channels segment eclipsing our Traditional segment in less than three years is one of our most significant recent accomplishments.
Forged New Inroads into International Markets – One of our key growth opportunities is in international markets. In fiscal 2019, we leaned into this opportunity with the launch of several marketplaces including but not limited to Amazon sites in Australia, Germany, Italy, France, Spain, and Japan. We believe that the use of marketplaces as a low-cost market research opportunity provides less expensive exposure into new markets. While leveraging the significant subscribers of these established online retail outlets, we have the opportunity to test products and price points to identify whether we have a customer in a given region and which products that customer has a propensity to buy. This allows us to then curate the right selection of products for a region and only then will we begin to invest significant digital marketing resources in order to grow a regional presence. Concurrently, we continued to support CBT efforts to drive international customers to our U.S.-based website with enhanced international shopping features. And lastly, we leveraged regional distributors to act as our ‘boots on the ground’ for certain regions, such as China, that require a significant local presence and investment of resources. With international sales increasing to $4.26 million, or 106%, inother assets. During the fiscal year ended June 30, 2019, our working capital increased by approximately $10.91 million from $2.07$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
twelve monthsfiscal year ended June 30,
2018 (unaudited), we feel confident2020, 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
agile international growth modelcash 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
planan 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
continue these efforts intothe purchase of new raw material SiC crystals during each fiscal
2020.
| • | Expanded Our Product Selection to Meet Market Demand – In May 2018 we introduced Moissanite by Charles & Colvard®, which is a value line of gemstones that offers cost-conscious consumers a competitively-priced option for moissanite jewels. Throughout fiscal 2019, we expanded the footprint of this new product line, closing the year with 6% of all sales attributable to this line of gemstones. In September of 2018 we announced our Signature Collection, a patent-pending line of exclusive jewelry featuring our unique floret logo. By the end of fiscal 2019, our Signature Collection represented 7% of our charlesandcolvard.com sales. We believe this is an indication of the significant recognition and adoption of our brand by consumers. In April 2019, we were named the Official Jewelry Sponsor of the North Carolina Courage, a professional women’s soccer team based in Raleigh, North Carolina, and a member of the National Women’s Soccer League, or NWSL. In fiscal 2019, we provided the entire North Carolina Courage sports and management teams with championship rings commemorating their NWSL 2018 National Championship. In coordination with this soccer team, we released a line of soccer-themed jewelry specifically targeted at the emerging Gen-Z consumer. Throughout fiscal 2019, we continually iterated our jewelry options while introducing new gemstone cuts, such as our Duet Rose, and additional styles of rose cut gems. We believe that we actively solicit customer feedback and respond timely to market demand with the introduction of current product trends.
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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 have broadened our relationship with Helzberg Diamonds stores withoffered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers during the additionthird and fourth quarters of incremental product styles and expanded case line presence in nearly all doors. In October 2018,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 announced the establishment of a new relationship with Macy’s, with whom we have built a significant and growing online presence. Notably,expect to continue to be pressured due to the maturityeffects of certain retail relationships,the ongoing COVID-19 pandemic. In addition, we believe our competitors and other vendors in the wholesale jewelry industry have expanded their use of extended payment terms and, in aggregate, we believe that, through our use of extended payment terms, we provide a competitive response in our market during the current global economic environment. We believe that we are unable to estimate the impact of these actions on our net sales, but if we ceased providing extended payment terms, we believe that we would not be competitive for some Traditional segment customers in the marketplace during this economic period and that our net sales and profits would likely be adversely impacted.
During the fiscal year ended June 30, 2020, prepaid expenses and other assets increased principally as a result of the timing of payments, principally for insurance-related expenses, in advance of goods or services received. During the fiscal year ended June 30, 2020, accounts payable increased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors’ payment terms. Likewise, accrued expenses and other liabilities increased principally due to the severance accrual in connection with our June 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to payments received prior to shipment of good from customers. During the fiscal year ended June 30, 2019, accrued expenses and other liabilities increased principally due to the timing of payments related to accrued compensation and related benefits, including year-end bonuses, as well as increased accrued sales and use taxes associated with higher current sales levels and additional liabilities for jurisdictions where we have recently migrated select brick-and mortar partnersreached 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
blended asset and consignment model account structure, which affords us more favorable customer payment terms that result in more favorablenegative impact on our operating cash
flow. We will continue to evolve our retail channel strategyflow as we
optimize our methods and partnership arrangements.
Historically, our raw material inventories of SiC crystals had been purchased under exclusive supply agreements with a limited number of suppliers. Because the supply agreements restricted the sale of these crystals exclusively to us, the suppliers negotiated minimum purchase commitments with us that, when combined with reduced sales levels during prior periods in which the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As of June 30, 2020 and 2019, $23.19 million and $21.82 million, respectively, of our inventories were classified as long-term assets. Loose jewel sales and finished jewelry that we manufacture will utilize both the finished goods loose jewels currently on-hand and, as we deplete certain shapes and sizes, our on-hand raw material SiC crystals of $3.53 million and new raw material that we purchase pursuant to the Supply Agreement.
A more detailed description of our inventories is included in Note 5 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
We made income tax payments of approximately $2,000 and $6,000 during the fiscal years ended June 30, 2020 and 2019, respectively. As of June 30, 2020 and 2019, we had approximately $309 and $102,000, respectively, of remaining federal income tax credits all of which expire in 2021 and can be carried forward to offset future income taxes. As of June 30, 2020 and 2019, we also had federal tax net operating loss carryforwards of approximately $23.72 million and $23.39 million, respectively, expiring between 2022 and 2037, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $20.12 million and $20.20 million, respectively, expiring between 2023 and 2033; and various other state tax net operating loss carryforwards expiring between 2021 and 2040, which can be used to offset against future state taxable income.
Contractual Commitment
On December 12, 2014, we entered into the Supply Agreement with Cree. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of our required SiC materials in quarterly installments that must equal or exceed a set minimum order quantity. The initial term of the Supply Agreement was scheduled to expire on June 24, 2018, unless extended by the parties. Effective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement, as amended, also provides for the exclusive production of our premium moissanite product, Forever One™ and provided us with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following the expiration of the initial term. In addition, the amendment to the Supply Agreement established a process by which Cree may begin producing alternate SiC material based on our specifications that will give us the flexibility to use the materials in a broader variety of our products, as well as to permit us to purchase certain amounts of SiC materials from third parties under limited conditions. On August 26, 2020, the Supply Agreement was further amended, effective June 30, 2020, to extend the expiration date to June 29, 2025, which may be further extended by mutual agreement of the parties. The Supply Agreement was also amended to, among other things, (i) spread our total purchase commitment under the Supply Agreement in the amount of approximately $52.95 million over the term of the Supply Agreement, as amended; (ii) establish a process by which Cree has agreed to accept purchase orders in excess of the agreed-upon minimum purchase commitment, subject to certain conditions; and (iii) permit us to purchase revised amounts of SiC materials from third parties under limited conditions. Our total purchase commitment under the Supply Agreement, as amended, until June 2025 is approximately $52.95 million, of which approximately $36.60 million remains to be purchased as of June 30, 2020.
For more information regarding the second amendment to our Supply Agreement, executed on August 26, 2020, see Note 15 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
During the fiscal years ended June 30, 2020 and 2019, we purchased approximately $7.47 million and $8.91 million, respectively, of SiC crystals from Cree. Going forward, we expect to use existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, together with future cash expected to be provided by operating activities and, if necessary, our White Oak Credit Facility, withto 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 Commercial Finance, LLC – During June and July of 2018, we negotiated and entered into a $5.00 million asset-based revolving credit facility with White Oak Commercial Finance, LLC, which replaced our previous asset-based revolving credit facility with a commercial bank.Credit Facility. The White Oak Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions, and matures in July 2021.acquisitions. The annual borrowing fees associated with our new White Oak Credit Facility, are lower than those in connection withwhich matures on July 13, 2021, is guaranteed by Charles & Colvard Direct, LLC, another of our previous credit facility, and moreover, we believewholly owned subsidiaries. Under the borrowing terms and financial covenants underlyingof the new White Oak Credit Facility, are less restrictive than those under our previous credit arrangement. Accordingly, we believe the newBorrowers must maintain at least $500,000 in excess borrowing availability at all times. The White Oak Credit Facility will empower us to be more nimble when executing our strategic plans.
contains no other financial covenants.
As we continue to execute our strategy to build and reinvest resources in our business, significant expenses and investment of cash will continue toAdvances under the White Oak Credit Facility may be required aheadeither revolving or non-revolving. During the first year of the revenue streams we expectterm 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 future. While this strategy resulted in some unprofitable reporting periods during 2017 andrate otherwise applicable.
We had not borrowed against the transition period endedWhite Oak Credit Facility as of June 30, 2018, we had four consecutive quarters2020. As a result of net income duringour diminished borrowing base, which is tied to our accounts receivable, our ability to draw down funds from the fiscal year ended June 30, 2019. Accordingly, we will continueWhite Oak Credit Facility is currently restricted.
A more detailed description of the White Oak Credit Facility is included in Note 10 to analyze each investment decision with the ongoing intent to grow our business while maintaining our goalconsolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of achieving positive financial resultsthis Annual Report on Form 10-K.
Liquidity and cash flows. Capital Trends
We believe that we will continue to generate or haveour existing cash and cash equivalents and access to sufficientother 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 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 fund operations as we executebe provided by operating activities combined will be sufficient to meet our plans to expandworking capital and growcapital expenditure needs over the business.next twelve months.
The execution as well as its impact on our rate of sales growth; the expansion of our strategy to continue growing our company,sales and marketing activities; the timing and extent of raw materials and labor purchases in connection with the ultimate goal of increasing consumer awareness and clearly communicating the value proposition of moissanite, is challenging and not without risk. As such, there can be no assurance that future results for each reporting period will exceed past results in sales, operating cash flow, and net income due to the challenging business environment in which we operate and our investment in various initiativesloose jewel production to support our growth strategies. In addition, salesmoissanite jewels business and precious metals and labor purchases in the retailconnection with jewelry industry are typically seasonal dueproduction to increased consumer purchasing patterns during the calendar year-end holiday season. We can also see the effect of seasonality due tosupport our finished jewelry business; the timing of orders we receive to support new or expanded distributioncapital expenditures; and the levelrisk factors described in more detail in “Risk Factors” in Part I, Item 1A of current inventory positions held by our customers. Whilethis Annual Report on Form 10-K. Currently, we have the effect of seasonalityWhite Oak Credit Facility through its expiration on our business, particularly with respect to the impact of the year-end holiday season, was less pronounced during the transition period ended June 30, 2018,July 13, 2021, that we expect to continue seeingbelieve would mitigate these types of seasonal trends impact financial results in future fiscal year-end reporting periods. However, as we execute our growth strategy, we remain committedrisks to our current prioritiescash and liquidity position. Also, we may make investments in, or acquisitions of, generating positive cash flow and strengthening our financial position while both monetizing our existing inventory and manufacturing products that meet sales demand. We believe the results of these efforts will propel our revenue growth and profitability, and further enhance shareholder value in coming years – however, we continuecomplementary businesses, which could also require us to fully recognize the business and economic challenges that we face.seek additional equity or debt financing.
Critical Accounting PoliciesCertain 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 Estimates
Our discussionrepeat customers. The following operating metrics, which we use to make strategic digital marketing related decisions and analysisto monitor the performance and return on investment of our financial condition and results of operationsmarketing activities, are based upon our consolidatedon financial statements, which we prepared in accordance with U.S. GAAP. The preparationresults and customer-related data for charlesandcolvard.com, LLC, a wholly-owned subsidiary 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 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 June 30, 2019, June 30, 2018 and December 31, 2017, work-in-process inventories issued to active production jobs approximated $1.23 million, $2.45 million, and $2.99 million, respectively.
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, on a period-by-period basis. 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.
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 $746,000, $648,000 and $537,000 at June 30, 2019, June 30, 2018 and December 31, 2017, 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 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.
Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstances of the specific account. During our reviewsCharles & Colvard, Ltd., for the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the year ended December 31, 2017, we determined no additional reserves were necessary for specific accounts. Based on these criteria, management determined that allowances for doubtful accounts receivable of $249,000, $233,000 and $254,000 at June 30, 2019, June 30, 2018 and December 31, 2017, respectively, were required.
Deferred Tax Assets -As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. Beginning in 2014, management 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, 2019, June 30, 2018 and December 31, 2017.2020:
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 deferred tax assetscalculation 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 Hong Kong were fully reserved with a valuation allowanceour advertising and marketing communication channels and broaden the underlying content types, notwithstanding the effects of $996,000the 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 June 30, 2019, June 30, 2018people enrolled in our program to continue increasing over time.
The following operating metrics, which we use to manage operations and December 31, 2017to also make strategic digital marketing related decisions and had been fully reserved in all prior periods due to monitor the uncertaintyperformance and return on investment 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 duringmarketing activities, are based on financial results and customer-related data for charlesandcolvard.com, LLC, for the fiscal year ended June 30, 2019,2020 compared to the transition periodfiscal year ended June 30, 2018 and the year ended December 31, 2017, previously ceased operations during 2008 and became a dormant entity during 2009. If we use any portion of our deferred tax assets in future periods, the valuation allowance would need to be reversed and may impact our future operating results.
As a result of the Tax Cuts and Jobs Act, or Tax Act, enacted in December 2017, we wrote down our net deferred tax assets as of December 31, 2017 by approximately $519,000 driven principally by the lowering of the U.S. corporate income tax rate from 35% to that of 21% effective January 1, 2018. Likewise, in December 2017, we 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 rate.
In connection with filing our 2017 U.S. corporate income tax return in June 2018, we completed our analysis of the income tax effects of the Tax Act and the effect on our existing corporate alternative minimum tax, or AMT, deferred tax asset, including the nature, validity, and recoverability of our AMT-related deferred tax credit carryforwards. Upon completing this analysis, we determined that we were able to recognize the underlying tax benefit relating to the realization of the recoverable portion of its AMT-related deferred tax credit carryforwards, net of an expected sequestration reduction, in the amount of approximately $328,000. Accordingly, we recorded the expected AMT credit refund as a receivable, net of an anticipated sequestration reduction and such amount was included with other long-term assets in our Consolidated Balance Sheets as of June 30, 2018.2019:
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.35 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.
However, on January 14, 2019,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 IRS, announced that refundform 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 refund offset transactionscovered 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 refundable minimum tax credits associated with the repeallimited amount of capital that would have been available to us under the corporate AMT as part of the TaxEIDL Program, we did not further pursue those funds.
The CARES Act would not be subject to sequestration. Accordingly, following the IRS’s announcementprovides that existing AMT credit refunds would notcarryforwards are now eligible for acceleration and refundable AMT credits are to be subjectcompletely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, we have elected to have the government sequestration amount, in January 2019 we recognizedAMT tax completely refunded and have filed a tentative refund claim for the additional available underlyingremaining AMT tax benefit and recordedcredit. Consequently, the sequestered portionremaining balance of itsour AMT credit refund in the amount of approximately $23,000. This$270,000 is expected to be completely refundable. Accordingly, the full amount net of amounts received, was also included with other long-term assets in our Consolidated Balance SheetsAMT credit refund has been classified as current as of June 30, 2019.2020.
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.
Uncertain Tax Positions –40 We account for
As discussed above, on June 18, 2020 we received a PPP Loan in the de-recognition, classification, accounting in interim periods,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 disclosure requirements for uncertain tax positions in accordancemay be extended with U.S. GAAP. 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 liabilityconsent 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 guidance was $493,000, $471,000long-term debt assumes there will be no principal forgiveness and $462,000principal 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 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 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,
20182020, 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
December 31, 2017, respectively. This liability is only resolved when we obtainother assets of $490,000; an
official rulingincrease 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
tax authority onimpact of the
positions or whenCOVID-19 pandemic. During the
statute of limitations expires. Our liability for accrued interest on these uncertain tax positions has increased by approximately $22,000, $10,000 and $28,000 as offiscal 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,
20182019. 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
December 31, 2017, respectively.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.
Revenue Recognition – Effective January 1, 2018, we adoptedDuring the new accounting standard in connection with revenue recognition guidance that was issued byfiscal year ended June 30, 2020, accounts receivable decreased principally due to decreased sales during the FASB,third and fourth quarters, as a result we changed our accounting policy for revenue recognition. Basedof the effects that the COVID-19 pandemic and the impact that the global economy had on our analysisTraditional 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 new accounting standard, the timingincreased level of sales during our third and measurement of revenues under the new guidance is consistent with our prior revenue recognition policies. Therefore, no adjustment was required to our opening balance of equity as of January 1, 2018, and comparative prior period information has not been adjusted and continues to be reported under the accounting guidance in effect prior to the change of accounting.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 our accounting policy, revenue is recognized to depict the transferglobal economy, the extension of promised goods or services to customers in an amount that reflects the consideration tothese terms may not immediately increase liquidity as a result of ongoing current-period sales, which we expect to continue to be entitledpressured due to the effects of the ongoing COVID-19 pandemic. In addition, we believe our competitors and other vendors in exchangethe 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 thosesome Traditional segment customers in the marketplace during this economic period and that our net sales and profits would likely be adversely impacted.
During the fiscal year ended June 30, 2020, prepaid expenses and other assets increased principally as a result of the timing of payments, principally for insurance-related expenses, in advance of goods or services. To achieve this principle,services received. During the fiscal year ended June 30, 2020, accounts payable increased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors’ payment terms. Likewise, accrued expenses and other liabilities increased principally due to the severance accrual in connection with our June 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to payments received prior to shipment of good from customers. During the fiscal year ended June 30, 2019, accrued expenses and other liabilities increased principally due to the timing of payments related to accrued compensation and related benefits, including year-end bonuses, as well as increased accrued sales and use taxes associated with higher current sales levels and additional liabilities for jurisdictions where we performhave 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
following five steps: (i) identificationcost 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
contractnegative 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 customer; (ii) identificationlimited number of any separate performance obligations; (iii) determinationsuppliers. Because the supply agreements restricted the sale of these crystals exclusively to us, the transaction price; (iv) allocationsuppliers 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 the transaction price to the performance obligations in the contract;inventories that are higher than we might otherwise maintain. As of June 30, 2020 and (v) recognition of revenue when we have satisfied the underlying performance obligations. We recognize substantially all2019, $23.19 million and $21.82 million, respectively, of our revenue at a point in time when control of our goods has passed to the customer, which typically occurs upon shipment, 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 netinventories were classified as long-term assets. Loose jewel sales in the current period. For our Traditional segment and Online Channels segment 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. Our charlesandcolvard.com customers may return purchases for any reason within 60 days in accordance with our returns policy as disclosed onthat we manufacture will utilize both the charlesandcolvard.com website. Periodically, we ship loose jewel goods and 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 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 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.Supply Agreement.
SeeA more detailed description of our inventories is included in Note 25 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K under10-K.
We made income tax payments of approximately $2,000 and $6,000 during the Changefiscal 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 Accounting Policy2021 and Revenue Recognition captions for additional information regarding the adoptioncan be carried forward to offset future income taxes. As of the new revenue recognition accounting standard asJune 30, 2020 and 2019, we also had federal tax net operating loss carryforwards of January 1, 2018,approximately $23.72 million and the underlying required disclosures arising from contracts with customers as well as a more detailed description$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 our revenue recognition accounting policy.
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.
Recent Accounting Pronouncements -42 See
Contractual Commitment
On December 12, 2014, we entered into the Supply Agreement with Cree. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of our required SiC materials in quarterly installments that must equal or exceed a set minimum order quantity. The initial term of the Supply Agreement was scheduled to expire on June 24, 2018, unless extended by the parties. Effective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement, as amended, also provides for the exclusive production of our premium moissanite product, Forever One™ and provided us with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following the expiration of the initial term. In addition, the amendment to the Supply Agreement established a process by which Cree may begin producing alternate SiC material based on our specifications that will give us the flexibility to use the materials in a broader variety of our products, as well as to permit us to purchase certain amounts of SiC materials from third parties under limited conditions. On August 26, 2020, the Supply Agreement was further amended, effective June 30, 2020, to extend the expiration date to June 29, 2025, which may be further extended by mutual agreement of the parties. The Supply Agreement was also amended to, among other things, (i) spread our total purchase commitment under the Supply Agreement in the amount of approximately $52.95 million over the term of the Supply Agreement, as amended; (ii) establish a process by which Cree has agreed to accept purchase orders in excess of the agreed-upon minimum purchase commitment, subject to certain conditions; and (iii) permit us to purchase revised amounts of SiC materials from third parties under limited conditions. Our total purchase commitment under the Supply Agreement, as amended, until June 2025 is approximately $52.95 million, of which approximately $36.60 million remains to be purchased as of June 30, 2020.
For more information regarding the second amendment to our Supply Agreement, executed on August 26, 2020, see Note 215 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
During the fiscal years ended June 30, 2020 and 2019, we purchased approximately $7.47 million and $8.91 million, respectively, of SiC crystals from Cree. Going forward, we expect to use existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, together with future cash expected to be provided by operating activities and, if necessary, our White Oak Credit Facility, to finance our purchase commitment under the Supply Agreement, as amended.
Line of Credit
On July 13, 2018, we and our wholly owned subsidiary, charlesandcolvard.com, LLC, collectively referred to as the Borrowers, obtained the $5.00 million asset-based revolving White Oak Credit Facility. The White Oak Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions. The White Oak Credit Facility, which matures on July 13, 2021, is guaranteed by Charles & Colvard Direct, LLC, 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 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 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 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 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 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 under10-K. Currently, we have the Recently Adopted/Issued Accounting Pronouncements caption for the descriptionWhite 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, recent accounting pronouncements, including the expected date of adoption and estimated effects, on our consolidated financial statements.complementary businesses, which could also require us to seek additional equity or debt financing.
Certain Operating MetricsResults of Operations
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 | |
The following operating metrics are based on financial results
Consolidated Net Sales
Consolidated net sales for the fiscal years ended June 30, 2020 and customer-related data for charlesandcolvard.com, LLC, a wholly-owned subsidiary of Charles & Colvard, Ltd.,2019 comprise the following:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 16,777,628 | | | $ | 15,457,343 | | | $ | 1,320,285 | | | | 9 | % |
| Loose jewels | | | 12,411,392 | | | | 16,786,766 | | | | (4,375,374 | ) | | | -26 | % |
| Total consolidated net sales | | $ | 29,189,020 | | | $ | 32,244,109 | | | $ | (3,055,089 | ) | | | -9 | % |
Consolidated net sales were $29.19 million for the fiscal year ended June 30, 2019:
Average order value, or AOV, is estimated2020 compared 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 $220, based on the total advertising spend focused on charlesandcolvard.com traffic divided by the number of first-time customer orders.
Repeat customers represent approximately 28% 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, we expect our average ad spend per customer to increase substantially going forward. Finally, as our Loyalty Program is revived, we expect the percentage of people enrolled in our program to continue increasing substantially over time.
The following operating metrics are based on financial results and customer-related data for charlesandcolvard.com, LLC,$32.24 million for the fiscal year ended June 30, 2019, compared to prior twelve-month period ended June 30, 2108 (unaudited):
51% year-over-year growtha decrease of $3.06 million, or 9%. The decrease in charlesandcolvard.com revenue.
5.5% year-over-year growth in social media followers; 21% year-over-year growth in opt-in email subscribers.
For the fiscal year ended June 30, 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 compared to 52% gross margin for the twelve-month period ended June 30, 2018 (unaudited).
Summary Financial Results for the Fiscal Year Ended June 30, 2019
The following is a summary of key financial results achieved for the fiscal year ended June 30, 2019 compared with the twelve months ended June 30, 2018 (unaudited):
| • | Our total consolidated net sales increased by $4.34 million, or 16%, to $32.24 million in the fiscal year ended June 30, 2019 from $27.91 million in the twelve-month period ended June 30, 2018 (unaudited). The increase in consolidated net sales for the fiscal year ended June 30, 2019 was due primarily to strong seasonal sales for both Valentine’s Day and the calendar year-end 2018 holidays coupled with increased demand for our Forever OneTM gemstones over the comparable period in the twelve months ended June 30, 2018 (unaudited), reflecting higher finished jewelry net sales.
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| • | Online Channels segment net sales during the fiscal year ended June 30, 2019 of $16.34 million were 25% higher than Online Channels segment net sales during the twelve months ended June 30, 2018 (unaudited). Expanded jewelry selections resulted in higher finished jewelry sales and ongoing increased demand for our Forever OneTM and Moissanite by Charles & Colvard® gemstones during the fiscal year ended June 30, 2019 as evidenced through our increased presence on e-commerce outlets, including marketplaces and through charlesandcolvard.com within our Online Channels segment.
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Traditional segment net sales for the fiscal year ended June 30, 2019 of $15.91 million were 7% higher than Traditional segment2020 compared with consolidated net sales for the twelve months ended June 30, 2018 (unaudited),prior fiscal year was primarily driven by an increasedue to the adverse impacts of the geopolitical unrest in Hong Kong in early 2020 which affected our international distributor market and the international distribution channel that primarily distributes loose gemsglobal outbreak of the COVID-19 pandemic. This pandemic has continued to independent retail jewelersnegatively affect the U.S. and global economies and has had a significant adverse impact on our worldwide sales and results of operations. Notwithstanding the impact of the COVID-19 pandemic, during the fiscal year ended June 30, 2019. This decrease2020, we saw increased seasonal sales for both the calendar year-end holiday and Valentine’s Day. We also witnessed increased consumer awareness for our moissanite products throughout these holiday periods. Our transactional website, charlesandcolvard.com, was offset somewhat by higher gemstoneflat compared with the prior fiscal year due to the strength of demand during the COVID-19 pandemic. Net sales through our international distribution network as a result ofcross-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 ongoing initiatives with these customers.
| • | Finished jewelry sales for the fiscal year ended June 30, 2019 comprised 48% of our total consolidated net sales and increased 19% to $15.46 million, compared with $13.00 million for the twelve months ended June 30, 2018 (unaudited), primarily due 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. Loose jewel sales comprised 52% of our total consolidated net sales for the fiscal year ended June 30, 2019 and increased 13% to $16.79 million, compared with $14.91 million for the twelve months ended June 30, 2018 (unaudited), primarily due to higher levels of loose jewel sales in both our Online Channels segment and principally through the international distribution network in our Traditional segment.
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Operating expenses increased by aresults have provided evidence that we had strong finished jewelry product net $167,000, or 1%, to $12.63 million insales during the fiscal year ended June 30, 2019 from $12.46 million2020 in both our Online Channels segment and Traditional segment.
Sales of finished jewelry represented 57% and 48% of total consolidated net sales for the twelve-month periodfiscal years ended June 30, 2018 (unaudited). Of this net increase,2020 and 2019, respectively. For the fiscal year ended June 30, 2020, finished jewelry sales and marketing expenses increased $342,000, or 4%,were $16.78 million compared to $7.98 million, primarily due to increased digital and social media marketing expenses associated with implementing our sales and marketing strategies, offset partially by a decrease in compensation-related expenses. Offsetting the increased sales and marketing expenses, general and administrative expenses decreased a net $176,000, or 4%, to $4.64 million primarily as a result of decreased professional services expenses, principally as a result of hiring a full-time in-house counsel, partially offset by increases in business franchise taxes, bad debt expense, insurance expenses, and compensation-related expenses.
Income before income taxes of approximately $2.27$15.46 million for the fiscal year ended June 30, 2019, improved from a lossan increase of $1.08$1.32 million, for the twelve-month period ended June 30, 2018 (unaudited)or 9%. TheThis increase in income before income taxesfinished jewelry sales was due primarily to strong seasonal holidayhigher finished jewelry retail sales in our Online Channels segment as well as increased consumer awarenesssales of Forever One™ and demand forMoissanite by Charles & Colvard® products in our moissanite gemstones and Traditional segment during periods prior to the COVID-19 pandemic. Net sales of our Forever One™finished jewelry that resultedand 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 higherour Online Channels segment and, in particular, lower levels of loose jewel sales through the international distribution network in our Traditional segment.
U.S. net sales accounted for approximately 92% and 87% of total consolidated net sales during the fiscal years ended June 30, 2020 and 2019, respectively. Notwithstanding the adverse impact of the COVID-19 pandemic, U.S. net sales increased during Fiscal 2020 as a percentage of net sales, principally resulting from the significant decrease in international sales as discussed below. The decrease in U.S. net sales during the fiscal year ended June 30, 2020 compared to the prior year was offset somewhat by increased sales to U.S. customers during periods prior to the impact of the COVID-19 pandemic in both our Online Channels segment and Traditional segment.
Our gross marginlargest U.S. customer during the fiscal years ended June 30, 2020 and 2019 accounted for 13% and 14% of total consolidated net sales during each respective period. Our second largest U.S. customer during the fiscal years ended June 30, 2020 and 2019 accounted for 12% and 10% of total consolidated net sales during each respective period. We expect that we will remain dependent on our ability, and that of our largest U.S. customers, to maintain and enhance retail and domestic distributor programs. A change in or loss of any of these customer or retailer relationships could have a material adverse effect on our results of operations.
International net sales accounted for approximately 8% and 13% of total consolidated net sales during the fiscal years ended June 30, 2020 and 2019, respectively. International net sales decreased to $2.37 million, or 44%, during the fiscal year ended June 30, 2020 compared to $4.26 million in the fiscal year ended June 30, 2019. International sales decreased due to lower demand in our international distributor market resulting from the adverse impact of the geopolitical unrest in Hong Kong and the COVID-19 pandemic affecting the distributors we serve in the China and Hong Kong markets. Prior to the effects of the COVID-19 pandemic, the lower demand in our international distributor market was offset somewhat by growth in our direct-to-consumer presence internationally, along with an increase in the number of CBT transactions in these periods reflecting increased direct-to-consumer sales from our Online Channels segment in international markets. In light of the ongoing global economic conditions, we continue to evaluate these and other potential distributors in international markets to determine the best long-term partners. As a result, and in light of the ongoing worldwide pandemic and international trade challenges, we expect our sales in these markets to continue to fluctuate significantly each reporting period.
We did not have an international customer account for 10% or more of total consolidated sales during the fiscal years ended June 30, 2020 and 2019. A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Finished jewelry | | $ | 7,469,790 | | | $ | 6,859,112 | | | $ | 610,678 | | | | 9 | % |
| Loose jewels | | | 6,062,186 | | | | 8,242,830 | | | | (2,180,644 | ) | | | -26 | % |
| Total product line cost of goods sold | | | 13,531,976 | | | | 15,101,942 | | | | (1,569,966 | ) | | | -10 | % |
| Non-product line cost of goods sold | | | 7,668,231 | | | | 2,250,225 | | | | 5,418,006 | | | | 241 | % |
| Total cost of goods sold | | $ | 21,200,207 | | | $ | 17,352,167 | | | $ | 3,848,040 | | | | 22 | % |
Total cost of goods sold was $21.20 million for the fiscal year ended June 30, 2020 compared to $17.35 million for the fiscal year ended June 30, 2019, was 46% compared to 40%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 twelve-month periodfiscal year ended June 30, 2018 (unaudited). These improvements were offset somewhat by a one-time gain on an insurance claim settlement that was recognized during the twelve-month period ended June 30, 2018 (unaudited).
We recorded net income of $2.28 million in 2020 as compared to the fiscal year ended June 30, 2019 compared towas primarily driven by a net losswrite-off during the third quarter of $767,000Fiscal 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 twelve-month period ended June 30, 2018 (unaudited). Fully dilutedAsia 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 income per share was $0.10increase in non-product line cost of goods sold for the fiscal year ended June 30, 2019 compared to a2020 comprises an unfavorable net loss per sharechange in inventory write-offs of $0.04 in the twelve-month period ended June 30, 2018 (unaudited). The improvement in our financial results period over period was primarily the result of strong sales growth and improved gross margins along with operating expenses that were essentially flat when comparedapproximately $5.47 million principally related to the comparable unaudited year-ago period. The improved resultswrite-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, 2019 were offset by2020. 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 one-time gain on an insurance claim settlement that was recognized during the twelve-month periodfiscal year ended June 30, 2018 (unaudited). In addition, while2019 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 net incomeconsolidated 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, reflectedan increase of approximately $1.46 million, or 18%.
The increase in sales and marketing expenses for the impactfiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 was primarily due to a $1.15 million increase in advertising and digital marketing expenses reflecting the activation of funds from our June 2019 underwritten public offering that we deployed to expand brand awareness; a $217,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; a $58,000 increase in professional services fees principally comprising consulting services for cybersecurity and merchandise imaging; a $46,000 increase in compensation-related expenses; and a $41,000 increase in general office-related expenses, which is primarily related to increased sales and use taxes. These increases were partially offset by a $52,000 decrease in travel expenses as a result of COVID-19 cost control measures.
The increase in digital and social media marketing expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 was primarily due to a $623,000 increase in Internet marketing; a $524,000 increase in outside agency fees; a $110,000 increase in cooperative advertising; and a $9,000 increase in promotional expenses, primarily related to sponsorship of a local professional sports team. These increases were partially offset by an $89,000 reduction in trade show expenses resulting from the cancelation of the recognitionjewelry industry’s premier annual event as a result of the COVID-19 pandemic; and a $29,000 reduction in print media advertising. In response to the COVID-19 pandemic, management drastically reduced advertising and digital marketing expenditures beginning in mid-March 2020. In addition, as a result of its digital marketing redirection in June 2020, management further reduced advertising and digital marketing expenditures during the last month of Fiscal 2020.
Compensation expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 increased primarily as a result of a $201,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $71,000 increase in severance accrual related to our June 2020 management reorganization and workforce reduction; and a $9,000 increase in employee stock-based compensation expense. These increases were partially offset by cost control measures implemented by management as a result of the COVID-19 pandemic and its effect on our operations that led to a $235,000 decrease in bonus expense.
General and Administrative
General and administrative expenses for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| General and administrative | | $ | 4,861,297 | | | $ | 4,640,810 | | | $ | 220,487 | | | | 5 | % |
General and administrative expenses were $4.86 million for the fiscal year ended June 30, 2020 compared to $4.64 million for the fiscal year ended June 30, 2019, an increase of approximately $220,000, or 5%.
The increase in general and administrative expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 was primarily due to a $250,000 increase in compensation expenses; a $236,000 increase in professional services fees; and a $6,000 increase in equipment-related rental expense. These increases were partially offset by an $84,000 decrease in business franchise taxes and licenses; a $49,000 decrease in board retainer fees as a result of COVID-19 cost control measures; a $48,000 decrease in bank fees as a result of lower credit card sales transactions during the COVID-19 pandemic; a $31,000 decrease in travel expenses as a result of COVID-19 cost control measures; a $24,000 decrease in insurance expenses; an $18,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy reflecting lower customer accounts receivable balances during the COVID-19 pandemic; a $12,000 decrease in general office-related expenses, which is primarily related to lower software maintenance agreement-related expenses; and a $6,000 net decrease in all other general and administrative expenses.
Compensation expenses increased for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 primarily due to a $282,000 increase in severance accrual related to our June 2020 management reorganization and workforce reduction; a $128,000 increase in salaries and related employee benefits in the aggregate; and a $33,000 increase in employee stock-based compensation expense. These increases were offset in part by cost control measures implemented as a result of the COVID-19 pandemic and its effect on our operations that led to a $193,000 decrease in bonus expense.
Professional services fees increased for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 primarily due to a $158,000 increase in legal fees associated with corporate governance matters; a $38,000 increase in accounting services related to higher annual audit and tax fees, as well as fees associated with tax consulting services; a $30,000 increase in investor and public relations expenses; and a $10,000 increase in consulting and other professional services primarily in connection with nonrecurring accounting and financial reporting related consulting fees.
Loss on Foreign Currency Exchange
Loss on foreign currency exchange related to foreign sales transacted in functional currencies other than the U.S. dollar for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | 1,829 | | | $ | 344 | | | $ | 1,485 | | | | 432 | % |
During the fiscal year ended June 30, 2020, we had international sales transactions denominated in currencies other than the U.S dollar that resulted in foreign currency exchange net losses. The increase in these losses for the fiscal years ended June 30, 2020, reflects changes in foreign currency fluctuation during the fiscal year ended June 30, 2020 compared with the prior fiscal year.
Interest Income
Interest income for the fiscal years ended June 30, 2020 and 2019 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Interest income | | $ | 158,091 | | | $ | 11,022 | | | $ | 147,069 | | | | 1,334 | % |
In June 2019, we completed an underwritten public offering of 6,250,000 shares of our common stock, which together with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July 2019, resulted in net proceeds of approximately $9.99 million. The net proceeds from this offering have been deposited into an interest-bearing account with a federally insured commercial bank. Accordingly, during the full fiscal year ended June 30, 2020, we earned interest income from cash on deposit in this interest-bearing account.
Provision for Income Taxes
We recognized a net income tax expense of approximately $1,700 and a net income tax benefit of approximately $1,400 for the fiscal years ended June 30, 2020 and 2019, respectively. Our income tax provisions in these periods primarily relate to estimated tax, penalties, and interest associated with uncertain tax positions. During the fiscal year ended June 30, 2019 we recognized a federal income tax benefit in the amount of approximately $23,000 in connection with changes in the Tax Act relatingthat related to the realization of athe 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,receivable.
As of each reporting date, we consider new evidence, both positive and negative, that could impact our resultsview with regard to future realization of deferred tax assets. Beginning in 2014, we determined that negative evidence outweighed the twelve-month period endedpositive and established a full valuation allowance against our deferred tax assets. We maintained a full valuation allowance as of June 30, 2018 (unaudited) also included a federal income tax benefit in the amount of approximately $328,000 also relating to the realization of an additional recoverable portion of the AMT deferred tax credit carryforwards that were reclassified from a deferred tax asset to that of an income tax receivable during the unaudited period then ended.
We generated net cash from operationsOur statutory tax rate as of approximately $917,000 in the fiscal year ended June 30, 2019, compared to negative cash flows from operations2020 is 22.11% and consists of $2.69 million in the twelve-month period ended June 30, 2018 (unaudited). The primary driversfederal income tax rate of our operating cash flow in the fiscal year ended June 30, 2019 were21% and a netblended state income tax rate 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.
Cash, cash equivalents and restricted cash at June 30, 2019 were $13.01 million compared to cash and cash equivalents of $3.39 million at June 30, 2018. The primary reasons for this increase are the $9.06 million of cash proceeds1.11%, net of the underwriting discountfederal benefit.
For discussion of the effects of the Tax Cuts and fees and expenses, from our Jobs Act, or theunderwritten public offering in June 2019 Tax Act, the CARES Act, and the approximately $917,000State of cash provided byNorth 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 operations. These increases were offset by approximately $426,000 used in investing activities, principally for capital expenditures during the fiscal year ended June 30, 2019.Annual Report on
Total inventory, including long-term and consignment inventory, was $33.73 million as of June 30, 2019, up from $31.83 million at June 30, 2018. This inventory increase was, in part, due to higher levels of consignment inventories that were produced to meet anticipated product demand, offset by increases in inventory reserves.
We continue to carry no long-term debt. And we believe that we will be able to continue to have access to additional working capital resources, including but not limited to the White Oak Credit Facility and the potential issuance of equity securities, to fund operations and our growth strategies for the foreseeable future.
Fiscal Year Ended June 30, 2019 and Twelve Months Ended June 30, 2018 (Unaudited)
The following table sets forth certain consolidated statements of operations data for the fiscal yearyears ended June 30, 20192020 and twelve-month period ended June 30, 2018 (unaudited):2019:
| | | Twelve Months Ended June 30, | | |
| | | 2019 | | | 2018 | | | Year Ended June 30, | |
| | | | | | (unaudited) | | | 2020 | | | 2019 | |
| Net sales | | $ | 32,244,109 | | | $ | 27,908,838 | | | $ | 29,189,020 | | | $ | 32,244,109 | |
| Costs and expenses: | | | | | | | | | | | | |
| Cost of goods sold | | 17,352,167 | | | 16,708,203 | | | 21,200,207 | | | 17,352,167 | |
| Sales and marketing | | 7,983,506 | | | 7,641,962 | | | 9,443,244 | | | 7,983,506 | |
| General and administrative | | 4,640,810 | | | 4,816,495 | | | 4,861,297 | | | 4,640,810 | |
| Research and development | | | 2,069 | | | | 571 | | | | - | | | | 2,069 | |
| Total costs and expenses | | | 29,978,552 | | | | 29,167,231 | | | | 35,504,748 | | | | 29,978,552 | |
| Income (Loss) from operations | | 2,265,557 | | | (1,258,393 | ) | |
| (Loss) Income from operations | | | (6,315,728 | ) | | 2,265,557 | |
| Other income (expense): | | | | | | | | | | | | |
| Interest income | | 11,022 | | | - | | | 158,091 | | | 11,022 | |
| Interest expense | | (2,198 | ) | | (742 | ) | | (884 | ) | | (2,198 | ) |
| Loss on foreign currency exchange | | (344 | ) | | (5 | ) | | (1,829 | ) | | (344 | ) |
| Gain on insurance claim settlement | | - | | | 183,217 | | |
| Other expense | | | (13 | ) | | | - | | | | - | | | | (13 | ) |
| Total other income (expense), net | | | 8,467 | | | | 182,470 | | |
| Income (Loss) before income taxes | | 2,274,024 | | | (1,075,923 | ) | |
| Income tax net benefit | | | 1,443 | | | | 309,046 | | |
| Net income (loss) | | $ | 2,275,467 | | | $ | (766,877 | ) | |
| 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 yearyears ended June 30, 20192020 and twelve months ended June 30, 2018 (unaudited)2019 comprise the following:
| | | Twelve Months Ended June 30, | | | Change | | |
| | | 2019 | | | 2018 | | | Dollars | | | Percent | | | Year Ended June 30, | | | Change | |
| | | | | | (unaudited) | | | | | | | | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 15,457,343 | | | $ | 13,001,941 | | | $ | 2,455,402 | | | 19 | % | | $ | 16,777,628 | | | $ | 15,457,343 | | | $ | 1,320,285 | | | 9 | % |
| Loose jewels | | | 16,786,766 | | | | 14,906,897 | | | | 1,879,869 | | | 13 | % | | | 12,411,392 | | | | 16,786,766 | | | | (4,375,374 | ) | | -26 | % |
| Total consolidated net sales | | $ | 32,244,109 | | | $ | 27,908,838 | | | $ | 4,335,271 | | | 16 | % | | $ | 29,189,020 | | | $ | 32,244,109 | | | $ | (3,055,089 | ) | | -9 | % |
Consolidated net sales were $29.19 million for the fiscal year ended June 30, 2020 compared to $32.24 million for the fiscal year ended June 30, 2019, compared to $27.91 million for the twelve months ended June 30, 2018 (unaudited), an increasea decrease of $4.34$3.06 million, or 16%9%. The increasedecrease in consolidated net sales for the fiscal year ended June 30, 20192020 compared with consolidated net sales for the prior fiscal year was primarily due primarily to strongthe 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 June 30, 2020, we saw increased seasonal sales for both Valentine’s Day and the calendar year-end holiday as well asand Valentine’s Day. We also witnessed increased consumer awareness and demand for our moissanite gemstones and jewelry. Theseproducts throughout these holiday periods. Our transactional website, charlesandcolvard.com, was flat compared with the prior fiscal year due to the strength of demand during the COVID-19 pandemic. Net sales through our cross-border trade, or CBT, platform increased 34% versus the prior fiscal year. Despite the sales pressures we have been experiencing during the COVID-19 pandemic, our results werehave provided evidence of boththat we had strong finished jewelry product net sales and higher loose jewel net sales during the fiscal year ended June 30, 20192020 in our Online Channels segment. The increases inboth our Online Channels segment and Traditional segment net sales in the fiscal year ended June 30, 2019 were partially offset by lower finished jewelry product sales in our Traditional segment.
Sales of finished jewelry represented 48%57% and 47%48% of total consolidated net sales for the fiscal yearyears ended June 30, 20192020 and the twelve-month period ended June 30, 2018 (unaudited),2019, respectively. For the fiscal year ended June 30, 2019,2020, finished jewelry sales were $15.46$16.78 million compared to $13.00$15.46 million for the twelve monthsfiscal year ended June 30, 2018 (unaudited),2019, an increase of $2.46$1.32 million, or 19%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.
Salessegment during periods prior to the COVID-19 pandemic. Net sales of our Forever One™finished jewelry and loose jewels represented 52% and 53%81% of total consolidated net sales for the fiscal year ended June 30, 20192020.
Sales of loose jewels represented 43% and 52% of total consolidated net sales for the twelve monthsfiscal years ended June 30, 2018 (unaudited),2020 and 2019, respectively. For the fiscal year ended June 30, 2019,2020, loose jewel sales were $16.79$12.41 million compared to $14.91$16.79 million for the twelve months ended June 30, 2018 (unaudited), an increase of $1.88 million, or 13%. The increase 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 higherthe 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 both our Online Channels segment and, principallyin particular, lower levels of loose jewel sales through the international distribution network in our Traditional segment.
U.S. net sales accounted for approximately 87%92% and 93%87% of total consolidated net sales during the fiscal years ended June 30, 2020 and 2019, respectively. Notwithstanding the adverse impact of the COVID-19 pandemic, U.S. net sales increased during Fiscal 2020 as a percentage of net sales, principally resulting from the significant decrease in international sales as discussed below. The decrease in U.S. net sales during the fiscal year ended June 30, 2019 and the twelve-month period ended June 30, 2018 (unaudited), respectively. As a percentage of net sales, U.S. net sales decreased during fiscal 2019 as a result of increased demand in the international distributor market and the growth of our direct-to-consumer presence internationally2020 compared to the twelve months ended June 30, 2018 (unaudited). However, U.S. net sales increased to $27.98 million, or 8%, during the fiscalprior year ended June 30, 2019 from $25.84 million for the twelve months ended June 30, 2018 (unaudited) primarily as a result of ongoing increased demand andwas offset somewhat by increased sales fromto U.S. customers during periods prior to the impact of the COVID-19 pandemic in both our Online Channels segment and Traditional segment.
Our largest U.S. customer during the fiscal yearyears ended June 30, 20192020 and the twelve months ended June 30, 2018 (unaudited)2019 accounted for 14%13% and 15%14% of total consolidated net sales during each respective period. Our second largest U.S. customer during the fiscal yearyears ended June 30, 20192020 and the twelve months ended June 30, 2018 (unaudited)2019 accounted for 10%12% and 12%10% of total consolidated net sales during each respective period. Other than our largest and second largest U.S. customers during the fiscal year ended June 30, 2019 and the twelve months ended June 30, 2018 (unaudited), we had no other customers with sales that represented 10% or more of total consolidated net sales for the periods then ended. 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 13%8% and 7%13% of total consolidated net sales during the fiscal yearyears ended June 30, 20192020 and the twelve months ended June 30, 2018 (unaudited),2019, respectively. International net sales increaseddecreased to $4.26$2.37 million, or 106%44%, during the fiscal year ended June 30, 20192020 compared to $2.07$4.26 million in the twelve monthsfiscal year ended June 30, 2018 (unaudited) as2019. 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 continueserve in the China and Hong Kong markets. Prior to serve distributorsthe 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. Based on current levelsIn light of demand for loose jewels in the markets,ongoing global economic conditions, we continue to evaluate these and other potential distributors in these international markets to determine the best long-term partners. Additionally, during the fiscal year ended June 30, 2019, we developed a direct-to-consumer presence in Australia, Germany, Italy, France, and Spain. These international locations are in addition to the presence we developed in the UK during the twelve month-period ended June 30, 2018 (unaudited). Going forward, we anticipate the need to further develop a direct-to-consumer presence in other locations throughout the world. This international expansion will continue to require additional investment in our multi-channel digital marketing strategy to drive expected growth in these regions. As a result, over timeand in light of the ongoing worldwide pandemic and international trade challenges, we expect our sales in these international markets mayto continue to fluctuate significantly each reporting period as our growth in these regions develops.period.
NoWe did not have an international customers accountedcustomer account for 10% or more than 10% of total consolidated sales induring 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. Our top threeretailers international distributors by sales volume during the fiscal year ended June 30, 2019 were, in order of sales volume, located in Hong Kong, Hong Kong, and Canada..
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal yearyears ended June 30, 20192020 and twelve months ended June 30, 2018 (unaudited)2019 are as follows:
| | | Twelve Months Ended June 30, | | | Change | | |
| | | 2019 | | | 2018 | | | Dollars | | | Percent | | | Year Ended June 30, | | | Change | |
| | | | | | (unaudited) | | | | | | | | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 6,859,112 | | | $ | 7,045,126 | | | $ | (186,014 | ) | | -3 | % | | $ | 7,469,790 | | | $ | 6,859,112 | | | $ | 610,678 | | | 9 | % |
| Loose jewels | | | 8,242,830 | | | | 7,761,793 | | | | 481,037 | | | 6 | % | | | 6,062,186 | | | | 8,242,830 | | | | (2,180,644 | ) | | -26 | % |
| Total product line cost of goods sold | | 15,101,942 | | | 14,806,919 | | | 295,023 | | | 2 | % | | 13,531,976 | | | 15,101,942 | | | (1,569,966 | ) | | -10 | % |
| Non-product line cost of goods sold | | | 2,250,225 | | | | 1,901,284 | | | | 348,941 | | | 18 | % | | | 7,668,231 | | | | 2,250,225 | | | | 5,418,006 | | | 241 | % |
| Total cost of goods sold | | $ | 17,352,167 | | | $ | 16,708,203 | | | $ | 643,964 | | | 4 | % | | $ | 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, compared to $16.71 million for the twelve months ended June 30, 2018 (unaudited), ana net increase of approximately $644,000,$3.85 million, or 4%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 valuation allowance adjustments;write-offs; and other inventory adjustments, comprising costs of quality issues, and damaged goods, and inventory write-downs.goods.
The increase in total cost of goods sold for the fiscal year ended June 30, 20192020 as compared to the twelve-month periodfiscal year ended June 30, 2018 (unaudited)2019 was due primarily to an increased leveldriven by a write-off during the third quarter of overall product sales during fiscal 2019, 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,offset somewhat by favorable costs resulting from manufacturing efficiencies achieved for work-in-process gemstones, loose finished gemstones and finished jewelry production when compared to product line cost of goods soldset 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 unaudited period of 2018. period.
The net increase in total cost of goods sold was also impacted by a net unfavorable change in non-product line cost of goods sold during fiscal 2019. This net increase in non-product line cost of goods sold for the fiscal year ended June 30, 2020 comprises a $437,000an 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 other inventory adjustments principally relatingnon-product line cost of goods sold was also related to an approximate $14,000 change in production standard cost variances and book-to-physical quantity adjustments; a $62,000 increase in freight out as a result ofcompared to the fiscal year ended June 30, 2019 as well as an increase in sales transaction volume; and an $8,000approximate $1,000 increase in non-capitalized manufacturing and production control expenses principally due to the timing of when work-in-process is received into inventory and overhead iscosts are allocated. These increases in non-product line cost of goods sold were offset in part by a $158,000 favorable changean approximate $68,000 decrease in inventory valuation allowances, including inventory obsolescence, shrinkage, recuts, and repairs reserves. 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 yearyears ended June 30, 20192020 and twelve months ended June 30, 2018 (unaudited)2019 are as follows:
| | Twelve Months Ended June 30, | | Change | |
| | 2019 | | 2018 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| Sales and marketing | | $ | 7,983,506 | | | $ | 7,641,962 | | | $ | 341,544 | | | | 4 | % |
| | | 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, compared to $7.64 million for the twelve-month period ended June 30, 2018 (unaudited), an increase of approximately $342,000,$1.46 million, or 4%18%.
The increase in sales and marketing expenses for the fiscal year ended June 30, 20192020 compared to the twelve monthsfiscal year ended June 30, 2018 (unaudited)2019 was primarily due to a $640,000$1.15 million increase in advertising and digital and social media marketing;marketing expenses reflecting the activation of funds from our June 2019 underwritten public offering that we deployed to expand brand awareness; a $140,000 increase in general office-related expenses, principally due to increased credit card clearing transactions; a $137,000 increase in professional services fees; a $76,000$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 $50,000$41,000 increase in depreciationgeneral office-related expenses, which is primarily related to increased sales and amortization expense.use taxes. These increases were partially offset by a $564,000 decrease in compensation-related expense; a $97,000$52,000 decrease in travel expense;expenses as a $37,000 decrease in recruiting fees; and a $3,000 net decrease in miscellaneous other sales and marketing expenses.result of COVID-19 cost control measures.
The increase in digital and social media marketing expenses for the fiscal year ended June 30, 2019,2020 compared to the twelve-month periodfiscal year ended June 30, 2018 (unaudited), comprises an $812,0002019 was primarily due to a $623,000 increase in Internet marketing andmarketing; a $54,000$524,000 increase in outside agency fees; a $110,000 increase in cooperative advertising.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 $153,000 decrease in outside agency fees;result of the COVID-19 pandemic; and a $50,000 decrease in promotional expenses; an $18,000 decrease$29,000 reduction in print media expenses;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 $5,000 net decreaseresult of its digital marketing redirection in all otherJune 2020, management further reduced advertising expenses.and digital marketing expenditures during the last month of Fiscal 2020.
Compensation expenses for the fiscal year ended June 30, 20192020 compared to the twelve-month periodfiscal year ended June 30, 2018 (unaudited) decreased2019 increased primarily as a result of a $714,000 decrease$201,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $47,000 decrease$71,000 increase in severance expense;accrual related to our June 2020 management reorganization and an $8,000 decrease in relocation expense. These decreases were partially offset by a $195,000 increase in bonus expenseworkforce reduction; and a $10,000$9,000 increase in employee stock-based compensation expense.
While 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 intent isoperations that led to invest significantlya $235,000 decrease 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.bonus expense.
General and Administrative
General and administrative expenses for the fiscal yearyears ended June 30, 20192020 and twelve months ended June 30, 2018 (unaudited)2019 are as follows:
| | Twelve Months Ended June 30, | | Change | |
| | 2019 | | 2018 | | Dollars | | | Percent | |
| | | | | | (unaudited) | | | | | | | |
| General and administrative | | $ | 4,640,810 | | | $ | 4,816,495 | | | $ | (175,685 | ) | | | -4 | % |
| | | 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, compared to $4.82 million for the twelve months ended June 30, 2018 (unaudited), a decreasean increase of approximately $176,000,$220,000, or 4%5%.
The decreaseincrease in general and administrative expenses for the fiscal year ended June 30, 20192020 compared to the twelve monthsfiscal year ended June 30, 2018 (unaudited)2019 was primarily due to a $332,000 decrease$250,000 increase in compensation expenses; a $236,000 increase in professional services; an $18,000 decrease in travel expenses;services fees; and a $12,000 decrease$6,000 increase in equipment-related rental expense; a $9,000 decrease in bank fees, which includes fees associated with the White Oak Credit Facility and credit card clearing transactions; and a $2,000 decrease in depreciation and amortization expense. These decreasesincreases were partially offset by an $85,000 increase$84,000 decrease in business franchise taxes and licenses, principally franchise taxes;licenses; a $33,000 increase$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;policy reflecting lower customer accounts receivable balances during the COVID-19 pandemic; a $29,000 increase$12,000 decrease in insurance expenses; a $20,000 increase in compensation expenses; a $19,000 increase ingeneral office-related expenses, which is primarily related to the timing of our annual meetinglower software maintenance agreement-related expenses; and shareholder communications due to the change in our fiscal year-end; a $6,000 increasenet decrease in board retainer fees; and a $5,000 net increase in miscellaneousall other general and administrative expenses.
Professional services decreased for the fiscal year ended June 30, 2019 compared to the twelve-month period ended June 30, 2018 (unaudited) primarily due to a decrease in legal fees of $332,000 principally as a result of hiring a full-time in-house counsel; a $23,000 decrease in investor and public relations expenses; and a decrease of $23,000 in consulting and other professional services primarily related to financial reporting consulting fees in the prior period. These decreases were partially offset by an increase of $46,000 in accounting services related to the timing of our annual and transition period audits due to the change in our fiscal year-end.
Compensation expenses increased for the fiscal year ended June 30, 20192020 compared to the twelve monthsfiscal year ended June 30, 2018 (unaudited)2019 primarily due to an $87,000a $282,000 increase in bonus expenseseverance accrual related to our June 2020 management reorganization and an $11,000workforce reduction; a $128,000 increase in salaries and related employee benefits in the aggregate; and a $33,000 increase in employee stock-based compensation expense. These increases were offset in part by cost control measures implemented as a $43,000result of the COVID-19 pandemic and its effect on our operations that led to a $193,000 decrease in severance expensesbonus expense.
Professional services fees increased for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 primarily due to a $158,000 increase in legal fees associated with corporate governance matters; a $38,000 increase in accounting services related to personnel changeshigher annual audit and tax fees, as well as fees associated with tax consulting services; a $30,000 increase in investor and public relations expenses; and a $35,000 decrease$10,000 increase in salariesconsulting and other professional services primarily in connection with nonrecurring accounting and financial reporting related employee benefits in the aggregate.consulting fees.
Loss on Foreign Currency Exchange
Loss on foreign currency exchange relatingrelated to foreign sales transacted in functional currencies other than the U.S. dollar settlement 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, 2019 and twelve months2020, 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, 2018 (unaudited) is as follows:
| | Twelve Months Ended June 30, | | Change | |
| | 2019 | | 2018 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| Loss on foreign currency exchange | | $ | 344 | | | $ | 5 | | | $ | 339 | | | | * | % |
* Not Meaningful
During the transition period ended June 30, 2018, we began developing an international direct-to-consumer presence. Accordingly, the underlying sales transactions have led to these immaterial2020, reflects changes in foreign currency exchange losses.
Gain on Insurance Claim Settlement
Gain on insurance claim settlement for the fiscal year ended June 30, 2019 and twelve months ended June 30, 2018 (unaudited) is as follows:
| | Twelve Months Ended June 30, | | Change | |
| | 2019 | | 2018 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| Gain on insurance claim settlement | | $ | - | | | $ | 183,217 | | | $ | (183,217 | ) | | | -100 | % |
In the fourth calendar year quarter of 2017, we recognized approximately $183,000 in connection with the settlement of an outstanding insurance claim related to recovery of costs previously expensed and written off associated with insured losses incurred in connection with a shipment of work-in-process materials. The gain represented the excess recovery over amounts previously expensed and written off in the previous trailing twelve-month financial reporting period. There was no such gainfluctuation during the fiscal year ended June 30, 2019.2020 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 ana net income tax expense of approximately $1,700 and a net income tax benefit of approximately $1,400 for the fiscal yearyears ended June 30, 2020 and 2019, compared with an income tax net benefit of approximately $309,000 for the twelve months ended June 30, 2018 (unaudited).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 and during the twelve-month period ended June 30, 2018 (unaudited), we recognized a federal income tax benefit in the amount of approximately $328,000 both of which relatethat 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, offset by approximately $22,000 and $19,000 of income tax expense relating to estimated tax, penalties, and interest associated with uncertain tax positions for the fiscal year ended June 30, 2019 and the twelve-month period ended June 30, 2018 (unaudited), respectively.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 June 30, 20192020 and June 30, 2018.2019.
Our statutory tax rate as of the fiscal year ended June 30, 20192020 is 22.16%22.11% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.16%1.11%, net of the federal benefit.
The Tax Act, which was signed into law in December 2017, among other things lowered the U.S. corporate income tax rate from 35% to that of 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 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Summary ResultsCertain 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 Operationsour 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 Transition Period Endedfiscal year ended June 30, 20182020:
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 Six Months Endedproducts – 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.
June 30, 2017 (Unaudited)
The following table sets forth certain consolidated statementsoperating 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 operationsour marketing activities, are based on financial results and customer-related data for charlesandcolvard.com, LLC, for the transition periodfiscal year ended June 30, 2018 and2020 compared to the six monthsfiscal year ended June 30, 2017 (unaudited):
| | | Six Months Ended June 30, | |
| | | 2018 | | | 2017 | |
| | | | | | (unaudited) | |
| Net sales | | $ | 13,163,048 | | | $ | 12,287,174 | |
| Costs and expenses: | | | | | | | | |
| Cost of goods sold | | | 8,298,286 | | | | 7,060,701 | |
| Sales and marketing | | | 3,856,796 | | | | 3,692,188 | |
| General and administrative | | | 2,601,554 | | | | 2,474,882 | |
| Research and development | | | - | | | | 3,143 | |
| Total costs and expenses | | | 14,756,636 | | | | 13,230,914 | |
| Loss from operations | | | (1,593,588 | ) | | | (943,740 | ) |
| Other expenses: | | | | | | | | |
| Interest expense | | | (293 | ) | | | (92 | ) |
| Loss on foreign currency exchange | | | (5 | ) | | | - | |
| Total other expenses | | | (298 | ) | | | (92 | ) |
| Loss before income taxes | | | (1,593,886 | ) | | | (943,832 | ) |
| Income tax net benefit (expense) | | | 318,060 | | | | (18,595 | ) |
| Net loss | | $ | (1,275,826 | ) | | $ | (962,427 | ) |
Consolidated Net Sales2019:
Consolidated net sales for1% 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 transition periodfiscal years ended June 30, 20182020 and the six months ended June 30, 2017 (unaudited) comprise the following:
| | Six Months Ended June 30, | | Change | |
| | 2018 | | 2017 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| Loose jewels | | $ | 6,999,998 | | | $ | 8,672,363 | | | $ | (1,672,365 | ) | | | -19 | % |
| Finished jewelry | | | 6,163,050 | | | | 3,614,811 | | | | 2,548,239 | | | | 70 | % |
| Total consolidated net sales | | $ | 13,163,048 | | | $ | 12,287,174 | | | $ | 875,874 | | | | 7 | % |
Consolidated2019, gross margin (defined as net sales were $13.16 millionless product line cost of goods sold) for the transition period ended June 30, 2018 compared to $12.29 million for the six months ended June 30, 2017 (unaudited), an increase of $876,000, or 7%. The increase in consolidated net sales for the transition period ended June 30, 2018 was due primarily to increased consumer awareness and demand for moissanite resulting in higher finished jewelry product net sales during the transition period ended June 30, 2018 in both our Online Channels segment and Traditional segment brick-and-mortar customers. However, this increase in the transition period ended June 30, 2018 was partially offset by lower loose jewel sales in our Traditional segment.
Sales58% of loose jewels represented 53% of total consolidated net sales for the transition period ended June 30, 2018, compared to 71% of total consolidated net sales for the six months ended June 30, 2017 (unaudited). For the transition period ended June 30, 2018, loose jewel sales were $7.00 million compared to $8.67 million for the six months ended December 31, 2017 (unaudited), a decrease of $1.67 million, or 19%. The decrease for the transition period ended June 30, 2018 was primarily due to lower loose jewel sales in our Traditional segment, driven by a large wholesale customer that had a one-time change in its inventory management practices across vendors.
Sales of finished jewelry represented 47% of total consolidated net sales for the transition period ended June 30, 2018, compared to 29% of total consolidated net sales for the six months ended June 30, 2017 (unaudited). For the transition period ended June 30, 2018, finished jewelry sales were $6.16 million compared to $3.61 million for the six months ended June 30, 2017 (unaudited), an increase of $2.55 million, or 70%. This increase was due primarily to strong finished jewelry sales in both our Online Channels segment and Traditional segment brick-and-mortar customers, which we believe resulted from leveraging our strategy to continue driving sales in 2018 through multiple channels. These results reflect the ongoing increased presence within our e-commerce outlets including marketplaces and through charlesandcolvard.com in our Online Channels segment and our expanded presence in Helzberg Diamonds stores in our Traditional segment.net sales.
U.S. net sales accounted for approximately 92% and 93% of total consolidated net sales during the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited), respectively. While the proportion of our consolidated net sales in the U.S. was essentially flat during the transition period ended June 30, 2018 compared with the six months ended June 30, 2017 (unaudited), U.S. net sales increased to $12.12 million, or 6%, during the transition period ended June 30, 2018 compared to $11.46 million in the six months ended June 30, 2017 (unaudited) as a result of increased sales to U.S. customers in both our Online Channels segment and Traditional segment.
Our largest U.S. customer during the transition period ended June 30, 2018 accounted for 12% of our total consolidated sales compared to 26% during the six months ended June 30, 2017 (unaudited). A second U.S. customer also accounted for 12% of our total consolidated net sales during the transition period ended June 30, 2018 but did not have net sales that represented 10% or more of total net sales for the six months ended June 30, 2017 (unaudited). No additional U.S. customers accounted for more than 10% of total consolidated sales during the transition period ended June 30, 2018 or the six months ended June 30, 2017 (unaudited).
International net sales accounted for approximately 8% and 7% of total consolidated net sales during the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited), respectively. While the proportion of our consolidated net sales in the international market was essentially flat during the transition period ended June 30, 2018 compared with the six months ended June 30, 2017 (unaudited), international net sales increased to $1.04 million, or 25%, during the transition period ended June 30, 2018 compared to $832,000 in the six months ended June 30, 2017 (unaudited) as we continue to serve distributors in international markets.
No international customers accounted for more than 10% of total consolidated sales during the transition period ended June 30, 2018 or the six months ended June 30, 2017 (unaudited). A portion of our international 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 transition period ended June 30, 2018 were, in order of sales volume, located in Hong Kong, Hong Kong, and India.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited) are as follows:
| | | Six Months Ended June 30, | | | Change | |
| | | 2018 | | | 2017 | | | Dollars | | | Percent | |
| | | | | | (unaudited) | | | | | | | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Loose jewels | | $ | 3,640,224 | | | $ | 4,403,274 | | | $ | (763,050 | ) | | | -17 | % |
| Finished jewelry | | | 3,435,233 | | | | 1,616,767 | | | | 1,818,466 | | | | 112 | % |
| Total product line cost of goods sold | | | 7,075,457 | | | | 6,020,041 | | | | 1,055,416 | | | | 18 | % |
| Non-product line cost of goods sold | | | 1,222,829 | | | | 1,040,660 | | | | 182,169 | | | | 18 | % |
| Total cost of goods sold | | $ | 8,298,286 | | | $ | 7,060,701 | | | $ | 1,237,585 | | | | 18 | % |
Total cost of goods sold was $8.30 million for the transition period ended June 30, 2018 compared to $7.06 million for the six months ended June 30, 2017 (unaudited), an increase of approximately $1.24 million, or 18%. Product line cost of goods sold is defined as product cost of goods sold in each of our Traditional segment and Online Channels 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; and other inventory adjustments, comprising costs of quality issues, damaged goods, and inventory write-downs.
The increase in cost of goods sold for the transition period ended June 30, 2018, as compared to the six months ended June 30, 2017 (unaudited) was due primarily to increased sales of finished jewelry during the first six months of 2018, which reflect higher material and labor costs, when compared to cost of goods sold in the same unaudited period of 2017 during which period we sold a higher level of loose jewels. The net increase in non-product line cost of goods sold comprises a $100,000 increase in freight out as a result of an increase in sales transaction volume; an $82,000 increase in non-capitalized manufacturing and production control expenses principally due to the timing when work-in-process is received into inventory and overhead is allocated; and a $47,000 increase in other inventory adjustments principally relating to production standard cost variances. These increases were offset in part by a $47,000 favorable change in inventory valuation allowances, including inventory obsolescence, shrinkage, recuts, and repairs reserves. 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 transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited) are as follows:
| | Six Months Ended June 30, | | | Change | |
| | 2018 | | 2017 | | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | | |
| Sales and marketing | | $ | 3,856,796 | | | $ | 3,692,188 | | | $ | 164,608 | | | | 4 | % |
Sales and marketing expenses were $3.86 million for the transition period ended June 30, 2018 compared to $3.69 million for the six months ended June 30, 2017 (unaudited), an increase of approximately $165,000, or 4%.
The increase in sales and marketing expenses for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited), was primarily due to a $235,000 increase in advertising and digital marketing expenses; a $37,000 increase in professional services fees; a $37,000 increase in general office-related expenses; a $25,000 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; and a $4,000 increase in depreciation and amortization expense. These increases were partially offset by a $113,000 decrease in compensation-related expense; a $22,000 decrease in recruiting fees; a $20,000 decrease in market research expenses; and an $18,000 decrease in travel expense.
The increase in advertising and digital marketing expenses for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) comprises a $118,000 increase in cooperative advertising; a $78,000 increase in outside agency fees; a $55,000 increase in Internet marketing; and a $14,000 increase in all other advertising expenses. These increases were partially offset by an $18,000 decrease in promotional expenses; and a $12,000 decrease in print media expenses.
Compensation-related expenses for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) decreased primarily as a result of a $189,000 decrease in severance expense primarily related to the departure of our Chief Revenue Officer during the first quarter of 2017; a $134,000 decrease in bonus expense; and a $20,000 decrease in relocation expense. These decreases were partially offset by a $229,000 increase in salaries, commissions, and related employee benefits in the aggregate; and a $1,000 increase in employee stock-based compensation expense.
General and Administrative
General and administrative expenses for the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited) are as follows:
| | Six Months Ended June 30, | | Change | |
| | 2018 | | 2017 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| General and administrative | | $ | 2,601,554 | | | $ | 2,474,882 | | | $ | 126,672 | | | | 5 | % |
General and administrative expenses were $2.60 million for the transition period ended June 30, 2018 compared to $2.47 million for the six months ended June 30, 2017 (unaudited), an increase of approximately $127,000, or 5%.
The increase in general and administrative expenses for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) was primarily due to a $215,000 increase in compensation expenses; a $98,000 increase in professional services; a $16,000 increase in board retainer fees; a $6,000 increase in miscellaneous other general and administrative expenses; and a $4,000 increase in depreciation and amortization expense. These increases were partially offset by an $86,000 decrease in bank fees, which includes fees associated with our prior credit facility with Wells Fargo and credit card clearing transactions; a $46,000 decrease in business taxes and licenses; a $38,000 decrease in computer and software related expenses; a $34,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; a $5,000 decrease in equipment-related rental expense; and a $3,000 decrease in insurance expenses.
Compensation expenses increased for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) primarily due to a $173,000 increase in salaries and related employee benefits in the aggregate; a $29,000 increase in employee stock-based compensation expense; and a $16,000 increase in bonus expense. These increases were partially offset by a decrease of $3,000 in severance expenses.
Professional services increased for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) primarily due to an increase of $87,000 in accounting services; an increase in legal fees of $51,000; and an increase of $21,000 in investor and public relations expenses. These increases were partially offset by a decrease of $61,000 in consulting and other professional services.
Provision for Income Taxes
We recognized an income tax net benefit of approximately $318,000 for the transition period ended June 30, 2018, compared with an income tax net expense of approximately $19,000 for the six months ended June 30, 2017 (unaudited). Our income tax provisions in these periods primarily relate to estimated tax, penalties, and interest associated with uncertain tax positions. However, during the transition period ended June 30, 2018, we recognized a federal income tax benefit in the amount of approximately $328,000 relating to the realization of the recoverable portion of the AMT deferred tax credit carryforwards being reclassified from a deferred tax asset to that of an income tax receivable, offset by approximately $10,000 of income tax expense relating to estimated tax, penalties, and interest associated with uncertain tax positions.
Our statutory tax rate as of the transition period ended June 30, 2018 was 22.13% and consisted of the federal income tax rate of 21% and a blended state income tax rate of 1.13%, net of the federal benefit.
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 requireremain 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 fundother 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 operating expensesuse 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 working capital requirements, including outlaysthat the PPP Loan will be forgiven, in whole or in part.
In April 2020, we also applied for capital expenditures. Asrelief 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 June 30,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 principal sourcesAMT credit refund in the amount of liquidity were cash, cash equivalents and restricted cash totaling $13.00 million, trade accounts receivableapproximately $270,000 is expected to be completely refundable. Accordingly, the full amount of $1.96 million, and netour AMT credit refund has been classified as current inventory of $11.91 million, as compared to cash and cash equivalents totaling $3.39 million, trade accounts receivable of $1.77 million, and net current inventory of $10.98 million as of June 30, 2018;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 and cash equivalents totaling $4.59 million, trade accounts receivable of $3.38 million, and net current inventory of $11.21 million as of December 31, 2017. flow.
As described more fully below, the cash, cash equivalents and restricted cash as of June 30, 2019, includes the net proceeds of approximately $9.06 million from the recent offeringa component of our common stockliquidity and capital structure, we also have access to our $5.00 million White Oak Credit Facility.
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.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 its effectivethe shelf registration statement is subject to market conditions.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
OnIn June 11, 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, onin July 3, 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 $0.93 million,$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. We intend to useDuring 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 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 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 to $23.17 million from $12.27 million at June 30, 2018. During the transition period ended June 30, 2018, our working capital decreased by approximately $2.44 million to $12.27 million from $14.70 million at December 31, 2017. 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. As described more fully below,
During the
decrease in working capital atfiscal year ended June 30,
2018 is primarily attributable to2020, 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
our cash and cash equivalents resulting from cash used in our operations and decreases in accounts receivable
as well as in our allocation of
inventory to short-term from long-term and$1.32 million; a decrease in prepaid expenses and other
assets.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
decreasesthe unfavorable effect of our net loss in
accounts payablethe amount of $6.16 million and
accrued expenses and other liabilities.
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.
During the transition period ended June 30, 2018, $1.04 million of cash was used by our operations. The primary drivers of our use of cash were a net loss of $1.28 million; an increase in inventory of $855,000; an increase in prepaid expenses and other assets of $271,000; a decrease in accounts payable of $295,000; and a decrease in accrued liabilities of $423,000. These factors were partially offset by a decrease in accounts receivable of $1.48 million. In addition, non-cash items totaling $594,000 partially offset the impact of the net loss and had a favorable impact on cash flow from continuing operations during the transition period ended June 30, 2018. The inventory increases during the fiscal
yearyears ended June 30,
20192020 and
the transition period ended June 30, 20182019 were, in part, due to the purchase of new raw material SiC crystals during each
periodfiscal 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.
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. Cash collections on sales made during our first and second fiscal quarters, which reflect robust year-end holiday sales, remained strong. During
As a result of the transition period ended June 30, 2018, accounts receivable decreased principally dueCOVID-19 pandemic, we offered extended Traditional segment customer payment terms beyond 90 days to increased cash collections during the transition period ended June 30, 2018 on sales madecertain credit-worthy customers during the third and fourth calendar quarters of 2017, which reflect year-end holiday sales levels. We did not offer any Traditional segment customers extended payment terms duringFiscal 2020. Because of the fiscal year ended June 30, 2019 orongoing impact of the transition period ended June 30, 2018; however, we may offerpandemic 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 could decrease.would likely be adversely impacted.
During the fiscal year ended June 30, 2020, prepaid expenses and other assets increased principally as a result of the timing of payments, principally for insurance-related expenses, in advance of goods or services received. During the fiscal year ended June 30, 2020, accounts payable increased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors’ payment terms. Likewise, accrued expenses and other liabilities increased principally due to the severance accrual in connection with our June 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to payments received prior to shipment of good from customers. During the fiscal year ended June 30, 2019, accrued expenses and other liabilities increased principally due to the timing of payments related to accrued compensation and related benefits, including year-end bonuses, as well as increased accrued sales and use taxes associated with higher current sales levels and additional liabilities for jurisdictions where we have reached sales tax nexus. During the transition period ended June 30, 2018, prepaid expenses and other assets increased principally as a result of an increase in other assets relating to the adoption of the new revenue recognition accounting standard as of January 1, 2018, and the timing of payments, principally for insurance-related expenses, in advance of goods or services received. During the transition period ended June 30, 2018 accounts payable decreased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors’ payment terms. Likewise, accrued expenses and other liabilities decreased principally due to the timing of payments related to accrued year-end bonuses.
We manufactured approximately
$14.09$10.64 million and
$7.36$14.09 million in loose jewels and
$7.66$7.82 million and
$7.61$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
yearyears ended June 30,
20192020 and
the transition period ended June 30, 2018,2019, 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,
we are subject to the worldwide fluctuation of the price of gold
that, ifhas increased
would resultsignificantly 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 June 30, 2020 and 2019, and June 30, 2018, $21.82$23.19 million and $20.85$21.82 million, respectively, of our inventories were classified as long-term assets. FinishedLoose jewel sales and finished jewelry that we manufacture and loose jewel sales 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 $3.81$3.53 million and $4.49 million as of June 30, 2019 and June 30, 2018, respectively, 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 and Moissanite by Charles & Colvard® 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 June 30, 2019, 79% of the total inventory was New Material, while 21% was Legacy Material, as compared to percentages of total inventory of 70% of New Material and 30% of Legacy Material at June 30, 2018. We are actively selling goods set with the Legacy Material gemstones through our omni-channel sales strategy in such outlets as marketplaces, drop-ship and pure-play retailers. 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 to provideprovided 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 was amended further to establishestablished 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 20232025 is approximately $52.9$52.95 million, of which approximately $43.98$36.60 million remains to be purchased as of June 30, 2019. As of June 30, 2018,2020.
For more information regarding the second amendment to our total purchase commitment under the Supply Agreement, was the full amountexecuted on August 26, 2020, see Note 15 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of the purchase commitment of approximately $52.9 million.this Annual Report on Form 10-K.
During the fiscal
yearyears ended June 30,
20192020 and
the transition period ended June 30, 2018,2019, we purchased approximately
$8.91$7.47 million and
$4.89$8.91 million, respectively, of SiC crystals from Cree.
These purchases of SiC crystals from Cree during the transition period ended June 30, 2018 were pursuant to the terms and conditions of the Supply Agreement prior to the effective date of its amendment as of June 22, 2018. 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.
We made income tax paymentsLine of
$74,000 and $44,000 during the fiscal year ended June 30, 2019 and the transition period ended June 30, 2018, respectively. As of June 30, 2019 and June 30, 2018, we had approximately $102,000 and $313,000, respectively, of remaining federal income tax credits that expire between 2020 and 2021 and all of which can be carried forward to offset future income taxes. As of June 30, 2019 and June 30, 2018, we also had federal tax net operating loss carryforwards of approximately $23.39 million and $26.28 million, respectively, expiring between 2030 and 2037, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $20.20 million and $20.24 million, respectively, expiring between 2023 and 2033; and various other state tax net operating loss carryforwards expiring between 2021 and 2034, which can be used to offset against future state taxable income.Credit
On July 13, 2018, we and our wholly-ownedwholly 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 and which is referred to as the Guarantor.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 covenants.
Advances under the White Oak Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers’ eligible accounts receivable and inventory, plus the value of precious metal jewelry components, less reserves. The inclusion of inventory and precious metal jewelry components in the borrowing base was subject to the completion of an inventory appraisal, which was completed subsequent to the execution of the White Oak Credit Facility. Eligible inventory is further limited to 60% of the net borrowing base, while precious metal jewelry components are limited to $500,000.
Advances may be either revolving or non-revolving. Non-revolving advances are limited to $1.00 million in aggregate principal amount outstanding and must be repaid on each January 15 (which may be effected by conversion to revolving advances, absent an event of default). There are no other mandatory prepayments or line reductions. We may elect to prepay advances in whole or in part at any time without penalty. In addition, the White Oak Credit Facility may be terminated by us at any time, subject to a $100,000 fee in the first year of the term of the White Oak Credit Facility, a $50,000 fee in the second year, and no fee thereafter. In connection with the White Oak Credit Facility, we will incur a non-refundable origination fee in the amount of $125,000 that is due and payable to White Oak in three installments. The first installment in the amount of $41,667 was paid upon execution of the White Oak Credit Facility on July 13, 2018 and the second installment in the amount of $41,667 was paid on July 13, 2019. The third and final installment in the amount of $41,666 will be due and payable on July 13, 2020, or the date of termination, whichever is sooner.
During the first year of the term of the White Oak Credit Facility, revolving advances will accrueaccrued 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 will accrueaccrued 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.
The White Oak 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. White Oak’s security interest in certain SiC material is subordinate to Cree’s security interest in such material pursuant to the Company’s Supply Agreement and an Intercreditor Agreement by and among the Borrowers and the Guarantor with White Oak. In addition, White Oak’s security interest in certain of our tangible personal property is subordinate to our landlord’s security interest in such tangible personal property.
The White Oak Credit Facility is evidenced by a credit agreement, dated as of July 13, 2018, or the Credit Agreement, a security agreement, dated as of July 13, 2018, or the Security Agreement, and customary ancillary documents. The Credit Agreement, Security Agreement, and ancillary documents contain customary covenants, representations, fees, and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, liens, loans, investments, mergers, acquisitions, divestitures, and affiliate transactions.
Events of default under the White Oak Credit Facility include, without limitation, a change in control, an event of default under other indebtedness of the Borrowers or Guarantor in excess of $250,000, a material adverse change in the business of the Borrowers or Guarantor or in their ability to perform their obligations under the White Oak Credit Facility, and other defined circumstances that White Oak believes may impair the prospect of repayment. If an event of default occurs, White Oak is entitled to take enforcement action, including acceleration of amounts due under the White Oak Credit Facility and foreclosure upon collateral. The Credit Agreement contains other customary terms that include indemnity, collateral monitoring fee, minimum interest charge, expense reimbursement, yield protection, and confidentiality provisions.
We had not borrowed against the White Oak Credit Facility as of June 30,
2019.2020. 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.
Prior to the executionA more detailed description of the White Oak Credit Facility
weis included in Note 10 to our consolidated financial statements in Item 8, “Financial Statements and
our wholly owned subsidiaries, Charles & Colvard Direct, LLC, and Moissanite.com, LLC (now charlesandcolvard.com, LLC)Supplementary Data”,
collectively referred to as the Wells Fargo Borrowers, had obtained a credit facility from Wells Fargo Bank, National Association, or Wells Fargo, hereinafter referred to as the Wells Fargo Credit Facility. The Wells Fargo Credit Facility was available 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. The effective date of the Wells Fargo Credit Facility was June 25, 2014, and it was scheduled to maturethis Annual Report on June 25, 2017. However, effective June 22, 2017, the Wells Fargo Credit Facility was amended to, among other things, extend the maturity date to June 25, 2018, the date upon which it matured in accordance with its terms.
Any advance would have accrued interest at a rate equal to either (i) Wells Fargo’s three-month LIBOR rate plus 2.00%, or (ii) Wells Fargo’s Prime Rate plus 1%, each calculated on an actual/360 basis and would have been payable monthly in arrears. Principal outstanding during an event of default, which did not occur during the term of the Wells Fargo Credit Facility, would have accrued interest at a rate of 3% in excess of the above rate. Any advance could have been prepaid in whole or in part at any time and there were no mandatory prepayments or line reductions.Form 10-K.
We had not borrowed against the Wells Fargo Credit Facility as of June 25, 2018, the date upon which the Wells Fargo Credit Facility maturedLiquidity and
was terminated in accordance with its terms.
As evidenced by what we believe is a vote of confidence by our shareholders and the financial success of the recent underwritten public offering of our common stock, we continue to execute our strategy to build and reinvest in our business. We plan to continue making various significant investments to drive near- and long-term sales growth, while balancing these initiatives with what we believe to be the overarching goal of generating ongoing and sustainable earnings improvement. While these steps have resulted from time to time in unprofitable financial results during the transition period ended June 30, 2018 and the year ended December 31, 2017, we will continue to be prudent about our investments by implementing a strategy that we believe will enable us to move nimbly, measure risks carefully and make data-driven decisions. When compared to the terms and covenants underlying our previous line of credit arrangement, we also believe that our White Oak Credit Facility, coupled with our potential ongoing access to the capital markets, combine to empower us to be more flexible and even more nimble when executing our strategic plans. We will continue to analyze each investment decision with the intent to grow our business while achieving our goal of maintaining profitable financial results and generating positive operating cash flows.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 the PPP Loan in whole or in part, access to available federal and state tax-related considerations, the issuance of equity securities, together withand 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, 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. 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 Policies and Estimates
The 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.
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.
Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstances of the specific account. During our reviews of customer accounts for the fiscal years ended June 30, 2020 and 2019, except for limited customers negatively affected by current economic conditions resulting from the COVID-19 pandemic, we determined no additional reserves were necessary for other specific accounts. Based on these criteria, as of June 30, 2020 and 2019, management determined that allowances for doubtful accounts receivable of $79,000 and $249,000, respectively, were required.
Deferred Tax Assets
As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. Beginning in 2014, management 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 2019.
Our deferred tax assets in Hong Kong were fully reserved with a valuation allowance of $996,000 as of June 30, 2020 and 2019, and had been fully reserved in all prior periods due to the uncertainty of future taxable income in this jurisdiction to utilize available deferred tax assets. Charles & Colvard (HK) Ltd., our Hong Kong subsidiary, which was re-activated in December 2017, but had no operating activity during the fiscal years ended June 30, 2020 and 2019, previously ceased operations during 2008 and became a dormant entity during 2009. If we use any portion of our deferred tax assets in future periods, the valuation allowance would need to be reversed and may impact our future operating results.
In connection with filing our 2017 U.S. corporate income tax return in June 2018, we analyzed the income tax effects of the Tax Act and the effect on our existing corporate AMT deferred tax asset, including the recoverability of our AMT-related deferred tax credit carryforwards. As a result, we determined that we were able to recognize the underlying tax benefit relating to the realization of the recoverable portion of its AMT-related deferred tax credit carryforwards, net of an anticipated sequestration reduction, in the amount of approximately $328,000. Accordingly, we recorded the expected AMT credit refund as a receivable, net of an anticipated sequestration reduction and such amount was included with other long-term assets in our consolidated balance sheets as of June 30, 2018.
In January 2019, the IRS announced that refund payments and refund offset transactions due to refundable minimum tax credits associated with the repeal of the corporate AMT as part of the Tax Act would not be subject to sequestration. Accordingly, in January 2019 we recognized the additional available underlying tax benefit and recorded the sequestered portion of its AMT credit refund in the amount of approximately $23,000. This amount, net of amounts received, was also included with other long-term assets in our consolidated balance sheets as of June 30, 2019.
In May 2019, we received our first installment refund in the amount of approximately $80,000 and approximately $6,000 in May 2019 and April 2020, respectively, from the IRS in accordance with the AMT refundability schedule as set forth in the Tax Act.
Pursuant to provisions of the CARES Act, 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.
For further discussion of the effects of the Tax Act, the CARES Act, and 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.
Uncertain Tax Positions
We account for the de-recognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positions in accordance with U.S. GAAP. 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 approximately $8,000 and $6,000 at June 30, 2020 and 2019, 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. Our liability for accrued interest on these uncertain tax positions has increased by approximately $2,000 and $1,000 as of June 30, 2020 and 2019, respectively.
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 Immaterial Correction of an Error caption for information regarding the release of a portion of our accrued income tax liability for uncertain tax positions that should have been derecognized in the prior years.
Recent Accounting Pronouncements
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 Recently Adopted/Issued Accounting Pronouncements caption for the description of recent accounting pronouncements, including the expected date of adoption and estimated effects, on our consolidated financial statements.
Off-Balance Sheet Arrangements
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 June 30, 20192020 and June 30, 2018,2019, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii)(ii) of Regulation S-K.
We have entered into an operating lease for approximately 36,350 square feet of mixed-use space, which we currently occupy, from an unaffiliated third-party for our offices and manufacturing facility in the normal course of business. This type of arrangement is often referred to as a form of off-balance sheet financing.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Not applicable.
| Item 8. | Financial Statements and Supplementary Data |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| | Page Number |
| | |
Report of Independent Registered Public Accounting Firm | 5449 |
| | |
Consolidated Balance Sheets as of June 30, 2019, June 30, 20182020 and December 31, 20172019 | 5550 |
| | |
Consolidated Statements of Operations for the fiscal yearyears ended June 30, 2019, the six months ended June 30, 20182020 and the calendar year ended December 31, 20172019 | 5651 |
| | |
Consolidated Statements of Shareholders’ Equity for the fiscal yearyears ended June 30, 2019, the six months ended June 30, 20182020 and the calendar year ended December 31, 20172019 | 5752 |
| | |
Consolidated Statements of Cash Flows for the fiscal yearyears ended June 30, 2019, the six months ended June 30, 20182020 and the calendar year ended December 31, 20172019 | 5853 |
| | |
Notes to Consolidated Financial Statements | 59
54 |
Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
Charles & Colvard, Ltd.
Morrisville, North Carolina
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Charles & Colvard, Ltd. (the “Company”) as of June 30, 2019, June 30, 20182020, and December 31, 2017,2019, the related consolidated statements of operations, shareholders’ equity, and cash flows for the yearyears then ended, June 30, 2019, the six-month transition period ended June 30, 2018 and the year ended December 31, 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at June 30, 2019, June 30, 20182020 and December 31, 2017,2019, and the results of its operations and its cash flows for the yearyears then ended, June 30, 2019, the six-month transition period ended June 30, 2018 and the year ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for leases during the year ended June 30, 2020 due to the adoption of Accounting Standards Codification Topic 842, Leases.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
We have served as the Company’s auditor since 2010.
Raleigh, North Carolina
September 5, 20193, 2020
CHARLES & COLVARD, LTD.
CONSOLIDATED BALANCE SHEETS
| | | June 30, | |
| | | 2020 | | | 2019 | |
| ASSETS | | | | | | |
| Current assets: | | | | | | |
| Cash and cash equivalents | | $ | 13,993,032 | | | $ | 12,465,483 | |
| Restricted cash | | | 624,202 | | | | 541,062 | |
| Accounts receivable, net | | | 670,718 | | | | 1,962,471 | |
| Inventory, net | | | 7,443,257 | | | | 11,909,792 | |
| Prepaid expenses and other assets | | | 1,177,860 | | | | 989,559 | |
| Total current assets | | | 23,909,069 | | | | 27,868,367 | |
| Long-term assets: | | | | | | | | |
| Inventory, net | | | 23,190,702 | | | | 21,823,928 | |
| Property and equipment, net | | | 999,061 | | | | 1,026,098 | |
| Intangible assets, net | | | 170,151 | | | | 97,373 | |
| Operating lease right-of-use assets | | | 584,143 | | | | - | |
| Other assets | | | 51,461 | | | | 330,615 | |
| Total long-term assets | | | 24,995,518 | | | | 23,278,014 | |
| TOTAL ASSETS | | $ | 48,904,587 | | | $ | 51,146,381 | |
| | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
| Current liabilities: | | | | | | | | |
| Accounts payable | | $ | 3,748,235 | | | $ | 3,279,548 | |
| Operating lease liabilities | | | 622,493 | | | | - | |
| Current maturity of long-term debt | | | 193,000 | | | | - | |
| Accrued expenses and other liabilities | | | 1,922,332 | | | | 1,418,232 | |
| Total current liabilities | | | 6,486,060 | | | | 4,697,780 | |
| Long-term liabilities: | | | | | | | | |
| Long-term debt, net | | | 772,000 | | | | - | |
| Noncurrent operating lease liabilities | | | 203,003 | | | | - | |
| Deferred rent | | | - | | | | 236,745 | |
| Accrued income taxes | | | 7,947 | | | | 6,214 | |
| Total long-term liabilities | | | 982,950 | | | | 242,959 | |
| Total liabilities | | | 7,469,010 | | | | 4,940,739 | |
| Commitments and contingencies (Note 9) | | | | | | | | |
| Shareholders’ equity: | | | | | | | | |
| Common stock, no par value; 50,000,000 shares authorized; 28,949,410 and 28,027,569 shares issued and outstanding at June 30, 2020 and 2019, respectively | | | 54,342,864 | | | | 54,342,864 | |
| Additional paid-in capital | | | 25,880,165 | | | | 24,488,147 | |
| Accumulated deficit | | | (38,787,452 | ) | | | (32,625,369 | ) |
| Total shareholders’ equity | | | 41,435,577 | | | | 46,205,642 | |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | | $ | 48,904,587 | | | $ | 51,146,381 | |
See Notes to Consolidated Financial Statements.
CHARLES & COLVARD, LTD.
CONSOLIDATED
BALANCE SHEETSSTATEMENTS OF OPERATIONS
| | | June 30, | | | December 31, | |
| | | 2019 | | | 2018 | | | 2017 | |
| ASSETS | | | | | | | | | |
| Current assets: | | | | | | | | | |
| Cash and cash equivalents | | $ | 12,465,483 | | | $ | 3,393,186 | | | $ | 4,594,007 | |
| Restricted cash | | | 541,062 | | | | - | | | | - | |
| Accounts receivable, net | | | 1,962,471 | | | | 1,765,722 | | | | 3,377,451 | |
| Inventory, net | | | 11,909,792 | | | | 10,979,891 | | | | 11,208,658 | |
| Prepaid expenses and other assets | | | 989,559 | | | | 916,162 | | | | 969,857 | |
| Total current assets | | | 27,868,367 | | | | 17,054,961 | | | | 20,149,973 | |
| Long-term assets: | | | | | | | | | | | | |
| Inventory, net | | | 21,823,928 | | | | 20,848,647 | | | | 19,764,959 | |
| Property and equipment, net | | | 1,026,098 | | | | 1,144,198 | | | | 1,242,200 | |
| Intangible assets, net | | | 97,373 | | | | 34,833 | | | | 8,597 | |
| Other assets | | | 330,615 | | | | 389,868 | | | | 64,978 | |
| Total long-term assets | | | 23,278,014 | | | | 22,417,546 | | | | 21,080,734 | |
| TOTAL ASSETS | | $ | 51,146,381 | | | $ | 39,472,507 | | | $ | 41,230,707 | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | | |
| Current liabilities: | | | | | | | | | |
| Accounts payable | | $ | 3,372,172 | | | $ | 4,170,952 | | | $ | 4,466,163 | |
| Accrued expenses and other liabilities | | | 1,325,608 | | | | 618,945 | | | | 980,800 | |
| Total current liabilities | | | 4,697,780 | | | | 4,789,897 | | | | 5,446,963 | |
| Long-term liabilities: | | | | | | | | | | | | |
| Deferred rent | | | 236,745 | | | | 393,051 | | | | 463,526 | |
| Accrued income taxes | | | 492,832 | | | | 471,126 | | | | 461,592 | |
| Total long-term liabilities | | | 729,577 | | | | 864,177 | | | | 925,118 | |
| Total liabilities | | | 5,427,357 | | | | 5,654,074 | | | | 6,372,081 | |
| Commitments and contingencies (Note 9) | | | | | | | | | | | | |
| Shareholders’ equity: | | | | | | | | | | | | |
Common stock, no par value; 50,000,000 shares authorized; 28,027,569, 21,705,173 and 21,580,102 shares issued and outstanding at June 30, 2019, June 30, 2018 and December 31, 2017, respectively | | | 54,342,864 | | | | 54,243,816 | | | | 54,243,816 | |
| Additional paid-in capital | | | 24,488,147 | | | | 14,962,071 | | | | 14,726,438 | |
| Accumulated deficit | | | (33,111,987 | ) | | | (35,387,454 | ) | | | (34,111,628 | ) |
| Total shareholders’ equity | | | 45,719,024 | | | | 33,818,433 | | | | 34,858,626 | |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | | $
| 51,146,381 | | | $ | 39,472,507 | | | $ | 41,230,707 | |
| | | 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 | |
| | | | | | | | | |
| Net (loss) income per common share: | | | | | | | | |
| Basic | | $ | (0.22 | ) | | $ | 0.10 | |
| Diluted | | | (0.22 | ) | | | 0.10 | |
| | | | | | | | | |
| Weighted average number of shares used in computing net (loss) income per common share: | | | | | | | | |
| Basic | | | 28,644,133 | | | | 21,860,699 | |
| Diluted | | | 28,644,133 | | | | 22,111,223 | |
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF
OPERATIONSSHAREHOLDERS’ EQUITY
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| | | | | | | | | | |
| Net sales | | $ | 32,244,109 | | | $ | 13,163,048 | | | $ | 27,032,964 | |
| Costs and expenses: | | | | | | | | | | | | |
| Cost of goods sold | | | 17,352,167 | | | | 8,298,286 | | | | 15,470,617 | |
| Sales and marketing | | | 7,983,506 | | | | 3,856,796 | | | | 7,477,354 | |
| General and administrative | | | 4,640,810 | | | | 2,601,554 | | | | 4,689,823 | |
| Research and development | | | 2,069 | | | | - | | | | 3,714 | |
| Total costs and expenses | | | 29,978,552 | | | | 14,756,636 | | | | 27,641,508 | |
| Income (Loss) from operations | | | 2,265,557 | | | | (1,593,588 | ) | | | (608,544 | ) |
| Other income (expense): | | | | | | | | | | | | |
| Interest income | | | 11,022 | | | | - | | | | - | |
| Interest expense | | | (2,198 | ) | | | (293 | ) | | | (541 | ) |
| Loss on foreign currency exchange | | | (344 | ) | | | (5 | ) | | | - | |
| Gain on insurance claim settlement | | | - | | | | - | | | | 183,217 | |
| Other expense | | | (13 | ) | | | - | | | | - | |
| Total other income (expense), net | | | 8,467 | | | | (298 | ) | | | 182,676 | |
| Income (Loss) before income taxes | | | 2,274,024 | | | | (1,593,886 | ) | | | (425,868 | ) |
| Income tax benefit (expense) | | | 1,443 | | | | 318,060 | | | | (27,609 | ) |
| Net income (loss) | | $ | 2,275,467 | | | $ | (1,275,826 | ) | | $ | (453,477 | ) |
| | | | | | | | | | | | | |
| Net income (loss) per common share: | | | | | | | | | | | | |
| Basic | | $ | 0.10 | | | $ | (0.06 | ) | | $ | (0.02 | ) |
| Diluted | | | 0.10 | | | | (0.06 | ) | | | (0.02 | ) |
| | | | | | | | | | | | | |
| Weighted average number of shares used in computing net income (loss) per common share: | | | | | | | | | | | | |
| Basic | | | 21,860,699 | | | | 21,406,487 | | | | 21,193,793 | |
| Diluted | | | 22,111,223 | | | | 21,406,487 | | | | 21,193,793 | |
| | | Common Stock | | | | | | | | | | |
| | | Number of Shares | | | Amount | | | Additional Paid-in Capital | | | Accumulated Deficit | | | Total Shareholders’ Equity | |
| Balance at June 30, 2018 | | | 21,705,173 | | | $ | 54,243,816 | | | $ | 14,962,071 | | | $ | (34,900,836 | ) | | $ | 34,305,051 | |
| Issuance of common stock, net of offering costs | | | 6,250,000 | | | | - | | | | 9,058,568 | | | | - | | | | 9,058,568 | |
| Stock-based compensation | | | - | | | | - | | | | 502,805 | | | | - | | | | 502,805 | |
| Issuance of restricted stock | | | 19,896 | | | | - | | | | - | | | | - | | | | - | |
| Stock option exercises | | | 52,500 | | | | 99,048 | | | | (35,297 | ) | | | - | | | | 63,751 | |
| Net income | | | - | | | | - | | | | - | | | | 2,275,467 | | | | 2,275,467 | |
Balance at June 30, 2019 | | | 28,027,569 | | | $ | 54,342,864 | | | $ | 24,488,147 | | | $ | (32,625,369 | ) | | $ | 46,205,642 | |
| Issuance of common stock, net of offering costs | | | 630,500 | | | | - | | | | 932,480 | | | | - | | | | 932,480 | |
| Stock-based compensation | | | - | | | | - | | | | 459,538 | | | | - | | | | 459,538 | |
| Issuance of restricted stock | | | 325,000 | | | | - | | | | - | | | | - | | | | - | |
| Retirement of restricted stock | | | (33,659 | ) | | | - | | | | - | | | | - | | | | - | |
| Net loss | | | - | | | | - | | | | - | | | | (6,162,083 | ) | | | (6,162,083 | )
|
| Balance at June 30, 2020 | | | 28,949,410 | | | $ | 54,342,864 | | | $ | 25,880,165 | | | $ | (38,787,452 | ) | | $ | 41,435,577 | |
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF
SHAREHOLDERS’ EQUITYCASH FLOWS
| | | Common Stock | | | | | | | | | | |
| | | Number of Shares | | | Amount | | | Additional Paid-in Capital | | | Accumulated Deficit | | | Total Shareholders’ Equity | |
| Balance at December 31, 2016 | | | 21,369,885 | | | $ | 54,243,816 | | | $ | 14,282,956 | | | $ | (33,658,151 | ) | | $ | 34,868,621 | |
| Stock-based compensation | | | - | | | | - | | | | 443,482 | | | | - | | | | 443,482 | |
| Issuance of restricted stock | | | 210,217 | | | | - | | | | - | | | | - | | | | - | |
| Net loss | | | - | | | | - | | | | - | | | | (453,477 | ) | | | (453,477 | ) |
| Balance at December 31, 2017 | | | 21,580,102 | | | $ | 54,243,816 | | | $ | 14,726,438 | | | $ | (34,111,628 | ) | | $ | 34,858,626 | |
| Stock-based compensation | | | - | | | | - | | | | 235,633 | | | | - | | | | 235,633 | |
| Issuance of restricted stock | | | 125,071 | | | | - | | | | - | | | | - | | | | - | |
| Net loss | | | - | | | | - | | | | - | | | | (1,275,826 | ) | | | (1,275,826 | ) |
| Balance at June 30, 2018 | | | 21,705,173 | | | $ | 54,243,816 | | | $ | 14,962,071 | | | $ | (35,387,454 | ) | | $ | 33,818,433 | |
| Issuance of common stock | | | 6,250,000 | | | | - | | | | 9,058,568 | | | | - | | | | 9,058,568 | |
| Stock-based compensation | | | - | | | | - | | | | 502,805 | | | | - | | | | 502,805 | |
| Issuance of restricted stock | | | 19,896 | | | | - | | | | - | | | | - | | | | - | |
| Stock option exercises | | | 52,500 | | | | 99,048 | | | | (35,297 | ) | | | - | | | | 63,751 | |
| Net income | | | - | | | | - | | | | - | | | | 2,275,467 | | | | 2,275,467 | |
| Balance at June 30, 2019 | | | 28,027,569 | | | $ | 54,342,864 | | | $ | 24,488,147 | | | $ | (33,111,987 | ) | | $ | 45,719,024 | |
| | | Year Ended June 30, | |
| | | 2020 | | | 2019 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | |
| Net (loss) income | | $ | (6,162,083 | ) | | $ | 2,275,467 | |
| Adjustments to reconcile net (loss) income to net cash provided by operating activities: | | | | | | | | |
| Depreciation and amortization | | | 490,235 | | | | 481,319 | |
| Stock-based compensation | | | 459,538 | | | | 502,805 | |
| Provision for uncollectible accounts | | | 8,788 | | | | 27,056 | |
| (Recovery of) Provision for sales returns | | | (42,000 | ) | | | 98,000 | |
| Inventory write-off | | | 5,863,991 | | | | 393,000 | |
| Provision for accounts receivable discounts | | | 3,751 | | | | 6,275 | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Accounts receivable | | | 1,321,214 | | | | (328,080 | ) |
| Inventory | | | (2,764,230 | ) | | | (2,298,182 | ) |
| Prepaid expenses and other assets, net | | | 490,438 | | | | (14,144 | ) |
| Accounts payable | | | 468,687 | | | | (891,404 | ) |
| Deferred rent | | | - | | | | (156,306 | ) |
| Accrued income taxes | | | 1,733 | | | | 21,706 | |
| Accrued expenses and other liabilities | | | 109,123 | | | | 799,287 | |
| Net cash provided by operating activities | | | 249,185 | | | | 916,799 | |
| | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | |
| Purchases of property and equipment | | | (458,854 | ) | | | (361,440 | ) |
| Payments for intangible assets | | | (77,122 | ) | | | (64,319 | ) |
| Net cash used in investing activities | | | (535,976 | ) | | | (425,759 | ) |
| | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | |
| Proceeds from long-term debt | | | 965,000 | | | | - | |
| Issuance of common stock, net of offering costs | | | 932,480 | | | | 9,058,568 | |
| Stock option exercises | | | - | | | | 63,751 | |
| Net cash provided by financing activities | | | 1,897,480 | | | | 9,122,319 | |
| | | | | | | | | |
| NET INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH | | | 1,610,689 | | | | 9,613,359 | |
| CASH, CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING OF YEAR | | | 13,006,545 | | | | 3,393,186 | |
| CASH, CASH EQUIVALENTS AND RESTRICTED CASH, END OF YEAR | | $ | 14,617,234 | | | $ | 13,006,545 | |
| | | | | | | | | |
| Supplemental disclosure of cash flow information: | | | | | | | | |
| Cash paid during the year for interest | | $ | 884 | | | $ | 2,198 | |
| Cash paid during the year for income taxes | | $ | 2,050 | | | $ | 5,764 | |
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | | | |
| Net income (loss) | | $ | 2,275,467 | | | $ | (1,275,826 | ) | | $ | (453,477 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | | | | | |
| Depreciation and amortization | | | 481,319 | | | | 229,993 | | | | 422,018 | |
| Stock-based compensation | | | 502,805 | | | | 235,633 | | | | 443,482 | |
| Provision for (recovery of) uncollectible accounts | | | 27,056 | | | | (4,511 | ) | | | 28,000 | |
| Provision for sales returns | | | 98,000 | | | | 110,390 | | | | 122,000 | |
| Provision for inventory reserves | | | 393,000 | | | | - | | | | 598,000 | |
| Provision for accounts receivable discounts | | | 6,275 | | | | 22,802 | | | | - | |
| Gain on insurance claim settlement | | | - | | | | - | | | | (183,217 | ) |
| Changes in operating assets and liabilities: | | | | | | | | | | | | |
| Accounts receivable | | | (328,080 | ) | | | 1,483,048 | | | | (732,825 | ) |
| Inventory | | | (2,298,182 | ) | | | (854,921 | ) | | | (3,503,032 | ) |
| Prepaid expenses and other assets, net | | | (14,144 | ) | | | (271,195 | ) | | | (36,250 | ) |
| Accounts payable | | | (798,780 | ) | | | (295,211 | ) | | | 489,014 | |
| Deferred rent | | | (156,306 | ) | | | (70,475 | ) | | | (131,390 | ) |
| Accrued income taxes | | | 21,706 | | | | 9,534 | | | | 27,609 | |
| Accrued expenses and other liabilities | | | 706,663 | | | | (361,855 | ) | | | 349,693 | |
| Net cash provided by (used in) operating activities | | | 916,799 | | | | (1,042,594 | ) | | | (2,560,375 | ) |
| | | | | | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | | | | |
| Purchases of property and equipment | | | (361,440 | ) | | | (130,649 | ) | | | (271,390 | ) |
| Payments for intangible assets | | | (64.319 | ) | | | (27,578 | ) | | | (1,501 | ) |
| Net cash used in investing activities | | | (425,759 | ) | | | (158,227 | ) | | | (272,891 | ) |
| | | | | | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | | | | |
| Issuance of common stock, net of offering costs | | | 9,058,568 | | | | - | | | | - | |
| Stock option exercises | | | 63,751 | | | | - | | | | - | |
| Net cash provided by financing activities | | | 9,122,319 | | | | - | | | | - | |
| | | | | | | | | | | | | |
| NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH | | | 9,613,359 | | | | (1,200,821 | ) | | | (2,833,266 | ) |
| CASH, CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING OF PERIOD | | | 3,393,186 | | | | 4,594,007 | | | | 7,427,273 | |
| CASH, CASH EQUIVALENTS AND RESTRICTED CASH, END OF PERIOD | | $ | 13,006,545 | | | $ | 3,393,186 | | | $ | 4,594,007 | |
| | | | | | | | | | | | | |
| Supplemental disclosure of cash flow information: | | | | | | | | | | | | |
| Cash paid during the period for interest | | $ | 2,198 | | | $ | 293 | | | $ | 541 | |
| Cash paid during the period for income taxes | | $ | 73,562 | | | $ | 43,774 | | | $ | 84,786 | |
See Notes to Consolidated Financial Statements.
CHARLES & COLVARD, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 1. | DESCRIPTION OF BUSINESS |
Charles & Colvard, Ltd. (the “Company”), a North Carolina corporation founded in 1995, manufactures, markets, and distributes Charles & Colvard Created Moissanite® (hereinafter referred to as moissanite or moissanite jewels) and finished jewelry featuring moissanite for sale in the worldwide jewelry market. Moissanite, also known by its chemical name silicon carbide (“SiC”), is a rare mineral first discovered in a meteorite crater. Because naturally occurring SiC crystals are too small for commercial use, larger crystals must be grown in a laboratory. The Company sells loose moissanite jewels and finished jewelry at wholesale prices to distributors, manufacturers, retailers, and designers, including some of the largest distributors and jewelry manufacturers in the world. The Company’s finished jewelry and loose moissanite jewels that are mounted into fine jewelry by other manufacturers are sold at retail outlets and via the Internet. The Company sells at retail prices to end-consumers through its wholly owned operating subsidiary, charlesandcolvard.com, LLC, third-party online marketplaces, drop-ship, and other pure-play, exclusively e-commerce outlets.
| 2. | BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES |
Basis of Presentation and Principles of Consolidation – The accompanying consolidated financial statements as of and for the fiscal yearyears ended June 30, 2019, as of2020 and for the six months ended June 30, 2018 and as of and for the calendar year ended December 31, 20172019, include the accounts of the Company and its wholly owned subsidiaries charlesandcolvard.com, LLC (formerly Moissanite.com, LLC), formed in 2011;LLC; Charles & Colvard Direct, LLC, formed in 2011;LLC; and Charles & Colvard (HK) Ltd., the Company’s Hong Kong subsidiary, which was re-activated in December 2017. Charles & Colvard Direct, LLC, had no operating activity during the fiscal yearyears ended June 30, 2019, the six-month period ended June 30, 2018 and the calendar year ended December 31, 2017.2020 or 2019. Charles & Colvard (HK) Ltd. previously became dormant in the second quarter of 2009 and has had no operating activity since its operations ceased in 2008. All intercompany accounts have been eliminated.eliminated.
Change in Fiscal Year-End – In January 2018, the Board of Directors of the Company approved a change in the Company’s fiscal year from that of a calendar year-end beginning on January 1 and ending on December 31 of each year to a fiscal year beginning on July 1 of each year and ending on June 30 of the following calendar year. This change to the fiscal year reporting cycle began July 1, 2018. As a result of the change, the Company had a six-month transition period from January 1, 2018 to June 30, 2018 (the “transition period ended June 30, 2018”). Accordingly, the Company is filing its audited financial results as of and for the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the calendar year ended December 31, 2017 in this Annual Report on Form 10-K with the U.S. Securities and Exchange Commission (the “SEC”).
Use of Estimates – The future effects of the COVID-19 pandemic on the Company’s results of operations, cash flows, and financial position continue to remain unclear. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (
“U.S. GAAP
”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The most significant estimates impacting the Company’s consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions,
cooperative advertising, and revenue recognition. Actual results could differ materially from those estimates.
ChangeReclassifications – Certain amounts in the Company’s consolidated financial statements for the fiscal year ended June 30, 2019 have been reclassified to conform to current presentation related to certain customer credit balances that were reclassified from accounts payable to accrued expenses and other liabilities in the amount of approximately $93,000. These reclassifications had no impact on the Company’s consolidated financial position or consolidated results of operations as of or for the fiscal years ended June 30, 2020 and 2019.
Changes in Accounting Policy – TheEffective July 1, 2019, the Company adopted the new lease accounting standard in connection with revenue recognition guidance that was issued by the Financial Accounting Standards Board (the “FASB”) with a, which requires leases to be recorded as right-of-use (“ROU”) assets and lease liabilities on the consolidated balance sheet and provides guidance on the recognition of lease expense and income. The new guidance requires the modified retrospective transition approach when applying the new standard to an entity’s leases existing at the date of theinitial application. The guidance further states that an entity’s date of initial application may be either the effective date upon which it adopts the new standard or the beginning of January 1, 2018. As a result, the Company changed its accounting policy for revenue recognitionearliest comparative period presented in the financial statements during the transition period ended June 30, 2018,in which it adopts the new guidance. The Company used the date of initial application as detailed belowthe effective date, and as such, financial information and disclosures required under the Revenue Recognition caption.new accounting standard will not be provided for dates and periods prior to July 1, 2019.
The new standard provides a number of practical expedients for transition and policy elections for ongoing accounting. The Company applied this new accountingelected the “package of practical expedients”, which permits the Company to not reassess its prior conclusions about lease identification, lease classification, and initial direct costs. The standard usingprovides policy election options for recognition exemption for short-term leases and separation of lease and non-lease components. The Company elected the modified retrospective approach. Based“short-term lease recognition” exemption and elected not to separate lease and non-lease components for all underlying asset classes. The Company determines lease and non-lease components based on observable information, including terms provided by the Company’s analysis, the timing and measurement of revenues under the new revenue recognition guidance is consistent with the Company’s prior policies. Accordingly, no adjustment was required to the Company’s opening balance of equity as of January 1, 2018. Except for required disclosures of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, the changes resulting from thelessor.
The adoption of the new accounting standard resulted in the recognition of ROU assets and lease liabilities of approximately $983,000 and $1.38 million, respectively, for operating leases as of July 1, 2019. For purposes of adopting this new guidance, the Company’s most appropriate option for an incremental borrowing rate assumption was to assume that it would be based on the underlying fully-collateralized borrowing rate in effect within the Company’s credit facility with White Oak Commercial Finance, LLC (“White Oak”). Pursuant to the terms of the Company’s credit facility with White Oak (the “White Oak Credit Facility”), as of July 1, 2019, the Company’s incremental borrowing rate for funds in the form of non-revolving advances would have been White Oak’s one-month LIBOR (2.3878%) plus 4.75%, or 7.1378%. Management believes that this rate represents the incremental borrowing rate that would have been in effect if the Company had borrowed such funds from its White Oak Credit Facility on July 1, 2019. Currently, the Company has no other material leases that qualify as finance, variable, or short-term leases. The adoption did not have a material effectimpact on the Company’s consolidated financial statements. Comparative prior period information for the calendar year ended December 31, 2017 has not been adjusted and continues to be reported under the accounting guidance in effect priorstatement of operations or consolidated statement of cash flows.
Subsequent to the changedate of accounting.adoption, the Company determines if a contract is or contains a lease at inception of the agreement. Operating leases are recognized as ROU assets and the related obligations are recognized as current or noncurrent liabilities on the Company’s consolidated balance sheet. Leases with an initial lease term of one year or less are not recorded on the balance sheet.
59ROU assets, which represent the Company’s right to use an underlying asset, and lease liabilities, which represent the Company’s obligation to make lease payments arising from the lease, are recognized based on the present value of the future lease payments over the lease term at the commencement date. The ROU asset also includes any lease payments made at or before the commencement date and any initial direct costs incurred and excludes lease incentives. Certain of the Company’s leases contain renewal and/or termination options. The Company recognizes renewal or termination options as part of its ROU assets and lease liabilities when the Company has the unilateral right to renew or terminate and it is reasonably certain these options will be exercised. The Company determines the present value of lease payments based on the implicit rate, which may be explicitly stated in the lease if available or the Company’s estimated collateralized incremental borrowing rate based on the term of the lease. For operating leases, lease expense is recognized on a straight-line basis over the lease term.
Some leases could require the Company to pay non-lease components, which may include taxes, maintenance, insurance and certain other expenses applicable to the leased property, and are primarily considered variable costs. When applicable, such costs are expensed as incurred.
For additional information regarding the Company’s accounting for lease arrangements, see Note 9, “Commitments and Contingencies.”
Cash and Cash Equivalents – All highly liquid investments with an original maturity of three months or less from the date of purchase are considered to be cash equivalents. The Company’s cash and cash equivalents include cash on deposit and a money market fund. See the Restricted Cash caption below for further details on the nature and classifications of the Company’s restricted cash balances.
Restricted Cash – In accordance with cash management process requirements relating to the Company’s asset-based revolving credit facility from White Oak Commercial Finance, LLC (“White Oak”), there are access and usage restrictions on certain cash deposit balances for periods of up to two business days during which time such deposits are held by White Oak for the benefit of the Company. During the period these cash deposits are held by White Oak, such amounts are classified as restricted cash for reporting purposes on the Company’s Consolidated Balance Sheets. In the event that the Company has an outstanding balance on its revolving credit facility from White Oak, restricted cash balances held by White Oak would be applied to reduce such outstanding amounts.
The Company has full access to its cash balances without restriction following the period of time such cash is held by White Oak. For additional information regarding the Company’s asset-based revolving credit facility, see Note 10, “Line of Credit.”
The reconciliation of cash, cash equivalents, and restricted cash, as presented on the Consolidated Statements of Cash Flows, consists of the following as of the dates presented:
| | | | June 30, | |
| | | Year Ended June 30, 2019 | | Six Months Ended June 30, 2018 | | Year Ended December 31, 2017 | | | 2020 | | | 2019 | |
| Cash and cash equivalents | | $ | 12,465,483 | | | $ | 3,393,186 | | | $ | 4,594,007 | | | $ | 13,993,032 | | | $ | 12,465,483 | |
| Restricted cash | | | 541,062 | | | | - | | | | - | | | | 624,202 | | | | 541,062 | |
| Total cash, cash equivalents and restricted cash | | $ | 13,006,545 | | | $ | 3,393,186 | | | $ | 4,594,007 | | |
| Total cash, cash equivalents, and restricted cash | | | $ | 14,617,234 | | | $
| 13,006,545 | |
Concentration of Credit Risk – Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash on deposit and cash equivalents held with one bank and trade accounts receivable. At times, cash and cash equivalents balances may exceed the Federal Deposit Insurance Corporation (“FDIC”) insurable limits. The Company’s money market fund investment account (recognized as cash and cash equivalents) is with what the Company believes to be a high-quality issuer. The Company has never experienced any losses related to these balances. Non-interest-bearing amounts on deposit in
excess of FDIC insurable limits at June 30,
2020 and 2019
June 30, 2018 and December 31, 2017 approximated
$2.12 million, $3.11$2.01 million and
$4.32$2.12 million, respectively. Interest-bearing amounts on deposit in excess of FDIC insurable limits at June 30,
2020 and 2019
June 30, 2018approximated $11.64 million and
December 31, 2017 approximated $10.01 million,
$0 and $0, respectively.
Trade receivables potentially subject the Company to credit risk. Payment terms on trade receivables for the Company’s Traditional segment customers are generally between 30 and 90 days, though it may offer extended terms with specific customers and on significant orders from time to time. The Company extends credit to its customers based upon a number of factors, including an evaluation of the customer’s financial condition and credit history that is verified through trade association reference services, the customer’s payment history with the Company, the customer’s reputation in the trade, and/or an evaluation of the Company’s opportunity to introduce its moissanite jewels or finished jewelry featuring moissanite to new or expanded markets. Collateral is not generally required from customers. The need for an allowance for doubtful accounts is determined based upon factors surrounding the credit risk of specific customers, historical trends, and other information.
See Note 13, “Major Customers and Concentration of Credit Risk”, for further discussion of credit risk within trade accounts receivable.
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, the Company estimates 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 it reduces sales and trade accounts receivable by this estimated amount. The Company’s allowance for sales returns was $746,000, $648,000$704,000 and $537,000$746,000 at June 30, 2019, June 30, 20182020 and December 31, 2017,2019, respectively.
The following are reconciliations of the allowance for sales returns balances as of the periods presented:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| Balance, beginning of period | | $ | 648,000 | | | $ | 537,000 | | | $ | 415,000 | |
| Additions charged to operations | | | 4,533,077 | | | | 2,462,049 | | | | 3,878,736 | |
| Sales returned | | | (4,435,077 | ) | | | (2,351,049 | ) | | | (3,756,736 | ) |
| Balance, end of period | | $ | 746,000 | | | $ | 648,000 | | | $ | 537,000 | |
| | | Year Ended June 30, | |
| | | 2020 | | | 2019 | |
| Balance, beginning of year | | $ | 746,000 | | | $ | 648,000 | |
| Additions charged to operations | | | | | | | 4,533,077 | |
| Sales returns | | | | ) | | | (4,435,077 | ) |
| Balance, end of year | | $ | 704,000 | | | $ | 746,000 | |
The second reserve is an allowance for doubtful accounts for estimated losses resulting from the failure of the Company’s 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, the Company determines a percentage based on the age of the receivable that it deems uncollectible. The allowance is then calculated by applying the appropriate percentage to each of the Company’s 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. The Company generally uses an internal collection effort, which may include its sales personnel as it deems appropriate. After all internal collection efforts have been exhausted, the Company generally writes off the account receivable.
Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstances of the specific account. During its review for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017,2019, the Company determined no additional reserves were necessary for specific accounts. Based on these criteria, management determined that allowances for doubtful accounts receivable of $249,000, $233,000$79,000 and $254,000$249,000 at June 30, 2020 and 2019, June 30, 2018 and December 31, 2017, respectively, were required.
The following are reconciliations of the allowance for doubtful accounts balances as of the periods presented:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| Balance, beginning of period | | $ | 233,000 | | | $ | 254,000 | | | $ | 226,000 | |
| Additions (reductions) charged to operations | | | 27,056 | | | | (4,511 | ) | | | 28,000 | |
| Write-offs, net of recoveries | | | (11,056 | ) | | | (16,489 | ) | | | - | |
| Balance, end of period | | $ | 249,000 | | | $ | 233,000 | | | $ | 254,000 | |
| | | Year Ended June 30, | |
| | | 2020 | | | 2019 | |
| Balance, beginning of year | | $ | 249,000 | | | $ | 233,000 | |
| Additions charged to operations | | | 8,788 | | | | 27,056 | |
| Write-offs, net of recoveries | | | (178,788 | ) | | | (11,056 | ) |
| Balance, end of year | | $ | 79,000 | | | $ | 249,000 | |
Although the Company believes that its reserves are adequate, if the financial condition of its customers deteriorates, resulting in an impairment of their ability to make payments, or if it underestimates the allowances required, additional allowances may be necessary, which would result in increased expense in the period in which such determination is made.
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 the Company’s current requirements based on historical and anticipated levels of sales is classified as long-term on the Company’s Consolidated Balance Sheets. The Company’s classification of its inventory as either current or long-term inventory requires it 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.
Each accounting period, the Company evaluates the valuation and classification of inventories including the need for potential adjustments to inventory-related reserves, which also include significant estimates by management. The Company’s inventory-related valuation allowances are recorded in the aggregate rather than an individual item approach for each obsolescence, rework, and shrinkage valuation allowance.
Property and Equipment – Property and equipment are stated at cost and are depreciated over their estimated useful lives using the straight-line method as follows:
Machinery and equipment | 5 to 12 years |
Computer hardware | 3 to 5 years |
Computer software | 3 years |
Furniture and fixtures | 5 to 10 years |
Leasehold improvements | Shorter of the estimated useful life or the lease term |
Intangible Assets – The Company capitalizes costs associated with obtaining or defending patents issued or pending for inventions and license rights related to the manufacture of moissanite jewels. Such costs are amortized over the life of the patent, generally 15 years. The Company also capitalizes licenses it obtains for the use of certain advertising images and external costs incurred for trademarks. Such costs are amortized over the period of the license or estimated useful life of the trademark, respectively.
Impairment of Long-Lived Assets – The Company evaluates the recoverability of its long-lived assets by reviewing them for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of the asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment is measured as the amount by which the carrying amount exceeds the fair value and is recognized as an operating expense in the period in which the determination is made. Assets to be disposed are reported at the lower of the carrying amount or fair value less costs to sell once the held-for-sale criteria are met. As of June 30, 2019,2020, the Company did not identify any indicators of long-lived asset impairment.
In addition to the recoverability assessment, the Company routinely reviews the remaining estimated useful lives of its long-lived assets. Any reduction in the useful-life assumption will result in increased depreciation and amortization expense in the period when such determination is made, as well as in subsequent periods.
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 the Company expects to be entitled in exchange for those goods or services. To achieve this principle, the Company performs the following five steps: (i)(i) identification of a contract with a customer; (ii)(ii) identification of any separate performance obligations; (iii)(iii) determination of the transaction price; (iv)(iv) allocation of the transaction price to the performance obligations in the contract; and (v)(v) recognition of revenue when the Company has satisfied the underlying performance obligations. The Company recognizes substantially all of its revenue at a point in time when control of the Company’s goods has passed to the customer which typically occurs upon shipment, with the exception of consigned goods. The Company considers its sole performance obligation related to the shipment of goods satisfied at the time this control is transferred. Customer payment terms for these shipments typically range between 30- and 90-days. The Company has elected to treat shipping and handling performed after control has transferred to customers as a fulfillment activity, and additionally, has elected the practical expedient to report sales taxes on a net basis. The Company records shipping and handling expense related to product sales as cost of sales.
The Company has a variable consideration element related to most of its 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 the Company’s Traditional segment and Online Channels segment 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. The Company’s charlesandcolvard.com customers can return purchases for any reason within 60 days of such purchase in accordance with the Company’s returns policy as disclosed on the charlesandcolvard.com website.
Periodically, the Company ships 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. The Company’s 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 the Company that it will keep the inventory. Accordingly, the Company does not recognize revenue on these consignment transactions until the earlier of (i)(i) the customer informing the Company that it will keep the inventory; (ii)(ii) the expiration of the right of return period; or (iii)(iii) the customer informing the Company that the inventory has been sold.
Certain Traditional segment finished jewelry customers have migrated from consignment arrangements whereby the terms were strictly consignment-only to that of a blended program whereby the terms comprise both consignment and sale of asset arrangements. The structure of these new blended programs allows the Company to recognize the finished jewelry sale and related revenue in accordance with the Company’s revenue recognition accounting policy for the asset portion of these programs upon transfer of the Company’s finished jewelry to the retail customer.
In March 2019, the Company entered into a nonmonetary transaction with a Raleigh, North Carolina, based professional sports team. In accordance with the terms of the agreement, in exchange for a specific quantity of finished jewelry items the Company received certain sponsorship and advertising benefits, which based on the sports team’s current sponsorship and advertising market rate card prices, are valued at approximately $117,000. The Company’s finished jewelry in connection with this transaction, the cost of which is based on the Company’s stated inventory average cost accounting method, was designed and produced to meet discrete specifications and branding requirements of the professional sports team. In accordance with the Company’s revenue recognition policy, it recognized the full amount of the sponsorship and advertising benefits as gross revenue upon delivery of the finished jewelry in April 2019 and the deferred cost of the advertising is recorded and classified within prepaid expenses and other assets in the Company’s Consolidated Balance Sheet and is being amortized and recognized in sales and marketing expenses over the professional sports team’s current competitive season that runs from April through September 2019.
The Company presents disaggregated net sales by its Online Channels segment and its Traditional segment for both finished jewelry and loose jewels product lines. The Company also presents disaggregated net sales by geographic area between the United States and international locations. For financial reporting purposes, disaggregated net sales amounts are presented in Note 3, “Segment Information and Geographic Data.”
Returns Asset and Refund Liabilities
In connection with the Company’s adoption of the revenue recognition accounting standard issued by the FASB as of the initial application date of January 1, 2018, theThe Company establishedmaintains a returns asset account and a refund liabilities account to record the effects of its estimated product returns and sales returns allowance. The Company’s returns asset and refund liabilities are updated at the end of each financial reporting period and the effect of such changes are accounted for in the period in which such changes occur.
The Company estimates anticipated product returns in the form of a refund liability based on historical return percentages and current period sales levels. The Company also accrues a related returns asset for goods expected to be returned in salable condition, less any expected costs to recover such goods, including return shipping costs that the Company may incur. As of June 30, 2019, June 30, 20182020 and December 31, 2017,2019, the Company’s refund liabilities balances were $746,000, $648,000$704,000 and $537,000,$746,000, respectively, and are included as allowances for sales returns within accounts receivable, net, in the accompanying Consolidated Balance Sheets.consolidated balance sheets. As of June 30, 2019, June 30, 20182020 and December 31, 2017,2019, the Company’s returns asset balances were $279,000, $250,000$289,000 and $0,$279,000, respectively, and are included within prepaid expenses and other assets in the accompanying Consolidated Balance Sheets. Prior to the adoption of the new consolidated balance sheetsrevenue recognition accounting standard, the Company reported the net effect of its estimated returns asset as an adjustment to its inventory balances..
Cost of Goods Sold – Cost of goods sold is primarily composed of inventory sold during the period; inventory written off during the period due to ongoing quality and obsolescence reviews or through customer returns; salaries and payroll-related expenses for personnel involved in preparing and shipping product to customers; an allocation of shared expenses such as rent, utilities, communication expenses, and depreciation related to preparing and shipping product to customers; and outbound freight charges.
Advertising Costs – Advertising production costs are expensed as incurred. Media placement costs are expensed the first time the underlying advertising appears.
The Company also offers a cooperative advertising program to certain of its distributor and retail partners that reimburses, via a credit towards future purchases, a portion of their marketing costs based on the customers’ net purchases from the Company and is subject to the customer providing documentation of all advertising performed that includes the Company’s products. For the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017,2019, these approximate amounts were $381,000, $154,000$491,000 and $210,000,$381,000, respectively, and are included as a component of sales and marketing expenses.
Advertising expenses, inclusive of the cooperative advertising program, for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017,2019, were approximately $2.82 million, $1.09$3.96 million and $1.94$2.82 million, respectively.
Sales and Marketing – Sales and marketing costs are expensed as incurred. These costs include all expenses of promoting and selling the Company’s products and include such items as the salaries, payroll-related expenses, and travel of sales and marketing personnel; digital marketing; advertising; trade shows; market research; sales commissions; and an allocation of overhead expenses attributable to these activities. Except for an allocation to general and administrative expenses, these costs also include the operating expenses of charlesandcolvard.com, LLC, the Company’s wholly owned operating subsidiary.
General and Administrative – General and administrative costs are expensed as incurred. These costs include the salaries and payroll-related expenses of executive, finance, information technology, and administrative personnel; legal, investor relations, and professional fees; general office and administrative expenses; Board of Directors fees; rent; bad debts; and insurance.
Research and Development – Research and development costs are expensed as incurred. These costs primarily comprise salary allocations, samples of competitive products entering the market, and consultant fees associated with the study of product enhancement and manufacturing process efficiencies.
Stock-Based Compensation – The Company recognizes compensation expense for stock-based awards based on estimated fair values on the date of grant. The Company uses the Black-Scholes-Merton option pricing model to determine the fair value of stock options. The fair value of other stock-based compensation awards is determined by the market price of the Company’s common stock on the date of grant. The expense associated with stock-based compensation is recognized on a straight-line basis over the requisite service period of each award.
Fair value of stock options using the Black-Scholes-Merton option pricing model is estimated on the date of grant utilizing certain assumptions for dividend yield, expected volatility, risk-free interest rate, and expected lives of the awards, as follows:
Dividend Yield. Although the Company issued dividends in prior years, a dividend yield of zero is used due to the lack of recent dividend payments and the uncertainty of future dividend payments;
Expected Volatility. Volatility is a measure of the amount by which a financial variable such as share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company estimates expected volatility giving primary consideration to the historical volatility of its common stock;
Risk-Free Interest Rate. The risk-free interest rate is based on the published yield available on U.S. Treasury issues with an equivalent term remaining equal to the expected life of the stock option; and
Expected Lives. The expected lives of the issued stock options represent the estimated period of time until exercise or forfeiture and are based on the simplified method of using the mid-point between the vesting term and the original contractual term.
The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and the Company uses different assumptions, the Company’s stock-based compensation expense could be materially different in the future. In addition, the Company is required to estimate the expected forfeiture rates of stock-based awards and only recognize expense for those shares expected to vest. In estimating the Company’s forfeiture rates, the Company analyzed its historical forfeiture rates, the remaining lives of unvested stock-based awards, and the number of vested awards as a percentage of total awards outstanding. If the Company’s actual forfeiture rates are materially different from its estimates, or if the Company re-evaluates the forfeiture rates in the future, the stock-based compensation expense could be significantly different from what the Company has recorded in the current period.
Income Taxes – Deferred income taxes are recognized for the income tax consequences of “temporary” differences by applying enacted statutory income tax rates applicable to future years to differences between the financial statement carrying amounts and the income tax bases of existing assets and liabilities. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount that is more likely than not to be realized.
In light of the Tax CutsThe Coronavirus Aid, Relief, and JobsEconomic Security Act (the “Tax“CARES Act”) enactedprovides that existing alternative minimum tax (“AMT”) credit carryforwards are now eligible for acceleration and refundable AMT credits are to be completely refunded to companies for taxable years beginning in December 2017,2019, or by election, taxable years beginning in 2018. Accordingly, the Company provisionally recorded its U.S. deferred taxes as ofhas elected to have the calendar year ended December 31, 2017, based on the federal corporate incomeAMT tax rate of 21%. In June 2018, the Companycompletely refunded and has filed its 2017 U.S. corporate income tax return, and in conjunction therewith, finalized its accounting policy with respect to accounting for its deferred income taxes as of anda tentative refund claim for the transition period ended June 30, 2018. remaining AMT tax credit. For further discussion of the effects of the TaxCARES Act on ourthe Company’s income tax provision and deferred tax assets, see Note 12, “Income Taxes.”
Net (Loss) Income (Loss) per Common Share – Basic net (loss) income (loss) per common share is computed by dividing net (loss) income (loss) by the weighted average number of common shares outstanding during the periods. Diluted net (loss) income (loss) per common share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the periods. Common equivalent shares consist of stock options and unvested restricted shares that are computed using the treasury stock method. Anti-dilutive stock awards consist of stock options that would have been anti-dilutive in the application of the treasury stock method.
The following table reconciles the differences between the basic and diluted net (loss) income (loss) per share presentations:
| | | | Year Ended June 30, | |
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | 2020 | | | 2019 | |
| Numerator: | | | | | | | | | | | | | | | |
| | $ | 2,275,467 | | | $ | (1,275,826 | ) | | $ | (453,477 | ) | |
| Net (loss) income | | | $ | (6,162,083 | ) | | $ | 2,275,467 | |
| | | | | | | | | | | | | | | | |
| Denominator: | | | | | | | | | | | | | | | |
| Weighted average number of common shares outstanding: | | | | | | | | | | |
| Weighted average common shares outstanding: | | | | | | | |
| Basic | | 21,860,699 | | | 21,406,487 | | | 21,193,793 | | | 28,644,133 | | | 21,860,699 | |
| Effect of dilutive securities | | | 250,524 | | | | - | | | | - | | | | - | | | | 250,524 | |
| Diluted | | | 22,111,223 | | | | 21,406,487 | | | | 21,193,793 | | | | 28,644,133 | | | | 22,111,223 | |
| | | | | | | | | | | | | | | | |
| Net income (loss) per common share: | | | | | | | | | | |
| Net (loss) income per common share: | | | | | | | |
| Basic | | $ | 0.10 | | | $ | (0.06 | ) | | $ | (0.02 | ) | | $ | (0.22 | ) | | $ | 0.10 | |
| Diluted | | 0.10 | | | (0.06 | ) | | (0.02 | ) | | $ | (0.22 | ) | | $ | 0.10 | |
For the fiscal year ended June 30, 2019,2020, stock options to purchase approximately 2.81 million shares were excluded from the six-month periodcomputation of diluted net loss per common share because the effect of inclusion of such amounts would be anti-dilutive to net loss per common share. For the fiscal year ended June 30, 2018, and the calendar year ended December 31, 2017,2019, stock options to purchase approximately 2.33 million 2.39 million and 2.38 million shares, respectively, were excluded from the computation of diluted net income (loss) per common share because the exercise price of the stock options was greater than the average market price of the common shares or the effect of inclusion of such amounts would be anti-dilutive to net income (loss) per common share. For the fiscal year ended June 30, 2019, noThe quantity of 162,500 shares of unvested restricted shares that were issued but not yet vested were excluded from the computation of diluted net income per common share. For the transition period ended June 30, 2018 and the calendar year ended December 31, 2017, approximately 264,000 and 355,000, respectively, of restricted shares that were issued but not yet vested werestock are excluded from the computation of diluted net loss per common share as of June 30, 2020 because the shares are performance-based and the underlying conditions have not been met as of the periods presented and the effects of the inclusion of such number of shares would be anti-dilutive to net income or loss per common share. Additionally,
Immaterial Correction of an Error – An immaterial error correction was made within the underwriters’ over-allotment optionCompany’s financial statements for the quarterly period ended December 31, 2019. The Company determined that an accrued income tax liability for uncertain tax positions should have been derecognized in the prior years. Specifically, the Company had a liability of approximately $492,000 relating to purchase 630,500 shares is excluded fromuncertain tax positions that should have been derecognized between the computationfiscal years ended December 31, 2012 and December 31, 2015. The Company evaluated the effect of diluted netthis error and concluded it was not material to any of its previously issued consolidated financial statements. Upon revision, the Company recorded a reduction to the accrued income per share astax liability and related accumulated deficit balance of approximately $492,000 which has been reflected in the June 30, 2019 because the effects of inclusion would be anti-dilutive to net income per common share. Recently Adopted/Issued Accounting Pronouncements – In February 2016, as amended in July 2018 and amended further in December 2018 and March 2019, the Financial Accounting Standards Board (the “FASB”) issued guidance which requires lessees to recognize a right-of-use (“ROU”) asset and lease liability on theconsolidated balance sheet for most lease arrangements and expands disclosures about leasing arrangements for both lessees and lessors, among other items. The new standard is effective for fiscal years beginning after December 15, 2018, which makes the new standard effective for the Company on July 1, 2019. The Company may apply the transition provisions of the new guidance, as amended, either at the beginning of the earliest period presented in the Company’sthis annual report on Form 10-K for the fiscal year endingended June 30, 2020. The impact of this error on the consolidated statement of operations for the fiscal years ended June 30, 2020 which would be July 1, 2018, or on the effective date of adoption, which would be July 1, 2019. Among other requirements, the transition provisions require the lessee to recognize an ROU asset and liability2019, including for most existing lease arrangements on the date the transition provisions are applied. The Company has elected to apply the transition provisions of this new standard on July 1, 2019. Therefore,interim financial reporting periods prior to the effective date of adoption will continue to be reported consistent withtherein, was the accounting guidance in effect prior to the change of accounting. All of the Company’s existing lease arrangements are classified as operating leases, which will continue to be classified as operating under the new guidance. Upon adoption of the new standard on July 1, 2019, the Company will record an ROU assetde minimis and lease liability in amounts that will be material on its Consolidated Balance Sheet for the Company’s lease arrangements. The Company has identified all of its leases and is finalizing the analysis of its incremental borrowing rate in order to quantify the amounts to be recorded upon adoption of the new accounting guidance. Management does not anticipate that adoption of this new guidance will have a significanthad no impact on the Company’s net earnings orconsolidated statements of cash flows.flows for the fiscal years ended June 30, 2020 and 2019. Related balances within Note 12, “Income Taxes”, associated with the federal tax benefit on state income taxes under uncertain tax positions and the related valuation allowance have also been recast for the two-year period ended June 30, 2020.
Recently Issued Accounting Pronouncements – In June 2018,2016, the FASB issued guidance that is intendedrelated to reduce costthe measurement of credit losses on financial instruments and
complexityto provide more information in financial statements about expected credit losses on financial instruments and other commitments to improve financial reporting for share-based payments to nonemployees. Thisextend credit. The new guidance is effective for fiscal years beginning after December 15, 2018.2019. The Company
will adoptdoes not expect the adoption of the new guidance
asto have a material impact to the Company’s financial statements.
In August 2018, the FASB issued additional guidance in connection with accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. The updated guidance is effective for fiscal years beginning after December 15, 2019. The Company is in the process of July 1, 2019, as required,finalizing its analysis and believes the impacteffect of the adoption of this new pronouncement is not expected to be material to the Company’s financial statements.
In December 2019, the FASB issued guidance on simplifying the accounting for income taxes that is intended to reduce the complexity while maintaining or improving the usefulness of tax disclosure information in financial statements. The new guidance is effective for fiscal years beginning after December 15, 2020. The Company does not expect the impact of the new guidance to have a material impact to the Company’s financial statements.
In March 2020, in response to concerns about structural risks of interbank offered rates (“IBORs”), and, particularly, the risk of cessation of the London Interbank Offered Rate (“LIBOR”), the FASB issued new guidance to ease the burden in accounting for or recognizing the effects of referenced interest rate reform on financial reporting. The new guidance is effective as of March 12, 2020 through December 31, 2022. As described in more detail in Note 10, “Line of Credit”, borrowings under the Company’s line of credit are based on a rate equal to the one-month LIBOR. As of June 30, 2020, the Company had not borrowed against its line of credit, and therefore, is not subject to recognizing or disclosing any effect of referenced rate reform as of its fiscal year ended June 30, 2020.
| 3. | SEGMENT INFORMATION AND GEOGRAPHIC DATA |
The Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of the Company’s operating and reportable segments.
The Company manages its business through two operating and reportable segments based on its distribution channels to sell its product lines – finished jewelry and loose jewels: its “Online Channels” segment, which consists of e-commerce outlets including charlesandcolvard.com, third-party online marketplaces, drop-ship, and other pure-play, exclusively e-commerce outlets; and its “Traditional” segment, which consists of wholesale and retail customers. The accounting policies of the Online Channels segment and Traditional segment are the same as those described in Note 2, “Basis of Presentation and Significant Accounting Policies.”
The Company evaluates the financial performance of its segments based on net sales; product line gross profit, or the excess of product line sales over product line cost of goods sold; and operating income (loss). income. The Company’s product line cost of goods sold is defined as product cost of goods sold, excluding non-capitalized expenses from the Company’s manufacturing and production control departments, comprising personnel costs, depreciation, rent, utilities, and corporate overhead allocations; freight out; inventory valuation allowance adjustments; and other inventory adjustments, comprising costs of quality issues, damaged goods, and inventory write-downs.
The Company allocates certain general and administrative expenses between its Online Channels segment and its Traditional segment based on net sales and number of employees to arrive at segment operating income (loss). income. Unallocated expenses remain in its Traditional segment.
Summary financial information by reportable segment for the periods presented is as follows:
| | | Year Ended June 30, 2019 | |
| | | Online Channels | | | Traditional | | | Total | |
| Net sales | | | | | | | | | |
| Finished jewelry | | $ | 12,641,687 | | | $ | 2,815,656 | | | $ | 15,457,343 | |
| Loose jewels | | | 3,697,069 | | | | 13,089,697 | | | | 16,786,766 | |
| Total | | $ | 16,338,756 | | | $ | 15,905,353 | | | $ | 32,244,109 | |
| | | | | | | | | | | | | |
| Product line cost of goods sold | | | | | | | | | | | | |
| Finished jewelry | | $ | 5,220,551 | | | $ | 1,638,561 | | | $ | 6,859,112 | |
| Loose jewels | | | 1,583,404 | | | | 6,659,426 | | | | 8,242,830 | |
| Total | | $ | 6,803,955 | | | $ | 8,297,987 | | | $ | 15,101,942 | |
| | | | | | | | | | | | | |
| Product line gross profit | | | | | | | | | | | | |
| Finished jewelry | | $ | 7,421,136 | | | $ | 1,177,095 | | | $ | 8,598,231 | |
| Loose jewels | | | 2,113,665 | | | | 6,430,271 | | | | 8,543,936 | |
| Total | | $ | 9,534,801 | | | $ | 7,607,366 | | | $ | 17,142,167 | |
| | | | | | | | | | | | | |
| Operating income | | $ | 1,643,552 | | | $ | 622,005 | | | $ | 2,265,557 | |
| | | | | | | | | | | | | |
| Depreciation and amortization | | $ | 172,819 | | | $ | 308,500 | | | $ | 481,319 | |
| | | | | | | | | | | | | |
| Capital expenditures | | $ | 69,975 | | | $ | 291,465 | | | $ | 361,440 | |
| | | Six Months Ended June 30, 2018 | | | Year Ended June 30, 2020 | |
| | | Online Channels | | | Traditional | | | Total | | | Online Channels | | | Traditional | | | Total | |
| Net sales | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 4,490,984 | | | $ | 1,672,066 | | | $ | 6,163,050 | | | $ | 13,680,440 | | | $ | 3,097,188 | | | $ | 16,777,628 | |
| Loose jewels | | | 1,878,388 | | | | 5,121,660 | | | | 6,999,998 | | | | 2,944,100 | | | | 9,467,292 | | | | 12,411,392 | |
| Total | | $ | 6,369,322 | | | $ | 6,793,726 | | | $ | 13,163,048 | | | $ | 16,624,540 | | | $ | 12,564,480 | | | $ | 29,189,020 | |
| | | | | | | | | | | | | | | | | | | |
| Product line cost of goods sold | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 1,972,862 | | | $ | 1,462,371 | | | $ | 3,435,233 | | | $ | 5,760,413 | | | $ | 1,709,377 | | | $ | 7,469,790 | |
| Loose jewels | | | 951,664 | | | | 2,688,560 | | | | 3,640,224 | | | | 1,198,275 | | | | 4,863,911 | | | | 6,062,186 | |
| Total | | $ | 2,924,526 | | | $ | 4,150,931 | | | $ | 7,075,457 | | | $ | 6,958,688 | | | $ | 6,573,288 | | | $ | 13,531,976 | |
| | | | | | | | | | | | | | | | | | | |
| Product line gross profit | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 2,518,122 | | | $ | 209,695 | | | $ | 2,727,817 | | | $ | 7,920,027 | | | $ | 1,387,811 | | | $ | 9,307,838 | |
| Loose jewels | | | 926,674 | | | | 2,433,100 | | | | 3,359,774 | | | | 1,745,825 | | | | 4,603,381 | | | | 6,349,206 | |
| Total | | $ | 3,444,796 | | | $ | 2,642,795 | | | $ | 6,087,591 | | | $ | 9,665,852 | | | $ | 5,991,192 | | | $ | 15,657,044 | |
| | | | | | | | | | | | | | | | | | | |
| Operating loss | �� | $ | (243,832 | ) | | $ | (1,349,756 | ) | | $ | (1,593,588 | ) | | $ | (249,016 | ) | | $ | (6,066,712 | )
| | $ | (6,315,728 | ) |
| | | | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | $ | 59,409 | | | $ | 170,584 | | | $ | 229,993 | | | $ | 177,703 | | | $ | 312,532 | | | $ | 490,235 | |
| | | | | | | | | | | | | | | | | | | |
| Capital expenditures | | $ | 29,689 | | | $ | 100,960 | | | $ | 130,649 | | | $ | 305,570 | | | $ | 153,284 | | | $ | 458,854 | |
| | | Year Ended December 31, 2017 | | | Year Ended June 30, 2019 | |
| | | Online Channels | | Traditional | | Total | | | Online Channels | | | Traditional | | | Total | |
| Net sales | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 7,936,773 | | | $ | 2,515,443 | | | $ | 10,452,216 | | | $ | 12,641,687 | | | $ | 2,815,656 | | | $ | 15,457,343 | |
| Loose jewels | | | 3,149,972 | | | | 13,430,776 | | | | 16,580,748 | | | | 3,697,069 | | | | 13,089,697 | | | | 16,786,766 | |
| Total | | $ | 11,086,745 | | | $ | 15,946,219 | | | $ | 27,032,964 | | | $ | 16,338,756 | | | $ | 15,905,353 | | | $ | 32,244,109 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Product line cost of goods sold | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 3,615,815 | | | $ | 1,610,845 | | | $ | 5,226,660 | | | $ | 5,220,551 | | | $ | 1,638,561 | | | $ | 6,859,112 | |
| Loose jewels | | | 1,526,358 | | | | 6,998,485 | | | | 8,524,843 | | | | 1,583,404 | | | | 6,659,426 | | | | 8,242,830 | |
| Total | | $ | 5,142,173 | | | $ | 8,609,330 | | | $ | 13,751,503 | | | $ | 6,803,955 | | | $ | 8,297,987 | | | $ | 15,101,942 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Product line gross profit | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 4,320,958 | | | $ | 904,598 | | | $ | 5,225,556 | | | $ | 7,421,136 | | | $ | 1,177,095 | | | $ | 8,598,231 | |
| Loose jewels | | | 1,623,614 | | | | 6,432,291 | | | | 8,055,905 | | | | 2,113,665 | | | | 6,430,271 | | | | 8,543,936 | |
| Total | | $ | 5,944,572 | | | $ | 7,336,889 | | | $ | 13,281,461 | | | $ | 9,534,801 | | | $ | 7,607,366 | | | $ | 17,142,167 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | $ | 228,253 | | | $ | (836,797 | ) | | $ | (608,544 | ) | |
| Operating income | | | $ | 1,643,552 | | | $ | 622,005 | | | $ | 2,265,557 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | $ | 121,710 | | | $ | 300,308 | | | $ | 422,018 | | | $ | 172,819 | | | $ | 308,500 | | | $ | 481,319 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Capital expenditures | | $ | 147,446 | | | $ | 123,944 | | | $ | 271,390 | | | $ | 69,975 | | | $ | 291,465 | | | $ | 361,440 | |
The Company does not allocate any assets to the reportable segments, and therefore, no asset information is reported to the chief operating decision-maker or disclosed in the financial information for each segment.
The reconciliations of the Company’s product line cost of goods sold to cost of goods sold, as reported in the consolidated financial statements for the periods presented, are as follows:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| | | | | | | | | | |
| Product line cost of goods sold | | $ | 15,101,942 | | | $ | 7,075,457 | | | $ | 13,751,503 | |
| Non-capitalized manufacturing and production control expenses | | | 1,442,446 | | | | 805,400 | | | | 1,352,311 | |
| Freight out | | | 578,772 | | | | 272,790 | | | | 417,074 | |
| Inventory valuation allowances | | | 393,000 | | | | - | | | | 598,000 | |
| Other inventory adjustments | | | (163,993 | ) | | | 144,639 | | | | (648,271 | ) |
| Cost of goods sold | | $ | 17,352,167 | | | $ | 8,298,286 | | | $ | 15,470,617 | |
| | | Year Ended June 30, | |
| | | 2020 | | | 2019 | |
| Product line cost of goods sold | | $ | 13,531,976 | | | $ | 15,101,942 | |
| Non-capitalized manufacturing and production control expenses | | | 1,443,698 | | | | 1,442,446 | |
| Freight out | | | 510,612 | | | | 578,772 | |
| Inventory write-off | | | | | | | 393,000 | |
| Other inventory adjustments | | | | )
| | | (163,993 | ) |
| Cost of goods sold | | $ | 21,200,207 | | | $ | 17,352,167 | |
The Company recognizes sales by geographic area based on the country in which the customer is based. Sales to international end consumers made through ourthe Company’s transactional website, charlesandcolvard.com, are included in international sales for financial reporting purposes. During periods prior to the quarterly periodquarter ended December 31, 2018, sales to international end consumers made through charlesandcolvard.com were included in U.S. sales because during those prior periods products were shipped and invoiced to a U.S.-based intermediary party that assumed all international shipping and credit risks. Currently, sales to international end consumers are made directly by the Company’s own transactional website. A portion of the Company’s Traditional segment sales made to international wholesale distributors represents products sold internationally that may be re-imported to U.S. retailers.
All intangible assets, andas well as property and equipment, as of June 30, 2019, June 30, 20182020 and December 31, 20172019, are held and located in the United States.
The following presents net sales data by geographic area for the periods presented:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | Year Ended June 30, | |
| Net sales: | | | | | | | | | | |
| | | | 2020 | | | 2019 | |
| Net sales | | | | | | | |
| United States | | $ | 27,979,835 | | | $ | 12,121,003 | | | $ | 25,176,220 | | | $ | 26,814,024 | | | $ | 27,979,835 | |
| International | | | 4,264,274 | | | | 1,042,045 | | | | 1,856,744 | | | | 2,374,996 | | | | 4,264,274 | |
| Total | | $ | 32,244,109 | | | $ | 13,163,048 | | | $ | 27,032,964 | | | $ | 29,189,020 | | | $ | 32,244,109 | |
| 4. | FAIR VALUE MEASUREMENTS |
Under U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability.
The fair value hierarchy consists of three levels based on the reliability of inputs, as follows:
Level 11. - Quoted prices in active markets for identical assets and liabilities;
Level 22. - Inputs other than Level 1 quoted prices that are directly or indirectly observable; and
Level 33. - Unobservable inputs that are not corroborated by market data.
The Company evaluates assets and liabilities subject to fair value measurements on a recurring and non-recurring basis to determine the appropriate level to classify them for each reporting period. This determination requires significant judgments to be made by management of the Company. The financial instruments identified as subject to fair value measurements on a recurring basis are cash and cash equivalents, trade accounts receivable, and trade accounts payable. All financial instruments are reflected in the Consolidated Balance Sheetsconsolidated balance sheets at carrying value, which approximates fair value due to the short-term nature of these financial instruments.
Assets that are measured at fair value on a non-recurring basis include property and equipment, leasehold improvements, and intangible assets, comprising patents, license rights, and trademarks. These items are recognized at fair value when they are considered to be impaired. As of June 30, 2019, June 30, 20182020 and December 31, 2017,2019, no assets were identified for impairment. Level 3 inputs are primarily based on the estimated future cash flows of the asset determined by market inquiries to establish fair market value of used machinery or future revenue expected to be generated with the assistance of patents and trademarks.
The Company’s total inventories, net of reserves, are as followsconsisted of the following as of the dates presented:
| | | June 30, | |
| | | 2020 | | | 2019 | |
| Finished jewelry: | | | | | | |
| Raw materials | | $ | 821,536 | | | $ | 643,797 | |
| Work-in-process | | | 602,390 | | | | 487,680 | |
| Finished goods | | | 6,019,985 | | | | 6,332,533 | |
| Finished goods on consignment | | | 2,297,907 | | | | 1,867,549 | |
| Total finished jewelry | | | 9,741,818 | | | | 9,331,559 | |
| Loose jewels: | | | | | | | | |
| Raw materials | | | 3,526,399 | | | | 3,806,681 | |
| Work-in-process | | | 10,453,586 | | | | 10,384,143 | |
| Finished goods | | | 6,619,487 | | | | 9,878,691 | |
| Finished goods on consignment | | | 204,635 | | | | 203,535 | |
| Total loose jewels | | | 20,804,107 | | | | 24,273,050 | |
| Total supplies inventory | | | 88,034 | | | | 129,111 | |
| Total inventory | | $ | 30,633,959 | | | $ | 33,733,720 | |
| | | June 30, | | | December 31, | |
| | | 2019 | | | 2018 | | | 2017 | |
| Raw materials | | $ | 4,450,478 | | | $ | 5,083,436 | | | $ | 4,853,049 | |
| Work-in-process | | | 10,871,823 | | | | 10,659,786 | | | | 9,219,383 | |
| Finished goods | | | 18,557,224 | | | | 17,483,773 | | | | 17,896,992 | |
| Finished goods on consignment | | | 2,086,084 | | | | 523,971 | | | | 1,093,752 | |
| Supplies inventory | | | 129,111 | | | | 45,572 | | | | 75,441 | |
| Less: inventory reserves | | | (2,361,000 | ) | | | (1,968,000 | ) | | | (2,165,000 | ) |
| Total classified inventories | | $ | 33,733,720 | | | $ | 31,828,538 | | | $ | 30,973,617 | |
| | | | | | | | | | | | | |
| Short-term portion | | $ | 11,909,792 | | | $ | 10,979,891 | | | $ | 11,208,658 | |
| Long-term portion | | | 21,823,928 | | | | 20,848,647 | | | | 19,764,959 | |
| Total short- and long-term inventories | | $ | 33,733,720 | | | $ | 31,828,538 | | | $ | 30,973,617 | |
As of the dates presented, the Company’s total inventories, net of reserves, are classified as follows:
| | | June 30, | |
| | | 2020 | | | 2019 | |
| Short-term portion | | $ | 7,443,257 | | | $ | 11,909,792 | |
| Long-term portion | | | 23,190,702 | | | | 21,823,928 | |
| Total inventory | | $ | 30,633,959 | | | $ | 33,733,720 | |
The Company’s work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurredincurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. The Company’s 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, 2019, June 30, 20182020 and December 31, 2017,2019, work-in-process inventories issued to active production jobs approximated $1.23 million, $2.45$1.34 million and $2.99$1.23 million, respectively.
The Company’s jewels do not degrade in quality over time and inventory generally consists of the shapes and sizes most commonly used in the jewelry industry. In addition, the majority of jewel inventory is not mounted in finished jewelry settings and is therefore not subject to fashion trends, norand product obsolescence is obsolescence a significant factor.closely monitored and reviewed by management as of and for each financial reporting period.
The Company manufactures finished jewelry featuring moissanite. Relative to loose moissanite jewels, finished jewelry is more fashion-oriented and subject to styling trends that could render certain designs obsolete over time. The majority of the Company’s finished jewelry featuring moissanite is held in inventory for resale and largely consists of such core designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets that tend not to be subject to significant obsolescence risk due to their classic styling. In addition, the Company generally holds smaller quantities of designer-inspired and trend moissanite fashion jewelry that is available for resale through retail companies and through its Online Channels segment. The Company also carries a limited amount of inventory as part of its sample line that is used in the selling process to its customers.
The Company’s continuing operating subsidiary carriessubsidiaries carry no net inventories, and inventory is transferred without intercompany markup from the parent entity as product line cost of goods sold when sold to the end consumer.
The Company’s total inventories net of reserves, consisted ofare stated at the following as of the dates presented:
| | | June 30, | | | December 31, | |
| | | 2019 | | | 2018 | | | 2017 | |
| Finished jewelry: | | | | | | | | | |
| Raw materials | | $ | 643,797 | | | $ | 595,649 | | | $ | 564,689 | |
| Work-in-process | | | 487,680 | | | | 1,196,268 | | | | 890,664 | |
| Finished goods | | | 6,332,533 | | | | 5,517,951 | | | | 6,304,747 | |
| Finished goods on consignment | | | 1,867,549 | | | | 476,648 | | | | 1,007,471 | |
| Total finished jewelry | | | 9,331,559 | | | | 7,786,516 | | | | 8,767,571 | |
| Loose jewels: | | | | | | | | | | | | |
| Raw materials | | | 3,806,681 | | | | 4,487,787 | | | | 4,288,360 | |
| Work-in-process | | | 10,384,143 | | | | 9,463,518 | | | | 8,328,719 | |
| Finished goods | | | 9,878,691 | | | | 10,015,822 | | | | 9,487,245 | |
| Finished goods on consignment | | | 203,535 | | | | 29,323 | | | | 26,281 | |
| Total loose jewels | | | 24,273,050 | | | | 23,996,450 | | | | 22,130,605 | |
| Total supplies inventory | | | 129,111 | | | | 45,572 | | | | 75,441 | |
| Total inventory | | $ | 33,733,720 | | | $ | 31,828,538 | | | $ | 30,973,617 | |
Total net finished jewelry inventories at June 30, 2019, June 30, 2018 and December 31, 2017, including inventory on consignment net of reserves and finished jewelry featuring moissanite manufactured by the Company, were $9.33 million, $7.79 million, and $8.77 million, respectively. Total net loose jewel inventories at June 30, 2019, June 30, 2018 and December 31, 2017, including inventory on consignment net of reserves, were $24.27 million, $24.00 million and $22.13 million, respectively.
As of June 30, 2019, June 30, 2018 and December 31, 2017, management established an obsolescence reserve of $1.79 million, $1.30 million and $1.42 million, respectively. Typically, in the jewelry industry, slow-moving or discontinued lines are sold as closeouts or liquidated in alternative sales channels. Regularly, management reviews both the finished jewelry inventory and the legacy loose jewel inventory for any lower of cost or net realizable value on an average cost basis. Each accounting period the Company evaluates the valuation and obsolescence issues. Accordingly, asclassification of June 30, 2019, June 30, 2018inventories including the need for potential adjustments to inventory-related reserves, which also include significant estimates by management. As a result of the deterioration of marketability of the Company’s legacy inventory, management determined that the inventory has lost its revenue-generating ability and Decemberthe net realizable value of this inventory has fallen below that of its historical carrying cost. The Company recognized a loss in net realizable value in the quarterly period ended March 31, 2017, management identified certain2020, for its legacy material inventory, i.e., raw materials, or boules, preforms, work-in-process gemstones, finished gemstones, and gemstones set in finished jewelry, that was obsolete due to damage and other factors that indicate the finished jewelry is unsaleable, and established an obsolescence reserve of $19,000, $7,000 and $91,000, respectively, for the carrying costscost of which was approximately $5.26 million.
Included in excesscost of any estimated scrap values. Likewise, with respect to the Company’s loose jewels inventory, based on current period demand, and ongoing feedback from distribution customers on the value of some of these goods management identified some of the remaining inventory of these lower quality goods that could not be sold at its current carrying value. Accordingly, management’s analysis of items sold during the fiscal year ended June 30, 2019, resulted in an increase in2020, is the lowerabove-referenced write-off of cost or net realizableapproximately $5.26 million representing the carrying value reserve on this remaining inventory to approximately $1.77 million as of June 30, 2019 from $1.29 million as of June 30, 2018. This reserve balance was $1.33 million as of December 31, 2017.
As of June 30, 2019, June 30, 2018 and December 31, 2017, management established a rework reserve for recut and repairs of $460,000, $534,000 and $557,000, respectively. Finished jewelry inventories at June 30, 2019, June 30, 2018 and December 31, 2017 include a repairs reserve of $0, $116,000 and $89,000, respectively. Thethe Company’s legacy loose jewel inventories at June 30, 2019, June 30, 2018inventory and December 31, 2017 included recut reserves of $460,000, $418,000 and $468,000, respectively.
As of June 30, 2019, June 30, 2018 and December 31, 2017, management established a shrinkage reserve of $112,000, $136,000 and $191,000, respectively. Finished jewelry inventories at June 30, 2019, June 30, 2018 and December 31, 2017 include shrinkage reserves of $105,000, $88,000 and $173,000, respectively. The loose jewel inventories at June 30, 2019, June 30, 2018 and December 31, 2017 include shrinkage reserves of $7,000, $48,000 and $18,000, respectively.
Periodically, the Company ships finished goods inventory to certain 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. Included in the total shrinkage reserve is the shrinkage reserve for finished goods on consignment of $15,000, $18,000 and $60,000 as of June 30, 2019, June 30, 2018 and December 31, 2017, respectively, to allow for certain finished jewelry inventory set with these legacy gemstones. The legacy inventory raw materials were purchased and loose jewels on consignment with certain Traditional segment customers that may not be returned or may be returned in a condition that does not meetfinished gemstone products were produced through the period ended August 2015. These gemstone products and finished jewelry items are known and marketed as the Company’s current grading or quality standards. Finished jewelry inventories on consignment at June 30, 2019, June 30, 2018older Forever ClassicTM, Forever Brilliant®, and December 31, 2017 include shrinkage reserves of $14,000, $7,000 and $55,000, respectively. The loose jewel inventories on consignment at June 30, 2019, June 30, 2018 and December 31, 2017 include shrinkage reserves of $1,000, $11,000 and $5,000, respectively.lower-grade gemstones.
The need for adjustments to inventoryinventory-related reserves and valuation allowances is evaluated on a period-by-period basis. Changes to the Company’s inventory reserves and allowances are accounted for in the current accounting period in which a change in such reserves and allowances is observed and deemed appropriate, including changes in management’s estimates used in the process to determine such reserves and valuation allowances. Total inventory write-downs were $5.86 million and $393,000 for the years ended June 30, 2020 and 2019, respectively.
Property and equipment consists of the following as of the dates presented:
| | | June 30, | | | December 31, | | | June 30, | |
| | | 2019 | | | 2018 | | | 2017 | | | 2020 | | | 2019 | |
| Computer software | | $ | 1,512,533 | | | $ | 1,253,894 | | | $ | 1,206,465 | | | $ | 1,827,581 | | | $ | 1,512,533 | |
| Machinery and equipment | | 1,100,629 | | | 1,048,288 | | | 1,026,736 | | | 1,145,525 | | | 1,100,629 | |
| Computer hardware | | 1,064,302 | | | 1,026,987 | | | 1,009,008 | | | 1,158,559 | | | 1,064,302 | |
| Leasehold improvements | | 1,158,218 | | | 1,151,659 | | | 1,126,553 | | | 1,158,807 | | | 1,158,218 | |
| Furniture and fixtures | | | 343,808 | | | | 337,210 | | | | 318,627 | | | | 347,872 | | | | 343,808 | |
| Total | | 5,179,490 | | | 4,818,038 | | | 4,687,389 | | | 5,638,344 | | | 5,179,490 | |
| Less: accumulated depreciation | | | (4,153,392 | ) | | | (3,673,840 | ) | | | (3,445,189 | ) | |
| Less accumulated depreciation | | | | (4,639,283 | ) | | | (4,153,392 | ) |
| Property and equipment, net | | $ | 1,026,098 | | | $ | 1,144,198 | | | $ | 1,242,200 | | | $ | 999,061 | | | $ | 1,026,098 | |
Depreciation expense for the fiscal
yearyears ended June 30,
2019, the transition period ended June 30, 20182020 and
the calendar year ended December 31, 20172019 was approximately
$486,000 and $480,000,
$229,000, and $420,000, respectively.
Intangible assets consist of the following as of the dates presented:
| | |
June 30, | | December 31, | | Weighted Average
Remaining Amortization Period | | |
June 30, | | | Weighted Average Remaining Amortization Period (in Years) | |
| | | 2019 | | 2018 | | 2017 | | (in Years) | 2020 | |
| 2019 |
| Patents | | $ | 1,007,497 | | | $ | 969,632 | | | $ | 958,604 | | | | 15.0 | | | $ | 1,024,267 | | | $ | 1,007,497 | | | 14.6 | |
| Trademarks | | | 100,331 | | | | 73,877 | | | | 57,325 | | | | 9.5 | | | 160,683 | | | 100,331 | | | 9.7 | |
| License rights | | | 6,718 | | | | 6,718 | | | | 6,718 | | | | - | | | | 6,718 | | | | 6,718 | | | - | |
| Total | | | 1,114,546 | | | | 1,050,227 | | | | 1,022,647 | | | | | | | 1,191,668 | | | 1,114,546 | | | | |
| Less accumulated amortization | | | (1,017,173 | ) | | | (1,015,394 | ) | | | (1,014,050 | ) | | | | | | | (1,021,517 | ) | | | (1,017,173 | ) | | | |
| | $ | 97,373 | | | $ | 34,833 | | | $ | 8,597 | | | | | | | $ | 170,151 | | | $ | 97,373 | | | | |
Amortization expense for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 20172019 was approximately $2,000, $1,000$4,000 and $2,000, respectively. Amortization expense on existing intangible assets is estimated to be approximately $9,000$16,000 for the fiscal year ending June 30, 2021 and $15,000 for each of the fiscal years ending June 30, 2020, 20212022, 2023, 2024 and 2022 and $8,000 for each of the fiscal years ending June 30, 2023 and 2024.2025. The amortization expense for the remaining unamortized balance of the total intangible assets, net, will be recognized in fiscal years ending after June 30, 2024.2025.
| 8. | ACCRUED EXPENSES AND OTHER LIABILITIES |
Total accrued expenses and other liabilities consist of the following as of the dates presented:
| | | June 30, | | | December 31, | | | June 30, | |
| | | 2019 | | | 2018 | | | 2017 | | | 2020 | | | 2019 | |
| Deferred revenue | | | $ | 794,740 | | | $ | 100,088 | |
| Accrued compensation and related benefits | | $ | 760,324 | | | $ | 359,077 | | | $ | 652,177 | | | 395,006 | | | 760,324 | |
| Accrued severance | | | 338,355 | | | - | |
| Accrued sales tax | | | 295,651 | | | 286,864 | |
| Deferred rent | | | - | | | 156,306 | |
| Accrued cooperative advertising | | 73,033 | | | 60,784 | | | 134,018 | | | 89,517 | | | 73,033 | |
| Deferred rent | | 156,306 | | | 139,558 | | | 131,389 | | |
| Accrued sales tax | | 286,864 | | | 17,149 | | | 20,844 | | |
| Other | | | 49,081 | | | | 42,377 | | | | 42,372 | | | | 9,063 | | | | 41,617 | |
| Accrued expenses and other liabilities | | $ | 1,325,608 | | | $ | 618,945 | | | $ | 980,800 | | | $ | 1,922,332 | | | $ | 1,418,232 | |
| 9. | COMMITMENTS AND CONTINGENCIES |
Lease CommitmentsArrangements
On December 9, 2013, the Company entered into a Lease Agreement, as amended on December 23, 2013 and April 15, 2014 (the “Lease Agreement”), for its corporate headquarters, which occupies approximately 36,350 square feet of office, storage, and light manufacturing space. space and is classified as an operating lease for financial reporting purposes. The base term of the Lease Agreement expires on October 31, 2021 and the terms of the Lease Agreement contain no early termination provisions. Provided there is no outstanding uncured event of default under the Lease Agreement, the Company has two options to extend the lease term for a period of five years under each option. The Company’s option to extend the term of the Lease Agreement must be exercised in writing on or before 270 days prior to expiration of the then-current term. If the options are exercised, the monthly minimum rent for each of the extended terms will be adjusted to the then prevailing fair market rate.
The Company took possession of the leased property on May 23, 2014, once certain improvements to the leased space were completed and did not have access to the property before this date. These improvements and other lease signing and movingrelated incentives offered by the landlord totaled approximately $550,000$623,000, of which approximately $393,000 was unamortized as of July 1, 2019, the effective date upon which the Company adopted the new lease accounting standard as described in more detail in Note 2, “Basis of Presentation and $73,000, respectively, which are being amortized over the life of the lease until October 31, 2021. Included in the Lease Agreement is a seven-month rent abatement period effective June 2014 through December 2014.Significant Accounting Policies.”
The Company recognizeshas no other material operating leases and is not party to leases that would qualify for classification as a finance lease, variable lease, or short-term lease.
As of June 30, 2020, the Company’s balance sheet classifications of its leases are as follows:
| Operating Leases: | | | |
| Noncurrent operating lease ROU assets | | $ | 584,143 | |
| | | | | |
| Current operating lease liabilities | | $ | 622,493 | |
| Noncurrent operating lease liabilities | | | 203,003 | |
| Total operating lease liabilities | | $ | 825,496 | |
The Company’s total operating lease cost was approximately $469,000 for the fiscal year ended June 30, 2020.
As of June 30, 2020, the Company’s estimated incremental borrowing rate used and assumed discount rate with respect to operating leases was 7.14% and the remaining operating lease term was 1.33 years.
As of June 30, 2020, the Company’s remaining future payments under operating leases for each fiscal year ending June 30 are as follows:
| 2021 | | $ | 642,997 | |
| 2022 | | | 219,723 | |
| Total lease payments | | | 862,720 | |
| Less: imputed interest | | | (37,224 | ) |
| Present value of lease payments | | | 825,496 | |
| Less: current lease obligations | | | 622,493 | |
| Total long-term lease obligations | | $ | 203,003 | |
The Company makes cash payments for amounts included in the measurement of its lease liabilities. During the fiscal year ended June 30, 2020, cash paid for operating leases was approximately $668,000 and, except for the ROU assets recorded upon adoption of the new lease accounting standard as of July 1, 2019, there were no ROU assets obtained in exchange for new operating lease liabilities.
Lease Disclosures for the fiscal year ended June 30, 2019, as reported
The Company recognized rent expense on a straight-line basis, givinghaving given consideration to the rent holidays and escalations, the lease signing and moving allowance to be paid to the Company, and the rent abatement.
As of June 30, 2019, theThe Company’s future minimum payments under thetotal rent expense for operating leases were as follows:
| | $ | 625,788 | |
2021 | | | 642,997 | |
2022 | | | 219,723 | |
| Total | | $ | 1,488,508 | |
Rent expensewas approximately $528,000 for the fiscal year ended June 30, 2019, the transition period ended2019. The Company also had future minimum payments as of June 30, 2018 and the calendar2019 under its operating leases for each fiscal year ended December 31, 2017 was approximately $528,000, $260,000 and $510,000, respectively.ending June 30 that were as follows:
| 2020 | | $ | 625,788 | |
| 2021 | | | 642,997 | |
| 2022 | | | 219,723 | |
| Total | | $ | 1,488,508 | |
On December 12, 2014, the Company entered into an exclusive supply agreement (the “Supply Agreement”) with Cree, Inc. (“Cree”). Under the Supply Agreement, subject to certain terms and conditions including a security interest as defined, the Company agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of the Company’s 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 was also amended to (i)(i) provide the Company with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following expiration of the initial term; (ii)(ii) establish a process by which Cree may begin producing alternate SiC material based on the Company’s specifications that will give the Company the flexibility to use the materials in a broader variety of its products; and (iii)(iii) permit the Company to purchase certain amounts of SiC materials from third parties under limited conditions.
The Company’s total purchase commitment under the Supply Agreement until June 2023 is approximately $52.95 million, of which approximately $43.98$36.60 million remains to be purchased as of June 30, 2019.2020. Over the life of the Supply Agreement, as amended, the Company’s future minimum annual purchase commitments of SiC crystals range from approximately $9 million to $12 million each year.
During the fiscal year ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017,2019, the Company purchased approximately $8.91 million, $4.89$7.47 million and $9.39$8.91 million, respectively, of SiC crystals from Cree.
See Note 15, “Subsequent Event”, for details in connection with the second amendment to the Supply Agreement executed on August 26, 2020. Amendments to the Supply Agreement include, among other things, changes to the expiration date and an extension of the period over which the Company must fulfill the total purchase commitment, which remains unchanged under the Supply Agreement, as amended.
COVID-19 Update
In March 2020, the novel strain of coronavirus, known as COVID-19, was declared a pandemic by the World Health Organization and declared a national emergency by the U.S. Government, and has negatively affected the U.S. and global economies. In response to this pandemic, federal, state, county, and local governments and public health organizations and authorities around the world have implemented a variety of measures intended to control the spread of the virus, including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing, and hygiene requirements. These measures have adversely affected workforces, customers, economies, and global supply chains, and resulted in significant travel and transport restrictions – all of which have combined to lead to an economic downturn. It has also disrupted the normal operations of many businesses, including that of the Company’s. In early 2020 in the Asia Pacific region and during our quarter ended March 31, 2020 globally, the pandemic and related governmental and business responses began to have an adverse effect on the Company’s operations, supply chains, distribution channels, and consumer buying behaviors. Cumulatively, these things also impacted the net realizable value and marketability of the Company’s legacy inventory, which was subsequently written-off.
The overall impacts of the COVID-19 pandemic include the following:
Across the Company’s purchasessupply chain, it experienced instances of SiC crystals priorsuppliers temporarily closing their operations, delaying order fulfillment, or limiting their production. Where applicable, the Company utilized alternative supply arrangements with partners whose businesses are not under stay-at-home orders or whose production came back online. During the quarter ended June 30, 2020, many of the Company’s suppliers began returning to normal operating and production levels. However, the Company and its suppliers remain subject to ongoing changes to governmental closure requirements that may have a long-term impact on the Company’s supply chain and ability to produce gemstones and finished jewelry for sale.
In the Company’s Online Channels segment, its transactional website charlesandcolvard.com remained open under restricted fulfillment capabilities. However, a quickly rising unemployment rate combined with consumer uncertainty and lack of confidence began reducing website traffic and conversions in March 2020. Beginning in March 2020, the Company maintained limited shipping functions with support from third-party production and fulfillment partners. The Company was also able to support only a certain level of active products on marketplaces and drop-ship partner websites such as Macys.com, Helzberg.com, Overstock.com, ShopHQ.com, and more. This ongoing e-commerce presence was restricted to available stock and the limited production capacity of functioning suppliers. During the quarter ended June 30, 2020, the Company began seeing orders in our transactional website, along with orders in our marketplaces and drop-ship partner websites, increase as consumer confidence strengthened and the Company’s operating and shipping functions began to return to normal activity levels. However, until business resumes to pre-pandemic levels across our entire supply chain, the Company’s Online Channels segment is expected to continue to be adversely impacted by the pandemic.
In the Company’s Traditional segment, brick and mortar customers began closing their stores to foot traffic in March 2020, with tentative plans to re-open on a rolling schedule that may lead into the fall timeframe or later. The Company also experienced instances of distributors, whose businesses rely on sales into retail organizations, reducing or closing their operations. These adverse effects impacted the Company’s ability to maintain significant levels of sales through our wholesale customers. In addition, trade shows and industry events have been preemptively cancelled for the critical production season leading up to the calendar year-end 2020 holiday season. As a result, the Company’s selling activities in its Traditional segment were significantly modified, and its ability to convert those activities into sales have been adversely impacted by the pandemic. Consistent with the trends the Company is experiencing in its Online Channels segment, it has begun seeing business strengthen with its brick and mortar customers as these customers begin to move forward with their re-opening plans following their closures in March 2020, but until business resumes to pre-pandemic levels, the Company’s Traditional segment is expected to continue to be adversely impacted by the pandemic.
As global and U.S economic activity slowed in response to the COVID-19 pandemic, the Company experienced and anticipates ongoing constraints on its cash and working capital, including experiencing potential liquidity challenges. The impact of the pandemic has had – and is expected to continue having – an adverse effect on the Company’s operations and financial condition as revenues declined and, despite the Company’s cost-saving efforts, many business and operating expenses remained flat or continued to rise. Cash flow scrutiny will be crucial for the Company’s business in the months ahead as the Company anticipates seeing lower revenues resulting in less cash flow, along with delayed accounts receivable collections, as needs grow to step up payables to important suppliers. The Company continues to focus on being more nimble in managing its inventory levels given the uncertainty in the supply chain, which may also place further demands on working capital.
The COVID-19 pandemic has had a significant adverse impact on the Company’s business, results of operations, financial condition, and liquidity during Fiscal 2020. The full extent of the impact of the COVID-19 pandemic on the Company’s operational and financial performance is currently uncertain and will depend on many factors outside of its control, including, without limitation, the timing, extent, trajectory and duration of the pandemic, the development and availability of effective treatments and vaccines, the imposition of protective public safety measures, and the impact of the pandemic on the global economy and demand for consumer and wholesaler products.
Since the onset of the pandemic domestically, the Company has implemented the following measures:
The Company deployed a work-from-home option for its employees on March 13, 2020, and effective March 27, 2020, instituted a mandatory work-from-home policy for all, but essential, employees due to mandated stay-at-home orders by the State of North Carolina and local governmental authorities;
The Company temporarily suspended all hiring of employees starting April 13, 2020 and it furloughed approximately 50% of its employee base at that time, principally within our operations area. While most of the Company’s operations employees returned to full-time status as it moved forward with its phased reopening plans during May 2020, these actions materially impacted the Company’s productivity;
The Company extended new benefits to assist employees who participate in its 401(k) plan with additional distribution and new borrowing terms;
The Company implemented temporary salary and wage reductions for all employees, including a 25% reduction in salary for the President and Chief Executive Officer and a 15% reduction for each of the Chief Financial Officer and Chief Operating Officer. All employee salaries and wages were returned to pre-reduction levels in July 2020;
The Company reorganized its management and reduced its workforce. Effective June 1, 2020, Suzanne Miglucci, the Company’s former President and Chief Executive Officer, resigned and Don O’Connell was appointed as its new President and Chief Executive Officer. At the same time, the Company enacted a significant reduction-in-force, or RIF, that reduced its active workforce by approximately 25%. Included in the RIF were the elimination of senior-level sales, marketing, information technology, and operations personnel as well as executive-level sales and marketing positions. These RIF actions resulted in the Company’s recognition of severance-related expenses during the fourth quarter of Fiscal 2020 in the amount of approximately $427,000. The liability for the unpaid portion of the Company’s severance-related accrual in the amount of approximately $338,000 is included in accrued expenses and other liabilities in the accompanying consolidated balance sheet as of June 30, 2020;
The Company instituted a temporary 50% reduction in fees paid to its Board of Directors for the quarterly period ended June 30, 2020, which were also returned to pre-reduction levels in July 2020;
The Company successfully applied for and received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The loan in the principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, a nationally licensed lender under the SBA, on June 18, 2020 pursuant to a Promissory Note issued by us on June 15, 2020. As provided under the CARES Act, the Company intends to use the proceeds from this loan to enhance cash flow, to help maintain operations and fund current payroll requirements, and to assist the Company with the reopening phase of its business as it navigates the COVID-19 pandemic recovery efforts. There can be no assurance that such PPP loan will be forgiven; and
The Company reduced non-payroll operating expenses, including decreased digital marketing spend and significantly reduced product development investments and travel expenditures.
The Company is continuing to take the following steps to further address the impact of the COVID-19 pandemic:
The Company is actively renegotiating contracts with vendors and suppliers to amend commitments to size its supply with current demand and delivery terms with others to reduce its cost of goods and services;
The Company is negotiating extended payment terms with select partners;
The Company is continuing to align variable expenses to match current sales trends as it continues to move forward with its phased reopening; and
The Company is currently continuing to offer the flexibility of a work-from-home option for its employees who are able to perform full-time duties effectively from home as the State of North Carolina continues to reopen through its predetermined phased reopening plan.
Paycheck Protection Program Loan
The Company received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the U.S. Small Business Administration (the “SBA”). The loan in the principal amount of $965,000 (the “PPP Loan”) was disbursed by Newtek Small Business Finance, LLC, (“Lender”), a nationally licensed lender under the SBA, on June 18, 2020 pursuant to a promissory note issued by the Company (the “Promissory Note”) on June 15, 2020. The Company accounted for the Promissory Note as debt within the accompanying consolidated financial statements.
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 long-term debt assumes there will be no principal forgiveness and principal repayment for the full outstanding principal amount of the PPP Loan are assumed to be spread in equal monthly installments over the period from April 1, 2021 through the maturity date of the Promissory Note. If the Company is required to repay the full outstanding principal amount of the PPP Loan, approximately $193,000 of the principal is expected to be paid during the fiscal year endedending June 30, 2019 were pursuant2021 and approximately $772,000 is expected to be paid during the fiscal year ending June 30, 2022.
The Company did not provide any collateral or guarantees for the PPP Loan, nor did the Company 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. The Company may prepay the principal of the PPP Loan at any time without incurring any prepayment charges.
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 the Company currently believes that its use of the PPP Loan will meet the conditions for forgiveness of the PPP Loan, the Company cannot assure its future adherence to the termsforgiveness criteria and conditions ofthat the Supply Agreement prior to the effective date of its amendment as of June 22, 2018.PPP Loan will be forgiven, in whole or in part.
Line of Credit
On July 13, 2018, the Company and its wholly-owned subsidiary, charlesandcolvard.com, LLC (collectively, the “Borrowers”), obtained a $5.00 million asset-based revolving credit facility (the “White Oak Credit Facility”) from White Oak Commercial Finance, LLC (“White Oak”). 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, a wholly-owned subsidiary of the Company (the “Guarantor”). Under the terms of the White Oak Credit Facility, the Borrowers must maintain at least $500,000 in excess availability at all times. The White Oak Credit Facility contains no other financial covenants.
Advances under the White Oak Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers’ eligible accounts receivable and inventory, plus the value of precious metal jewelry components, less reserves. The inclusion of inventory and precious metal jewelry components in the borrowing base was subject to the completion of an inventory appraisal, which was completed subsequent to the execution of the White Oak Credit Facility. Eligible inventory is further limited to 60% of the net borrowing base, while precious metal jewelry components are limited to $500,000.
Advances may be either revolving or non-revolving. Non-revolving advances are limited to $1.00 million in aggregate principal amount outstanding and must be repaid on each January 15 (which may be effected by conversion to revolving advances, absent an event of default). There are no other mandatory prepayments or line reductions. The Company may elect to prepay advances in whole or in part at any time without penalty. In addition, the White Oak Credit Facility may be terminated by the Company at any time, subject to a $100,000 fee in the first year of the term of the White Oak Credit Facility, a $50,000 fee in the second year, and no fee thereafter. In connection with the White Oak Credit Facility, the Company
will incurincurred a non-refundable origination fee in the total amount of $125,000 that is due and payable to White Oak in three installments. The first installment in the amount of $41,667 was paid upon execution of the White Oak Credit Facility on July 13, 2018 and the second installment in the amount of $41,667 was paid on July 15, 2019. The third and final installment in the amount of $41,666
will be due and payablewas paid on
July 13, 2020, or the date of termination, whichever is sooner.August 14, 2020.
During the first year of the term of the White Oak Credit Facility, revolving advances will accruewould have 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 will accrue interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins will reduce upon the Company’s 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.
The White Oak 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. White Oak’s security interest in certain SiC materials is subordinate to Cree’s security interest in such materials pursuant to the Company’s Supply Agreement and an Intercreditor Agreement by and among the Borrowers and the Guarantor with White Oak. In addition, White Oak’s security interest in certain tangible personal property of the Company is subordinate to its landlord’s security interest in such tangible personal property.
The White Oak Credit Facility is evidenced by a credit agreement, dated as of July 13, 2018 (the “Credit Agreement”), a security agreement, dated as of July 13, 2018 (the “Security Agreement”), and customary ancillary documents. The Credit Agreement, Security Agreement, and ancillary documents contain customary covenants, representations, fees, and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, liens, loans, investments, mergers, acquisitions, divestitures, and affiliate transactions.
Events of default under the White Oak Credit Facility include, without limitation, a change in control, an event of default under other indebtedness of the Borrowers or Guarantor in excess of $250,000, a material adverse change in the business of the Borrowers or Guarantor or in their ability to perform their obligations under the White Oak Credit Facility, and other defined circumstances that White Oak believes may impair the prospect of repayment. If an event of default occurs, White Oak is entitled to take enforcement action, including acceleration of amounts due under the White Oak Credit Facility and foreclosure upon collateral.
The White Oak Credit Facility contains other customary terms, that include indemnity, collateral monitoring fee, minimum interest charge, expense reimbursement, yield protection, and confidentiality provisions.
As of June 30, 2019,2020, the Company had not borrowed against the White Oak Credit Facility.
Prior As a result of the Company’s diminished borrowing base, which is tied to obtainingits accounts receivable, its ability to draw down funds from the White Oak Credit Facility the Company and its wholly owned subsidiaries, Charles & Colvard Direct, LLC and Moissanite.com, LLC (now charlesandcolvard.com, LLC), had a $10.00 million asset-based revolving credit facility from Wells Fargo Bank, National Association. This asset-based revolving credit facility (the “Wells Fargo Credit Facility”) was available 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. The effective date of the Wells Fargo Credit Facility was June 25, 2014, and it was scheduled to mature on June 25, 2017. Effective June 22, 2017, the Wells Fargo Credit Facility was amended to, among other things, extend the maturity date to June 25, 2018, the date upon which it matured in accordance with its terms.is currently restricted.
Any advances would have accrued interest at a rate equal to either (i) Wells Fargo’s three-month LIBOR rate plus 2.00%, or (ii) Wells Fargo’s Prime Rate plus 1%, each calculated on an actual/360 basis and would have been payable monthly in arrears. Principal outstanding during an event of default, which did not occur during the term of the Wells Fargo Credit Facility, would have accrued interest at a rate of 3% in excess of the above rate.
The Company had not borrowed against the Wells Fargo Credit Facility as of June 25, 2018, the date upon which the Wells Fargo Credit Facility matured and was terminated in accordance with its terms.
| 11. | SHAREHOLDERS’ EQUITY AND STOCK-BASED COMPENSATION |
Common Stock
The Company is authorized to issue 50,000,000 shares of common stock, no par value. As of June 30, 2019, June 30, 20182020 and December 31, 2017,2019, it had 28,027,569, 21,705,17328,949,410 and 21,580,10228,027,569 shares of common stock outstanding, respectively. Holders of the Company’s common stock are entitled to one vote for each share held.
Preferred Stock
The Board of Directors is authorized, without further shareholder approval, to issue up to 10,000,000 shares of preferred stock, no par value. The preferred stock may be issued from time to time in one or more series. No shares of preferred stock had been issued as of June 30, 2019.2020.
Dividends
The Company has paid no cash dividends during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017.2019.
Shelf Registration Statement
The Company has an effective shelf registration statement on Form S-3 on file with the SECU.S. Securities and Exchange Commission (the “SEC”) which allows it 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 the Company’s June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option, as described below
. However, the Company may offer and sell no more than one-third of its public float (which is the aggregate market value of the Company’s outstanding common stock held by non-affiliates) in any 12-month period. The Company’s ability to issue equity securities under its effective shelf registration statement is subject to market conditions.conditions, which are in turn, subject to, among other things, the disruption and volatility caused by the COVID-19 pandemic.
On June 11, 2019, the Company 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 its 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 in the amount of approximately $941,000. Pursuant to the terms of the underwriting agreement entered in connection with this offering, the underwriters were granted a 30-day option to buy up to an additional 937,500 shares of the Company’s common stock to cover over-allotments.
Pursuant to the partial exercise of the underwriters’ over-allotment option, on July 3, 2019, the Company
issued an additional 630,500 shares of its common stock at a price of $1.60 per share for net proceeds of approximately
$930,000,$932,000, net of the underwriting discount and fees and expenses of approximately
$82,000$77,000. After giving effect to the partial exercise of the over-allotment option, the Company sold an aggregate of 6,880,500 shares of its common stock at a price of $1.60 per share with total gross proceeds of approximately $11.01 million, before deducting the total underwriting discount and fees and expenses of approximately $1.02 million.
Equity Compensation Plans
2018 Equity Incentive Plan
On November 21, 2018, the shareholders of the Company approved the adoption of the Charles & Colvard, Ltd. 2018 Equity Incentive Plan, (the “2018 Plan”). The 2018 Plan will expire by its terms on September 20, 2028.
The 2018 Plan provides for the grant of equity-based awards to selected employees, directors, and consultants of the Company and its affiliates. The aggregate number of shares of the Company’s common stock that could be issued pursuant to awards granted under the 2018 Plan are not to exceed the sum of 3,300,000 plus the number of shares of common stock underlying any award granted under any stock incentive plan maintained by the Company prior to the 2018 Plan (each, a “2018 Prior Plan”) that expires, terminates or is canceled or forfeited under the terms of the 2018 Prior Plans. Stock options granted to employees under the 2018 Plan generally vest over four years and have terms of up to 10 years. The vesting schedules and terms of stock options granted to independent contractors vary depending on the specific grant, but the terms are no longer than 10 years. Stock option awards granted to members of the Board of Directors generally vest at the end of one year from the date of the grant. The vesting schedules of restricted stock awards granted to employees or independent contractors vary depending on the specific grant but are generally four years or less. Only stock options and restricted stock have been granted under the 2018 Plan. As of June 30, 2020 and 2019, there were 790,407 and 285,025 stock options outstanding under the 2018 Plan.Plan, respectively.
2008 Stock Incentive Plan
In May 2008, the shareholders of the Company approved the adoption of the Charles & Colvard, Ltd. 2008 Stock Incentive Plan, as amended on March 31, 2015 and approved by the shareholders of the Company on May 20, 2015 and further amended on March 15, 2016 and approved by the shareholders of the Company on May 18, 2016 (the “2008 Plan”). The 2008 Plan expired (with respect to future grants) on May 26, 2018.
The 2008 Plan authorized the Company to grant stock options, stock appreciation rights, restricted stock, and other equity awards to selected employees, directors, and independent contractors. The aggregate number of shares of the Company’s common stock that could be issued pursuant to awards granted under the 2008 Plan were not to exceed the sum of 6,000,000 plus any shares of common stock subject to an award granted under any stock incentive plan maintained by the Company prior to the 2008 Plan (each, a “2008 Prior Plan”) that is forfeited, cancelled, terminated, expires, or lapses for any reason without the issuance of shares pursuant to the award, or shares subject to an award granted under a 2008 Prior Plan which shares are forfeited to, or repurchased or reacquired by, the Company. Stock options granted to employees under the 2008 Plan generally vest over four years and have terms of up to 10 years. The vesting schedules and terms of stock options granted to independent contractors vary depending on the specific grant, but the terms are no longer than 10 years. Stock option awards granted to members of the Board of Directors generally vest at the end of one year from the date of the grant. The vesting schedules of restricted stock awards granted to employees or independent contractors vary depending on the specific grant but are generally four years or less. Only stock options and restricted stock had been granted under the 2008 Plan. As of June 30, 2019, June 30, 20182020 and December 31, 2017,2019, there were 2,238,613, 2,388,1692,018,688 and 2,377,2652,238,613 stock options outstanding under the 2008 Plan, respectively.
Stock-Based Compensation
The following table summarizes the components of the Company’s stock-based compensation included in net (loss) income (loss) for the periods presented:
| | | | Year Ended June 30, | |
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | 2020 | | | 2019 | |
| Employee stock options | | $ | 235,984 | | | $ | 142,096 | | | $ | 336,534 | | | $ | 309,999 | | | $ | 235,984 | |
| Restricted stock awards | | | 266,821 | | | | 93,537 | | | | 106,948 | | | | 149,539 | | | | 266,821 | |
| Totals | | $ | 502,805 | | | $ | 235,633 | | | $ | 443,482 | | |
| Total | | | $ | 459,538 | | | $ | 502,805 | |
Due to the Company’s valuation allowance against deferred tax assets as discussed further in Note 12, “Income Taxes”, any income tax benefits associated with these grants and awards for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 20172019 were fully reserved.
No stock-based compensation was capitalized as a cost of inventory during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017.2019.
Stock Options
The following is a summary of the stock option activity for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017:2019:
| | | Shares | | | Weighted Average Exercise Price | | | Shares | | | Weighted Average Exercise Price | |
| Outstanding at December 31, 2016 | | 2,134,898 | | | $ | 1.99 | | |
| Granted | | 836,369 | | | $ | 0.94 | | |
| Forfeited | | (103,000 | ) | | $ | 1.22 | | |
| Expired | | | (491,002 | ) | | $ | 2.95 | | |
| Outstanding at December 31, 2017 | | 2,377,265 | | | $ | 1.46 | | |
| Granted | | 216,157 | | | $ | 1.27 | | |
| Forfeited | | (173,750 | ) | | $ | 1.05 | | |
| Expired | | | (31,503 | ) | | $ | 2.17 | | |
| Outstanding at June 30, 2018 | | 2,388,169 | | | $ | 1.46 | | | 2,388,169 | | | $ | 1.46 | |
| Granted | | 285,025 | | | $ | 1.00 | | | 285,025 | | | $ | 1.00 | |
| Exercised | | (52,500 | ) | | 1.21 | | | (52,500 | ) | | $ | 1.21 | |
| Forfeited | | (30,000 | ) | | $ | 1.20 | | | (30,000 | ) | | $ | 1.20 | |
| Expired | | | (67,056 | ) | | $ | 1.71 | | | | (67,056 | ) | | $ | 1.71 | |
| Outstanding at June 30, 2019 | | | 2,523,638 | | | $ | 1.41 | | | 2,523,638 | | | $ | 1.39 | |
| Granted | | | 605,387 | | | $ | 0.95 | |
| Forfeited | | | (125,005 | ) | | $ | 1.02 | |
| Expired | | | | (194,925 | ) | | $ | 1.18 | |
| Outstanding at June 30, 2020 | | | | 2,809,095 | | | $ | 1.33 | |
The weighted average grant date fair value of stock options granted during the fiscal year ended June 30, 2020 and 2019 the transition period ended June 30, 2018was $0.50 and the calendar year ended December 31, 2017 was $0.57, $0.68 and $0.53, respectively. The total fair value of stock options that vested during the fiscal year ended June 30, 2019, the transition period ended June 30, 20182020 and the year calendar ended December 31, 20172019 was approximately $282,000 and $176,000, $232,000 and $400,000, respectively.
The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option pricing model with the following weighted average assumptions for stock options granted during the periods presented:
| | | | Year Ended June 30, | |
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | 2020 | | | 2019 | |
| Dividend yield | | 0.0 | % | | 0.0 | % | | 0.0 | % | | 0.0 | % | | 0.0 | % |
| Expected volatility | | 61.0 | % | | 62.8 | % | | 63.4 | % | | 63.2 | % | | 61.0 | % |
| Risk-free interest rate | | 3.09 | % | | 2.76 | % | | 1.90 | % | | 0.82 | % | | 3.09 | % |
| Expected lives (years) | | 5.5 | | | 5.4 | | | 5.5 | | | 5.2 | | | 5.5 | |
The following tables summarize information in connection with stock options outstanding at June 30, 2019:2020:
| Options Outstanding | | | Options Exercisable | | | Options Vested or Expected to Vest | |
Balance as of 6/30/2019 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | | | Balance as of 6/30/2019 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | | | Balance as of 6/30/2019 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | |
| 2,523,638 | | | | 6.95 | | | $ | 1.41 | | | | 2,053,613 | | | | 6.51 | | | $ | 1.49 | | | | 2,460,292 | | | | 6.91 | | | $ | 1.42 | |
| Options Outstanding | | | Options Exercisable | | | Options Vested or Expected to Vest | |
Balance as of 6/30/2020 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | | | Balance as of 6/30/2020 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | | | Balance as of 6/30/2020 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | |
| | 2,809,095 | | | | 5.74 | | | $ | 1.33 | | | | 2,396,208 | | | | 5.11 | | | $ | 1.37 | | | | 2,743,077 | | | | 5.66 | | | $ | 1.34 | |
As of June 30, 2019,2020, the unrecognized stock-based compensation expense related to unvested stock options was approximately $167,000,$155,000, which is expected to be recognized over a weighted average period of approximately 1817 months.
The aggregate intrinsic value of stock options outstanding, exercisable, and vested or expected to vest at June 30, 20192020 was approximately $1.36 million.$500. These amounts are before applicable income taxes and represent the closing market price of the Company’s common stock at June 30, 2019,2020, less the grant price, multiplied by the number of stock options that had a grant price that is less than the closing market price. These amounts represent the amounts that would have been received by the optionees had these stock options been exercised on those dates. DuringNo stock options were exercised during the fiscal year ended June 30, 2020. The aggregate intrinsic value of stock options exercised during the fiscal year ended June 30, 2019 the aggregate intrinsic value of stock options exercised was approximately $51,000. No stock options were exercised during the transition period ended June 30, 2018 and the calendar year ended December 31, 2017.
Restricted Stock
The following is a summary of the restricted stock activity for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017:2019:
| | | Shares | | | Weighted Average Grant Date Fair Value | | | Shares | | | Weighted Average Grant Date Fair Value | |
| Unvested at December 31, 2016 | | 359,400 | | | $ | 0.91 | | |
| Granted | | 420,000 | | | $ | 1.11 | | |
| Vested | | (214,200 | ) | | $ | 0.92 | | |
| Canceled | | | (209,783 | ) | | $ | 0.96 | | |
| Unvested at December 31, 2017 | | 355,417 | | | $ | 1.11 | | |
| Granted | | 264,000 | | | $ | 1.25 | | |
| Vested | | (216,488 | ) | | $ | 1.11 | | |
| Canceled | | | (138,929 | ) | | $ | 1.11 | | |
| Unvested at June 30, 2018 | | 264,000 | | | $ | 1.25 | | | 264,000 | | | $ | 1.25 | |
| Granted | | 129,500 | | | $ | 1.07 | | | 129,500 | | | $ | 1.07 | |
| Vested | | (154,396 | ) | | $ | 1.20 | | | (154,396 | ) | | $ | 1.20 | |
| Canceled | | | (109,604 | ) | | $ | 1.31 | | | | (109,604 | ) | | $ | 1.31 | |
| Unvested at June 30, 2019 | | | 129,500 | | | $ | 1.08 | | | 129,500 | | | $ | 1.08 | |
| Granted | | | 325,000 | | | $ | 1.57 | |
| Vested | | | (258,341 | ) | | $ | 1.07 | |
| Canceled | | | | (33,659 | ) | | $ | 1.07 | |
| Unvested at June 30, 2020 | | | | 162,500 | | | $ | 1.57 | |
The unvested restricted shares as of June 30, 20192020 are all performance-based restricted shares that willare scheduled to vest, subject to achievement of the underlying performance goals, onin July 31, 2019.2020. As of June 30, 2019,2020, the estimated unrecognized stock-based compensation expense related to these unvested restricted shares subject to the achievement of performance goals was approximately $32,000, all$255,000. However, pursuant to the estimated success rates related to the performance-based criteria of the restricted shares, none of which are expected to vest, none of the underlying compensation expense related to the unvested shares is expected to be recognized over a weighted average period of approximately one month.recognized.
The Tax Act, which was signed into law in December 2017, among other things lowered the U.S. corporate income tax rate from 35% to that of 21% effective January 1, 2018. Consequently, the Company wrote down its net deferred tax assets as of December 31, 2017 by approximately $519,000 to reflect the estimated impact of the Tax Act. Likewise, the Company recorded a corresponding net adjustment to its valuation allowance related to the re-measurement of certain net deferred tax assets using the lower U.S. corporate income tax.
In connection with filing its 2017 U.S. corporate income tax return in June 2018, the Company’s management
completed its analysis ofanalyzed the income tax effects of the
Tax Cuts and Jobs Act (the “Tax Act”), enacted in December 2017, and the effect on its existing corporate
alternative minimum tax (“AMT”)AMT deferred tax asset, including the
nature, validity, and recoverability of its AMT-related deferred tax credit carryforwards.
Upon completing this analysis,As a result, management determined that it was able to recognize the underlying tax benefit relating to the realization of the recoverable portion of its AMT-related deferred tax credit carryforwards, net of an
expectedanticipated sequestration reduction in the amount of approximately $328,000. Accordingly, the Company recorded the expected AMT credit refund as a receivable, net of an anticipated sequestration reduction and such amount was included with other long-term assets
in the accompanying Consolidated Balance Sheets as of June 30, 2018.
However, onIn January 14, 2019, the Internal Revenue Service (the “IRS”) announced that refund payments and refund offset transactions due to refundable minimum tax credits associated with the repeal of the corporate AMT as part of the Tax Act would not be subject to sequestration. Accordingly, following the IRS’s announcement that AMT credit refunds would not be subject to the government sequestration amount, in January 2019 the Company recognized the additional available underlying tax benefit in the amount of approximately $23,000 relating to the sequestered portion of its AMT credit. This amount, net of amounts received, was also included in other long-term assets in the accompanying Consolidated Balance Sheetconsolidated balance sheet as of June 30, 2019.
InThe Company received installment refunds in May 2019 the Company received its first installment refund in the amountand April 2020 of approximately $80,000$75,000 and $6,000, respectively, from the IRS in accordance with the AMT refundability schedule as set forth in the Tax Act. The full
Pursuant to provisions of the CARES Act, existing AMT credit carryforwards are now eligible for acceleration and refundable amountAMT credits are to be completely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, the Company has elected to have the AMT tax completely refunded and has filed a tentative refund claim for the remaining AMT tax credit. Consequently, the remaining balance of the Company’s AMT credit carryover receivablerefund 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.
The Company continues to monitor future developments and interpretations of the CARES Act for any material impacts on its future results of operations, financial position, and liquidity.
Pursuant to provisions of the State of North Carolina General Assembly Senate Bill 704: COVID-19 Recovery Act, enacted in May 2020, the Company will be refundedreceive a tax credit towards its contribution to the Company in scheduled installment amounts throughNorth Carolina Unemployment Insurance Fund (the “Fund”) that is equal to the amount of the Company’s contribution to the Fund for the calendar year ending Decemberquarter ended March 31, 2021.2020. Accordingly, in June 2020 the Company recognized the available tax benefit in the amount of approximately $7,000 and such amount is included in prepaid expenses and other current assets in the accompanying consolidated balance sheet as of June 30, 2020.
The Company accounts for income taxes under the liability method. Under the liability method, deferred income taxes are recognized for the income tax consequences of “temporary differences” by applying enacted statutory income tax rates applicable to future years to differences between the financial statement carrying amounts and the income tax bases of existing assets and liabilities.
IncomeThe Company’s income tax net (expense) benefit (expense) for the periods presented comprises the following:
| | | | Year Ended June 30, | |
| | | Year Ended
June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | 2020 | | | 2019 | |
| Current: | | | | | | | | | | | | | | | |
| Federal | | $ | 23,149 | | | $ | 327,594 | | | $ | - | | | $ | - | | | $ | 23,149 | |
| State | | | (21,706 | ) | | | (9,534 | ) | | | (27,609 | ) | | | (1,733 | ) | | | (21,706 | ) |
| Total current benefit (expense) | | | 1,443 | | | | 318,060 | | | | (27,609 | ) | |
| Total current (expense) benefit | | | | (1,733 | ) | | | 1,443 | |
| | | | | | | | |
| Deferred: | | | | | | | | | | | | | | | |
| Federal | | - | | | - | | | - | | | - | | | - | |
| State | | | - | | | | - | | | | - | | | | - | | | | - | |
| Total deferred benefit (expense) | | | - | | | | - | | | | - | | |
| Income tax net benefit (expense) | | $ | 1,443 | | | $ | 318,060 | | | $ | (27,609 | ) | |
| Total deferred (expense) benefit | | | | - | | | | - | |
| Income tax net (expense) benefit | | | $ | (1,733 | ) | | $ | 1,443 | |
Significant components of the Company’s deferred income tax assets as of the dates presented are as follows:
| | | | June 30, | |
| | | June 30, | | | December 31, | | | 2020 | | | 2019 | |
| | | 2019 | | | 2018 | | | 2017 | | | | | | | |
| Reversals and accruals | | $ | 970,516 | | | $ | 668,813 | | | $ | 686,573 | | | $ | 476,666 | | | $ | 970,516 | |
| Prepaid expenses | | | (38,552 | ) | | | (38,944 | ) | | | (28,744 | ) | | (39,943 | ) | | (38,552 | ) |
| Federal NOL carryforwards | | | 4,911,437 | | | | 5,540,016 | | | | 5,185,438 | | | 4,980,513 | | | 4,911,437 | |
| State NOL carryforwards | | | 674,522 | | | | 714,588 | | | | 681,364 | | | 663,918 | | | 674,522 | |
| Hong Kong NOL carryforwards | | | 995,566 | | | | 995,566 | | | | 995,566 | | | 995,566 | | | 995,566 | |
| Federal benefit on state taxes under uncertain tax positions | | | 100,703 | | | | 96,144 | | | | 94,142 | | | 1,668 | | | 1,304 | |
| Stock-based compensation | | | 194,524 | | | | 412,148 | | | | 422,623 | | | 392,924 | | | 194,524 | |
| Research tax credit | | | 83,315 | | | | 235,742 | | | | 434,637 | | | 252 | | | 83,315 | |
| Alternative minimum tax | | | - | | | | 23,149 | | | | 350,743 | | |
| Contributions carryforward | | | - | | | | 1,923 | | | | - | | | 7,184 | | | - | |
| Depreciation | | | (157,310 | ) | | | (159,100 | ) | | | (178,670 | ) | | (172,010 | ) | | (157,310 | ) |
| Inventory valuation reserve | | | 1,594,795 | | | - | |
| Operating lease liabilities | | | 185,422 | | | - | |
| Operating lease right-of-use assets | | | (131,008 | ) | | - | |
| Accrued rent | | | 88,923 | | | | 121,124 | | | | 138,178 | | | - | | | 88,923 | |
| Loss on impairment of long-lived assets | | | 32,985 | | | | 33,157 | | | | 33,864 | | | 32,749 | | | 32,985 | |
| Valuation allowance | | | (7,856,629 | ) | | | (8,644,326 | ) | | | (8,815,714 | ) | | | (8,988,696 | ) | | | (7,757,230 | ) |
| Total deferred income tax assets, net | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
The following are reconciliations between expected income taxes, computed at the applicable statutory federal income tax rate applied to pretax accounting loss, and the income tax net (expense) benefit (expense) for the periods presented:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| | | | | | | | | | |
| Anticipated income tax (expense) benefit at statutory rate | | $ | (477,545 | ) | | $ | 334,716 | | | $ | 144,795 | |
| State income tax expense, net of federal tax effect | | | (42,334 | ) | | | 7,755 | | | | (54,083 | ) |
| Federal income tax effect of change in tax rate | | | - | | | | - | | | | (3,729,007 | ) |
| Income tax effect of uncertain tax positions | | | 17,494 | | | | 37,671 | | | | (17,946 | ) |
| Return to provision adjustments | | | 126 | | | | - | | | | 2,982 | |
| Stock-based compensation | | | (3,929 | ) | | | 9,855 | | | | (36,233 | ) |
| Other changes in deferred income tax assets, net | | | (280,066 | ) | | | (243,325 | ) | | | (437 | ) |
| Decrease in valuation allowance | | | 787,697 | | | | 171,388 | | | | 3,662,320 | |
| Income tax net benefit (expense) | | $ | 1,443 | | | $ | 318,060 | | | $ | (27,609 | ) |
| | | Year Ended June 30, | |
| | | 2020 | | | 2019 | |
| Anticipated income tax benefit (expense) at statutory rate | | $ | 1,293,673 | | | $ | (477,545 | ) |
| State income tax benefit (expense), net of federal tax effect | | | 64,034 | | | | (42,334 | ) |
| Income tax effect of uncertain tax positions | | | 17,508 | | | | 17,494 | |
| Return to provision adjustments | | | 1 | | | | 126 | |
| Stock-based compensation | | | (31,195 | ) | | | (3,929 | ) |
| Other changes in deferred income tax assets, net | | | (114,288 | ) | | | (280,066 | ) |
| (Increase) Decrease in valuation allowance | | | (1,231,466 | ) | | | 787,697 | |
| Income tax net (expense) benefit | | $ | (1,733 | ) | | $ | 1,443 | |
The Company’s statutory tax rate as of the fiscal year ended June 30, 20192020 is 22.16%22.11% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.16%1.11%, net of the federal benefit. The Company’s statutory tax rate as of June 30, 20182019 was 22.13%22.16% and consisted of the federal income tax rate of 21% and a blended state income tax rate of 1.13%, net of the federal benefit. The Company’s statutory tax rate as of December 31, 2017 was 23.25% and consisted of the federal income tax rate of 21% and a blended state income tax rate of 2.25%1.16%, net of the federal benefit.
As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. As of June 30, 2019,2020 and June 30, 2018 and December 31, 2017,2019, the Company’s management determined that sufficient negative evidence continued to exist to conclude it was uncertain that the Company would have sufficient future taxable income to utilize its deferred tax assets, and therefore, the Company maintained a valuation allowance against its deferred tax assets.
As of June 30,
2019, June 30, 20182020 and
December 31, 2017,2019, the Company had approximately
$102,000, $313,000$309 and
$884,000,$102,000, respectively, of remaining federal income tax credits
that expire between 2020 and 2021 and all of which
expire in 2021 and can be carried forward to offset future income taxes. As of June 30,
2019, June 30, 20182020 and
December 31, 2017,2019, the Company also had federal tax net operating loss carryforwards of approximately
$23.39 million, $26.28$23.72 million and
$24.59$23.39 million, respectively, expiring between
20302022 and 2037, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately
$20.20 million, $20.24$20.12 million and
$20.22$20.20 million, respectively, expiring between 2023 and 2033; and various other state tax net operating loss carryforwards expiring between 2021 and
2034,2040, which can be used to offset against future state taxable income.
As of each of June 30, 2019, June 30, 20182020 and December 31, 2017,2019, there was approximately $6.03 million in net operating loss carryforwards in Hong Kong. In accordance with the Hong Kong tax code, these amounts can be carried forward indefinitely to offset future taxable income in Hong Kong. The Company’s deferred tax assets in Hong Kong were fully reserved with a valuation allowance of $996,000 as of each of June 30, 2019, June 30, 20182020 and December 31, 2017,2019, and had been fully reserved in all prior fiscal periods due to the uncertainty of future taxable income in this jurisdiction to utilize the deferred tax assets. Charles & Colvard (HK) Ltd., the Company’s Hong Kong subsidiary, which was re-activated in December 2017, but had no operating activity during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017,2019, previously ceased operations during 2008 and became a dormant entity during 2009. If the Company uses any portion of its deferred tax assets in future periods, the valuation allowance would need to be reversed and may impact the Company’s future operating results.
Uncertain Tax Positions
The gross liability for income taxes associated with uncertain tax positions at June 30,
2019,2020 and June 30,
2018 and December 31, 2017,2019, was approximately
$512,000, $525,000$8,000 and
$560,000,$6,000, respectively.
These amounts are shown net of approximately $19,000, $54,000 and $98,000, respectively, recorded as a direct reduction to the associated deferred tax asset. The gross liability, if recognized, would favorably affect the Company’s effective tax rate.
The Company’s policy for recording interest and penalties associated with tax audits is to record such items as a component of the provision for income taxes. The Company accrued approximately $22,000, $10,000$2,000 and $28,000$1,000 of interest and penalties associated with uncertain tax positions for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017,2019, respectively. Including the interest and penalties recorded for uncertain tax positions, there is a total of approximately $225,000, $203,000$5,000 and $193,000$4,000 of interest and penalties included in the accrued income tax liability for uncertain tax positions as of June 30, 2019, June 30, 20182020 and December 31, 2017,2019, respectively. To the extent interest and penalties are not ultimately incurred with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.
In all significant federal and state jurisdictions where it is required to file income tax returns, the Company has analyzed filing positions for all tax years in which the statute of limitations is open. The only periods subject to examination by the major tax jurisdictions where the Company does business are the tax years ended December 31, 20142015 through June 30, 2018.2019. The Company does not believe that the outcome of any examination will have a material impact on its consolidated financial statements and does not expect settlement on any uncertain tax positions within the next 12 months. Beginning with the transition period ended June 30, 2018, the Company’s tax year conforms with its fiscal accounting period year ending on June 30 of each year.
The following table summarizes the activity related to the Company’s accrued gross income tax liability for uncertain tax positions for the two-year period from December 31, 2016 throughended June 30, 2019:2020:
Balance at December 31, 2016 | | $ | 532,764 | |
| Increases related to prior calendar year tax positions | | | 27,609 | |
Balance at December 31, 2017 | | | 560,373 | |
| Decreases related to prior calendar year tax positions | | | (35,670 | ) |
Balance at June 30, 2018 | | | 524,703 | |
| Decreases related to prior transition period tax positions | | | (12,936 | ) |
Balance at June 30, 2019 | | $ | 511,767 | |
| Balance at June 30, 2018 | | $ | 4,891 | |
| Increases related to prior fiscal year tax positions | | | 1,323 | |
| Balance at June 30, 2019 | | | 6,214 | |
| Increases related to prior fiscal year tax positions | | | 1,733 | |
| Balance at June 30, 2020 | | $ | 7,947 | |
For information regarding the Company’s decision during the fiscal year ended June 30, 2020 to reduce its accrued gross income tax liability for uncertain tax positions that should have been derecognized in prior years, see the Immaterial Correction of an Error section in Note 2, “Basis of Presentation and Significant Accounting Policies.”
| 13. | MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK |
At times, a portion of the Company’s accounts receivable will be due from customers that have individual balances of 10% or more of the Company’s total gross accounts receivable.
The following is a summary of customers that represent greater than or equal to 10% of total gross accounts receivable as of the dates presented:
| | | June 30, | | | December 31, | | | June 30, | |
| | | 2019 | | | 2018 | | | 2017 | | | 2020 | | | 2019 | |
| Customer A | | 25 | % | | 23 | % | | * | % | | 26 | % | | 13 | % |
| Customer B | | 15 | % | | ** | % | | **
| % | | 14 | % | | 25 | % |
| Customer C | | 13 | % | | 10 | % | | 18 | % | | 13 | % | | * | % |
| Customer D | | ***
| % | | ***
| % | | 12 | % | | ** | % | | 15 | % |
* Customer
A did not have individual balances that represented 10% or more of total gross accounts receivable as of December 31, 2017.** Customer BC did not have individual balances that represented 10% or more of total gross accounts receivable as of June 30, 2018 and December 31, 2017.2019.
*** Customer D did not have individual balances that represented 10% or more of total gross accounts receivable as of June 30, 2019 and 2018.2020.
A significant portion of sales is derived from certain customer relationships. The following is a summary of customers that represent greater than or equal to 10% of total net sales for the periods presented:
|
| Year Ended June 30, 2019 |
|
| Six Months Ended June 30, 2018 |
|
| Year Ended December 31, 2017 |
|
| Customer A | | | 14 | % | | | 12 | % | | | 21 | % |
| Customer C | | | 10 | % | | | 12 | % | | | * | % |
* Customer C did not have net sales that represented 10% or more of total net sales for the calendar year ended December 31, 2017.
| | | Year Ended June 30, | |
| | | 2020 | | | 2019 | |
| Customer A | | | 12 | % | | | 10 | % |
| Customer B | | | 13 | % | | | 14 | % |
The Company records its sales returns allowance at the corporate level based on several factors including historical sales return activity and specific allowances for known customer returns.
All full-time employees who meet certain length of service requirements are eligible to participate in and receive benefits from the Company’s 401(k) Plan. This plan provides for matching contributions by the Company in such amounts as the Board of Directors may annually determine, as well as a 401(k) option under which eligible participants may defer a portion of their salaries. The Company contributed a total of $67,000, $44,000$82,000 and $64,000$67,000 to this employee benefit plan during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182020 and the calendar year ended December 31, 2017,2019, respectively.
On August 26, 2020, the Supply Agreement was 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 the Company’s total purchase commitment under the Supply Agreement in the amount of approximately $52.95 million, of which approximately $36.60 million remains to be purchased as of June 30, 2020, 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 the Company to purchase revised amounts of SiC materials from third parties under limited conditions.
On July 3, 2019,Over the Company issued an aggregate of 630,500 shares of its common stock at a price of $1.60 per share pursuant to the partial exerciselife of the underwriters’ over-allotment option received in connection withSupply Agreement, as amended, the Company’s recently completed public offering. The Company received net proceedsfuture minimum annual purchase commitments of SiC crystals range from approximately $930,000, net of the underwriting discount and fees and expenses, from the partial exercise of the over-allotment option. A more detailed description of the Company’s underwritten public offering pursuant$4 million to its shelf registration statement on Form S-3 is included in Note 11, “Shareholders’ Equity and Stock-Based Compensation”.$10 million each year.
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2019.2020. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2019,2020, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
We routinely review our internal control over financial reporting and from time to time make changes intended to enhance the effectiveness of our internal control over financial reporting. We have not experienced any material impact to our internal control over financial reporting despite the fact that our corporate employees are principally working remotely due to the COVID-19 pandemic. We are continually monitoring and assessing the impact of COVID-19 on our internal control over financial reporting to minimize the impact on its design and operating effectiveness. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an ongoing basis and will take action as appropriate. During the three months ended June 30, 2019,2020, we made no changes to our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, that we believe materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system was designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Our internal control over financial reporting includes those policies and procedures that:
| (i)(i) | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; |
| (ii)(ii) | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and |
| (iii)(iii) | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. |
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to the reliability of financial reporting and the preparation of financial statements.
In making the assessment of internal control over financial reporting, our management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on that assessment and those criteria, management determined that our internal control over financial reporting was effective as of June 30, 2019.2020.
None.
PART III
| Item 10. | Directors, Executive Officers and Corporate Governance |
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
| Item 14. | Principal Accounting Fees and Services |
The information called for in Items 10 through 14 is incorporated by reference from our definitive Proxy Statement relating to our 20192020 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the end of the fiscal year ended June 30, 2019.2020.
PART IV
| Item 15. | Exhibits, Financial Statement Schedules |
(a)(1) and (2). The consolidated financial statements and report of our independent registered public accounting firm are filed as part of this report (see “Index to Financial Statements,” at Part II, Item 8). The financial statement schedules are not included in this Item as they are either not applicable or the information is otherwise included in the consolidated financial statements or the notes to the consolidated financial statements.
(a)(3). The following exhibits have been or are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:
Exhibit No. | | Description |
| | |
| Asset Purchase Agreement, effective March 4, 2016, by and among Yanbal USA, Inc., Charles & Colvard, Ltd., and Charles & Colvard Direct, LLC (incorporated herein by reference to Exhibit 2.1 to our Current Report on Form 8-K, as filed with the SEC on March 8, 2016)
|
| |
| List of Schedules Omitted from Asset Purchase Agreement included as Exhibit 2.1 above (incorporated herein by reference to Exhibit 2.2 to our Current Report on Form 8-K, as filed with the SEC on March 8, 2016)
|
| |
| | Restated Articles of Incorporation of Charles & Colvard, Ltd. (incorporated herein by reference to Exhibit 3.1 to our Annual Report on Form 10-K for the year ended December 31, 2004) |
| | | |
| | Bylaws of Charles & Colvard, Ltd., as amended and restated, effective May 19, 2011 (incorporated herein by reference to Exhibit 3.1 to our Current Report on Form 8-K, as filed with the SEC on May 24, 2011) |
| | | |
| | Specimen Certificate of Common Stock (incorporated herein by reference to Exhibit 4.1 to our Annual Report on Form 10-K for the year ended December 31, 1998) |
| | | |
| | Exclusive Supply Agreement, dated as of December 12, 2014, by and among Charles & Colvard, Ltd., Cree, Inc. and, solely for purposes of Section 6(c) of the Exclusive Supply Agreement, Charles & Colvard Direct, LLC and moissanite.com, LLC (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on December 16, 2014)* |
| | | |
| | First Amendment to Exclusive Supply Agreement, dated as of June 22, 2018, by and between Charles & Colvard, Ltd. and Cree, Inc. (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on June 27, 2018)* |
| | | |
| | Second Amendment to Exclusive Supply Agreement, effective as of June 30, 2020, by and between Charles & Colvard, Ltd. and Cree, Inc.** ++ |
| | |
| | Credit Agreement, dated as of July 13, 2018, by and among Charles & Colvard, Ltd., charlesandcolvard.com, LLC, Charles & Colvard Direct, LLC, and White Oak Commercial Finance, LLC (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on July 17, 2018) |
| | | |
| | Security Agreement, dated as of July 13, 2018, by and among Charles & Colvard, Ltd., charlesandcolvard.com, LLC, Charles & Colvard Direct, LLC, and White Oak Commercial Finance, LLC (incorporated herein by reference to Exhibit 10.4 to our Transition Report on Form 10-KT for the transition period ended June 30, 2018) |
| | | |
| | Intercreditor Agreement, dated as of July 13, 2018, by and among Charles & Colvard, Ltd., charlesandcolvard.com, LLC, Charles & Colvard Direct, LLC, Cree, Inc., and White Oak Commercial Finance, LLC (incorporated herein by reference to Exhibit 10.5 to our Transition Report on Form 10-KT for the transition period ended June 30, 2018) |
| | |
| | First Amendment to Credit and Security Agreement, dated as of June 25, 2014,15, 2020, by and among Charles & Colvard, Ltd., charlesandcolvard.com, LLC, Charles & Colvard Direct, LLC, moissanite.com, LLC, and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on June 30, 2014)White Oak Commercial Finance, LLC++ |
| | |
| First Amendment to Credit and Security Agreement, dated as of September 16, 2014, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2014)
|
| | |
| | Second Amendment to Credit and Security Agreement,Promissory Note, dated as of December 12, 2014,June 15, 2020, by and amongbetween Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.3 to our Current Report on Form 8-K, as filed with the SEC on December 16, 2014)Newtek Small Business Finance, LLC++
|
| Third Amendment to Credit and Security Agreement and Other Loan Documents, dated as of September 23, 2016, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, to be known as charlesandcolvard.com, LLC, and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2016)
|
| |
| Fourth Amendment to Credit and Security Agreement, dated as of June 22, 2017, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, charlesandcolvard.com, LLC (formerly known as Moissanite.com, LLC) and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on June 26, 2017)
|
| |
| Fifth Amendment to Credit and Security Agreement, dated as of April 3, 2018, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, charlesandcolvard.com, LLC (formerly known as Moissanite.com, LLC) and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.11 to our Transition Report on Form 10-KT for the transition period ended June 30, 2018)
|
| |
| Intercreditor Agreement, dated as of December 12, 2014, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, Cree, Inc., and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on December 16, 2014)
|
| |
| Lease Agreement, dated December 9, 2013, between Charles & Colvard, Ltd. and Southport Business Park Limited Partnership (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on December 12, 2013)* |
| | |
| | First Amendment to Lease, dated December 23, 2013, between Charles & Colvard, Ltd. and Southport Business Park Limited Partnership (incorporated herein by reference to Exhibit 10.20 to our Annual Report on Form 10-K for the year ended December 31, 2013) |
| | | |
| | Second Amendment to Lease, dated April 15, 2014, between Charles & Colvard, Ltd. and Southport Business Park Limited Partnership (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014) |
| | | |
| | Board Compensation Program, effective October 1, 2017 (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2017)+ |
| | | |
| | Charles & Colvard, Ltd. 2008 Stock Incentive Plan, as amended (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on May 20, 2016)+ |
| | | |
| | Form of Employee Incentive Stock Option Agreement under the Charles & Colvard, Ltd. 2008 Stock Incentive Plan (incorporated herein by reference to Exhibit 10.116 to our Current Report on Form 8-K, as filed with the SEC on June 2, 2008)+ |
| | |
| | Form of Employee Nonqualified Stock Option Agreement under the Charles & Colvard, Ltd. 2008 Stock Incentive Plan (incorporated herein by reference to Exhibit 10.118 to our Current Report on Form 8-K, as filed with the SEC on June 2, 2008)+ |
| | | |
| | Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
| | | |
| | Form of Restricted Stock Award Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
| | | |
| | Form of Employee Incentive Stock Option Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.3 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
| | | |
| | Form of Employee Nonqualified Stock Option Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.4 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
| | | |
| | Form of Non-Employee Director Nonqualified Stock Option Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.5 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
| | | |
| | Form of Independent Contractor Nonqualified Stock Option Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.6 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
| | |
| Charles & Colvard, Ltd. 2018 Senior Management Equity Incentive Program, effective January 1, 2018 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on February 1, 2018)+
|
| |
| | Charles & Colvard, Ltd. Fiscal 2019 Q1-Q2 Senior Management Equity Incentive Program, effective July 1, 2018 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on May 29, 2018)+ |
| | | |
| | Charles & Colvard, Ltd. Fiscal 2019 Q3-Q4 Senior Management Equity Incentive Program, effective January 1, 2019 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on February 13, 2019)+ |
| | Charles & Colvard, Ltd. Fiscal 2020 Senior Management Equity Incentive Program, effective July 1, 2019 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on July 11, 2019)+ |
| | | |
| | Charles & Colvard, Ltd. Fiscal 2021 Senior Management Equity Incentive Program, effective July 1, 2020 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on August 4, 2020)+ |
| | |
| | Employment Agreement, dated December 1, 2015, by and between Charles & Colvard, Ltd. and Suzanne Miglucci (incorporated herein by reference to Exhibit 10.2 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2015)+ |
| | | |
| | Employment Agreement, dated May 23, 2017, by and between Charles & Colvard, Ltd. and Clint J. Pete (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on May 24, 2017)+ |
| | | |
| | Employment Agreement, dated May 23, 2017, by and between Charles & Colvard, Ltd. and Don O’Connell (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on May 24, 2017)+ |
| | | |
| | Amendment to 2015 Employment Agreement, dated April 9, 2020, by and between Charles & Colvard, Ltd. and Suzanne Miglucci (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on April 9, 2020)+ |
| | |
| | Amendment to 2017 Employment Agreement, dated April 9, 2020, by and between Charles & Colvard, Ltd. and Clint J. Pete (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on April 9, 2020)+ |
| | |
| | Amendment to 2017 Employment Agreement, dated April 9, 2020, by and between Charles & Colvard, Ltd. and Don O’Connell (incorporated herein by reference to Exhibit 10.3 to our Current Report on Form 8-K, as filed with the SEC on April 9, 2020)+ |
| | |
| | Separation of Employment Agreement, dated May 28, 2020, by and between Charles & Colvard, Ltd. and Suzanne Miglucci (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on May 29, 2020)+
|
| | |
| | Amended and Restated Employment Agreement, effective as of June 1, 2020, by and between Charles & Colvard, Ltd. and Don O’Connell (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on May 29, 2020)+ |
| | |
| | Subsidiaries of Charles & Colvard, Ltd. (incorporated herein by reference to Exhibit 21.1 to our Transition Report on Form 10-KT for the transition period ended June 30, 2018) |
| | |
| | Consent of BDO USA, LLP++ |
| | | |
| | Certification by Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002++ |
| | | |
| | Certification by Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002++ |
| | | |
| | Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002++ |
| | | |
| | Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002++ |
| 101 | |
101 | The following materials from Charles & Colvard, Ltd.’s Annual Report on Form 10-K for the fiscal year ended June 30, 20192020 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i)(i) Consolidated Balance Sheets; (ii)(ii) Consolidated Statements of Operations; (iii)(iii) Consolidated Statements of Shareholders’ Equity; (iv)(iv) Consolidated Statements of Cash Flows; and (v)(v) Notes to Consolidated Financial Statements. |
| | | |
| * | | Asterisks located within the exhibit denote information which has been redacted pursuant to a request for confidential treatment filed with the SEC. |
| | | |
| ** | | Asterisks located within the exhibit denote information which has been redacted pursuant to Item 601(b)(10)(iv) of Regulation S-K because it is both not material and would likely cause competitive harm to us if publicly disclosed. |
| | |
| + | | Denotes management contract or compensatory plan or arrangement. |
| | | |
| ++ | | Denotes filed herewith. |
None.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | CHARLES & COLVARD, LTD. |
| | | |
| | By: | /s/ Suzanne MiglucciDon O’Connell |
September 5, 20193, 2020 | | Suzanne MiglucciDon O’Connell
|
| | | President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| | By: | /s/ Suzanne MiglucciDon O’Connell |
September 5, 20193, 2020 | | Suzanne MiglucciDon O’Connell
|
| | | Director, President and Chief Executive Officer |
| | | |
| | By: | /s/ Clint J. Pete |
September 5, 20193, 2020 | | Clint J. Pete |
| | | Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer) |
| | | |
| | By: | /s/ Neal I. Goldman |
September 5, 20193, 2020 | | Neal I. Goldman |
| | | Chairman of the Board of Directors |
| | | |
| | By: | /s/ Anne M. Butler |
September 5, 20193, 2020 | | Anne M. Butler |
| | Director
|
| By:
| /s/ Benedetta Casamento
|
September 5, 2019
| | Benedetta Casamento
|
| | | Director |
| | | |
| | By: | /s/ Jaqui LividiniBenedetta Casamento |
September 5, 20193, 2020 | | Jaqui LividiniBenedetta Casamento
|
| | | Director |
| | | |
| | By: | /s/ Ollin B. Sykes |
September 5, 20193, 2020 | | Ollin B. Sykes |
| | | Director |