This Quarterly Report on Form 10-Q 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,” “intend,” “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, the following:
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.
The COVID-19 pandemic continues to present unprecedented business challenges in Fiscal 2022. We have taken measures to protect the health and safety of our employees, work with our customers and suppliers to minimize disruptions, reduce our expenses, and support our community in addressing the challenges posed by the ongoing COVID-19 pandemic.
We have experienced impacts on our business related to the COVID-19 pandemic, primarily in increased coronavirus-related costs, including using accelerated payments in some cases to our suppliers that are due by their terms in future periods and we expect to continue accelerating payments to certain suppliers through at least a portion of Fiscal 2022. We are also seeing a sharp increase in international freight costs, with limited availability and long delays causing disruption in the global supply chain. According to reports regarding international import and export traffic, shipping container shortages and delays are expected to last into calendar year 2022. Accordingly, we are taking steps where possible to mitigate such potential delays in supplier deliveries by accelerating orders and increasing order quantities.
Following the government mandated shut down during the early days of the pandemic, work in our production and distribution facilities has continued throughout the remainder of the pandemic, consistent with guidance from federal, state and local officials to minimize the spread of COVID-19. We continue to take actions to equip employees with personal protective equipment, establish minimum staffing and social distancing policies, sanitize workspaces more frequently, adopt alternate work schedules, and institute other measures aimed to sustain production and related services while minimizing the transmission of COVID-19, including measures to facilitate the provision of vaccines to our employees in line with state and local guidelines. In addition, we have maintained a flexible teleworking policy for our employees who can meet customer commitments remotely, and a portion of our workforce continues teleworking.
Although the COVID-19 pandemic did not have a significant adverse impact on our financial results in the quarter ended September 30, 2021, the ultimate impact of COVID-19 on our operations and financial performance in future periods, including our ability to execute our strategic initiatives in the expected timeframes, remains uncertain and will depend on future pandemic related developments, including the duration of the pandemic, any potential subsequent waves of COVID-19 and its variant viral infections, the effectiveness, distribution and acceptance of COVID-19 vaccines, and related government actions to prevent and manage disease spread, all of which are uncertain and cannot be predicted. We cannot at this time predict the full impact of the COVID-19 pandemic, but we believe the risk exists that the COVID-19 pandemic could adversely impact our business, financial condition, results of operations and/or cash flows in the fiscal year ending June 30, 2022, or Fiscal 2022.
For additional risks to the Company related to the COVID-19 pandemic, see “Part I, Item 1A. Risk Factors”, contained in our 2021 Annual Report.
As we continue to manage through these challenging times, our strategic initiatives during Fiscal 2022 are designed to drive expansion and help us remain on a strong trajectory toward our goal for top line growth. We look to further position and articulate our brand in what we believe is a rapidly evolving consumer landscape and intend to meet the consumer’s current appetite for digital content. We believe that our plans to expand these digital capabilities will create additional platforms and innovative portals to showcase our brand and elevate its awareness. In addition to growing our online brand presence, in September 2021 we began construction on our first Charles & Colvard Signature Showroom, which we believe will complement and expand our omnichannel brand strategy in the fine jewelry space. This first retail showroom, which we plan to open during Fiscal 2022, will be featured in our corporate headquarters in North Carolina’s Research Triangle Park and allow us to showcase our exclusive Signature Collection designs as well as a wide assortment of Forever One™ moissanite and Caydia® lab grown diamond fine jewelry for those consumers who want to see and feel our products in person. During Fiscal 2022 we will be expanding our content production capabilities by constructing an innovative broadcast studio at our corporate headquarters, which will provide us a platform to live-stream broadcasts on our websites and through other online media channels, including those of our business partners. We believe this capability will provide another sales channel for our direct-to-consumer business and allow more personal interaction with our online consumer base. In August, we attended and had an exhibition booth at the JCK Trade Show in Las Vegas, Nevada, that allowed us to feature a collection of our fine jewelry and lab created gemstones. The JCK Trade Fair is among the most significant domestic trade events representing the jewelry industry and is attended by jewelry retailers, manufacturers, designers, and other industry influencers who create the jewelry business and drive it forward. This August trade show was the first such in-person JCK event held for the jewelry industry since before the onset of the COVID-19 pandemic. This opportunity provided the jewelry industry with re-entry into the live market space following the impact of the pandemic. It also allowed us to present our brand and gemstone product lines to a broad range of leaders in the jewelry industry.
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The following table sets forth certain consolidated statements of operations data for the three months ended September 30, 2021 and 2020:
Consolidated net sales for the three months ended September 30, 2021 and 2020 comprise the following:
Consolidated net sales were $10.28 million for the three months ended September 30, 2021 compared to $7.93 million for the three months ended September 30, 2020, an increase of approximately $2.35 million, or 30%. The increase in consolidated net sales for the three months ended September 30, 2021 was due to increased consumer awareness and ongoing strong demand for our moissanite jewels, lab grown diamonds, and finished jewelry featuring both moissanite and lab grown diamonds. These increases resulted in higher finished jewelry product net sales during the three months ended September 30, 2021 in our Online Channels segment and Traditional segment. As consumer confidence has strengthened and with traditional brick-and-mortar stores now having re-opened following their being shut down during much of the comparable prior year period, net sales during the three months ended September 30, 2021, in our Traditional segment increased over this period driven by stronger loose jewel sales in our distributor network.
Sales of finished jewelry represented 55% of total consolidated net sales for the three months ended September 30, 2021, which was consistent with 55% of total consolidated net sales for the corresponding period of the prior year. For the three months ended September 30, 2021, finished jewelry sales were $5.69 million compared to $4.34 million for the corresponding period of the prior year, an increase of approximately $1.35 million, or 31%. This increase in finished jewelry sales was due primarily to higher finished jewelry sales of Forever One™, Moissanite by Charles & Colvard®, and Signature Collection in our Online Channels segment as well as in our Traditional segment.
Sales of loose jewels represented 45% of total consolidated net sales for the three months ended September 30, 2021, which was consistent with 45% of total consolidated net sales for the corresponding period of the prior year. For the three months ended September 30, 2021, loose jewel sales were $4.59 million compared to $3.59 million for the corresponding period of the prior year, an increase of approximately $1.00 million, or 28%. The increase for the three months ended September 30, 2021 was primarily a result
of higher sales of loose jewels through our domestic distributors.
U.S. net sales accounted for approximately 96% of total consolidated net sales for the three-month period ended September 30, 2021, compared with 95% for the three-month period ended September 30, 2020. U.S. net sales increased to $9.82 million, or 31%, in the three months ended September 30, 2021 compared to $7.50 million in the comparable quarter of 2020 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
three months ended
September 30, 2021 and 2020 accounted for 19% and 14%, respectively, of total consolidated net sales. Our largest U.S. customer during the three-month period ended September 30, 2021, accounted for 14% of total consolidated net sales during the period ended September 30, 2020. Other than our U.S. customers noted above during the three-month periods ended September 30, 2021 and 2020, 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, along with our customers, will remain dependent on our ability to maintain and enhance our customer-related 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 4% and 5% of total consolidated net sales during the quarters ended September 30, 2021 and 2020, respectively. International net sales increased to $456,000, or 7%, during the first quarter of Fiscal 2022 compared to $427,000 in the first quarter of the year ended June 30, 2021, or Fiscal 2021.
International sales increased due to higher demand in our international distributor market coupled with growth in our direct-to-consumer presence internationally reflecting solid direct-to-consumer sales from our Online Channels segment in international markets. In light of the effects of ongoing global economic conditions and as the world continues to recover from the COVID-19 pandemic, 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 may fluctuate significantly each reporting period.
We did not have an international customer account for 10% or more of total consolidated sales during the three months ended September 30, 2021 or 2020. 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
Our total cost of goods sold for the three months ended September 30, 2021 and 2020 are as follows:
| | | Three Months Ended September 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Finished jewelry | | $ | 2,334,482 | | | $ | 1,754,289 | | | $ | 580,193 | | | | 33 | % |
| Loose jewels | | | 2,059,446 | | | | 1,743,922 | | | | 315,524 | | | | 18 | % |
| Total product line cost of goods sold | | | 4,393,928 | | | | 3,498,211 | | | | 895,717 | | | | 26 | % |
| Non-product line cost of goods sold | | | 622,622 | | | | 697,844 | | | | (75,222 | ) | | | (11 | )% |
| Total cost of goods sold | | $ | 5,016,550 | | | $ | 4,196,055 | | | $ | 820,495 | | | | 20 | % |
Total cost of goods sold was $5.02 million for the three months ended September 30, 2021 compared to $4.20 million for the three months ended September 30, 2020, an increase of approximately $820,000, or 20%. 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 three months ended
September 30, 2021 compared to the same period in 2020 was primarily due to increased sales of finished jewelry and loose jewels during the three months ended September 30, 2021, which reflect higher material and labor costs, in both our Online Channels segment and Traditional segment as a result of strong product demand during the quarter.
The net decrease in non-product line cost of goods sold for the three months ended September 30, 2021, comprises a $282,000 lower change in other inventory adjustments principally relating to favorable changes in production standard cost variances compared to the three months ended September 30, 2020. This net decrease in non-product line cost of goods sold was offset in part related to an approximate $152,000 change in inventory valuation adjustments primarily related to adverse changes in shrinkage and rework reserves, an approximate $42,000 increase in freight out from increased shipments resulting from Online Channels segment sales growth during the quarter ended September 30, 2021 as well as an approximate $13,000 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.
For additional disclosure relating to non-product line cost of goods sold, see Note 3 to our condensed consolidated financial statements in Item 1, “Financial Statements”, of this Quarterly Report on Form 10-Q.
Sales and marketing expenses for the three months ended
September 30, 2021 and 2021 are as follows:
| | | Three Months Ended September 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Sales and marketing | | $ | 2,730,153 | | | $ | 1,647,933 | | | $ | 1,082,220 | | | | 66 | % |
Sales and marketing expenses were $2.73 million for the three months ended September 30, 2021 compared to $1.65 million for the three months ended September 30, 2020, an increase of approximately $1.08 million, or 66%.
The increase in sales and marketing expenses for the three months ended September 30, 2021 compared to the same period in 2020 was primarily due to a $794,000 increase in advertising and digital marketing expenses; a $113,000 increase in compensation expenses; a $61,000 increase in general office-related expenses, which are principally related to higher credit card transaction fees from increased online sales levels and increased rent expense, related to our corporate headquarters operating lease amendment that was executed in January 2021; a $48,000 increase in software-related costs incurred primarily in connection with new software-related agreements associated with upgraded operating and cybersecurity systems; a $35,000 increase in professional services principally comprising non-recurring consulting services for cybersecurity and merchandising imaging in the current year period; a $19,000 increase in depreciation and amortization expense relating to capitalized costs associated with information technology-related upgrades; and a $12,000 increase in travel expenses as we returned to more normal business travel patterns following cut-backs relating to the COVID-19 pandemic and related cost-control measures in prior year periods.
The increase in advertising and digital marketing expenses for the three months ended September 30, 2021 compared to the same period in 2020 comprises a $731,000 increase in digital advertising spend; a $38,000 increase in expenses relating to our participation in the 2021 JCK Trade Show; a $15,000 increase in cooperative advertising; a $7,000 increase in print media expenses; and a $3,000 increase in outside agency fees. The comparable prior year period advertising and digital marketing expenses were lower due to cost reductions we imposed in response to the COVID-19 pandemic.
The increase in compensation expenses for the three months ended September 30, 2021 compared to the same period in 2020 was primarily due to a $75,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $36,000 increase in employee stock-based compensation expense; and a $4,000 increase in bonus expense.
The increases in employee stock-based compensation and bonus expenses reflect improved operating results that impact these performance-based compensation-related benefits. These increases were partially offset by a $2,000 decrease in employee-related severance costs from the prior year.
General and Administrative
General and administrative expenses for the three months ended September 30, 2021 and 2020 are as follows:
| | | Three Months Ended September 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| General and administrative | | $ | 1,584,275 | | | $ | 1,208,035 | | | $ | 376,240 | | | | 31 | % |
General and administrative expenses were $1.58 million for the three months ended September 30, 2021 compared to $1.21 million for the three months ended September 30, 2020, an increase of approximately $376,000, or 31%.
The increase in general and administrative expenses for the three months ended September 30, 2021 compared to the same period in 2020 was primarily due to a $295,000 increase in compensation expenses; a $62,000 increase in professional services; a $25,000 increase in travel-related expenditures; a $23,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed in January 2021; and a $10,000 increase in insurance expenses principally related to higher renewal premiums.
These increases were partially offset by a $23,000 decrease in depreciation and amortization expense, principally related to fully-depreciated assets when compared to those in prior periods; a $13,000 decrease in business taxes and licenses; a $1,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; and a $2,000 net decrease in miscellaneous other general and administrative expenses.
The increase in compensation expenses for the three months ended September 30, 2021 compared to the same period in 2020 comprises a $171,000 increase in bonus expense and a $124,000 increase in employee stock-based compensation expense. The increases in bonus and employee stock-based compensation expenses
reflect improved operating results that impact these performance-based compensation-related benefits.
Professional services expenses increased for the three months ended September 30, 2021 compared to the same period in 2020 primarily due to a $35,000 increase in fees associated with audit and tax services, principally related to a discrete income tax-related project; a $27,000 increase in legal fees associated with corporate governance matters; and a $19,000 net increase in consulting and other professional services principally related to a benefits consulting arrangement in the current year period. These increases were partially offset by a $19,000 decrease in investor relations fees resulting from the migration in-house for certain investor relation services during the current year.
Interest Income
Interest income for the three months ended September 30, 2021 and 2020 is as follows:
| | | Three Months Ended September 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Interest income | | $ | 355 | | | $ | 3,459 | | | $ | (3,104 | ) | | | (90 | )% |
Certain cash balances in excess of operating needs are deposited into and maintained in an interest-bearing account with a federally insured commercial bank. Accordingly, during the three months ended September 30, 2021 and 2020, we earned interest from cash on deposit in this interest-bearing account. The decrease in earned interest reflects adverse changes in interest rates during Fiscal 2022 compared with Fiscal 2021.
Interest Expense
Interest expense for the three months ended September 30, 2021 and 2020 is as follows:
| | | Three Months Ended September 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Interest expense | | $ | - | | | $ | 2,439 | | | $ | (2,439 | ) | | | (100 | )% |
In accordance with the terms of the Promissory Note, during the period of time the principal of the PPP Loan was outstanding, we accrued interest at a fixed rate of 1% per annum. Our accrual for interest expense associated with the PPP Loan began June 18, 2020, the date we received the proceeds for the PPP Loan from our Lender, through June 23, 2021, the date our PPP Loan was forgiven by the U.S. Small Business Administration, or the SBA.
We had no outstanding debt during the three months ended September 30, 2021.
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 three months ended September 30, 2021 and 2020 are as follows:
| | | Three Months Ended September 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | 34 | | | $ | 530 | | | $ | (496 | ) | | | (94 | )% |
During the three months ended September 30, 2021 and 2020, we had international sales transactions denominated in currencies other than the U.S. dollar that resulted in foreign currency exchange net losses. The decrease in these losses reflects the lower level of international sales denominated in foreign currencies during the three months ended September 30, 2021 compared with the same period in the prior year.
Provision for Income Taxes
For the three months ended September 30, 2021, our statutory tax rate was 22.24% and consisted of the federal income tax rate of 21% and a blended state income tax rate of 1.24%, net of the federal benefit. For the three months ended September 30, 2020, our statutory tax rate was 22.11% and consisted of the federal income tax rate of 21% and a blended state income tax rate of 1.11%, net of the federal benefit. Our effective income tax rate reflects the effect of federal and state income taxes on earnings and the impact of differences in book and tax accounting arising primarily from the permanent tax benefits associated with stock compensation transactions during the quarter. For the three months ended September 30, 2021, our effective tax rate was 12.91%.
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. As of June 30, 2021, cumulative positive taxable income over the last three tax years had been generated in the U.S., as compared to the negative evidence of cumulative losses in previous years. We also determined that our expectation of future taxable income in upcoming tax years, including estimated growth rates applied to future expected taxable income that included significant management estimates and assumptions, would be sufficient to result in full utilization of our federal net operating loss carryforwards and certain of our deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence existed as of June 30, 2021, to conclude that it was more likely than not deferred tax assets of approximately $6.35 million would be realizable, and we reduced our valuation allowance accordingly.
Accordingly, we recognized a net income tax expense of approximately $123,000 for the three months ended September 30, 2021, compared with a net income tax expense of $500 for the three months ended September 30, 2020. With the reduction of our valuation allowance during the fiscal year ended June 30, 2021, we recognized deferred income tax expense during the three months ended September 30, 2021 in the amount of approximately $122,000. Included in our tax provision, we record estimated taxes, penalties, and interest associated with uncertain tax positions as income tax expense and recognized such expense related to these items of approximately $500 for each of the three months ended September 30, 2021 and 2020.
As of September 30, 2021, we determined that our expectation of future taxable income in upcoming tax years, including estimated growth rates applied to future expected taxable income that includes significant management estimates and assumptions, would continue to be sufficient to result in full utilization of our remaining federal net operating loss carryforwards and certain of our deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence existed as of September 30, 2021, to conclude that it is more likely than not deferred tax assets of approximately $6.23 million remain realizable. Conversely, we further determined that sufficient negative evidence continued to exist to conclude it was uncertain that we would have sufficient future taxable income to utilize certain of our deferred tax assets. Therefore, we continued to maintain a valuation allowance against the deferred tax assets relating to certain state net operating loss carryforwards from our e-commerce subsidiary due to the timing uncertainty of when we will generate positive taxable income to utilize the associated deferred tax assets. In addition, a valuation allowance remains against certain deferred tax assets relating to operating loss carryforwards relating to our dormant subsidiary located in Hong Kong.
Liquidity and Capital Resources
The full impact of the COVID-19 pandemic on the global and domestic economy remains uncertain and the world continues adapting to the ongoing pandemic and evolving viral variants and its adverse effects on global economics and worldwide business operations. The impact of the COVID-19 pandemic continues to place unprecedented pressures on global and U.S. businesses including our own. Depending on future developments, including the success of the global vaccine efforts to control the spread of the underlying virus and evolving variants, the pandemic could materially adversely impact our capital resources and liquidity in the future. We remain increasingly focused on the COVID-19 pandemic and are continually evaluating its potential effect on our business and liquidity and capital resources.
Capital Structure and Long-Term Debt
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 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 all is available. 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 may be in turn, subject to, among other things, the potential disruption and volatility that may be caused by ongoing effects of the COVID-19 pandemic. Any capital raise is not assured and may not be at terms that would be acceptable to us.
We have no outstanding debt as of September 30, 2021.
Operating Activities and Cash Flows
We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of September 30, 2021, our principal sources of liquidity were cash, cash equivalents and restricted cash totaling $19.17 million, trade accounts receivable, net, of $2.67 million, and net current inventory of $12.04 million, as compared to cash and cash equivalents totaling $21.45 million, trade accounts receivable, net, of $1.66 million, and net current inventory of $11.45 million as of June 30, 2021. As described more fully herein, we also have access to a $5.00 million cash collateralized line of credit facility with JPMorgan Chase Bank, N.A., or JPMorgan Chase.
During the three months ended September 30, 2021, our working capital decreased
by approximately $646,000 to $29.49 million from $30.14 million at June 30, 2021. As described more fully below, the decrease in working capital at September 30, 2021 is primarily attributable to a decrease in our cash, cash equivalents, and restricted cash, principally resulting from cash used in our operations, an increase in our accounts payable, and an increase in our short-term operating lease liabilities. These factors were offset partially by an increase in our accounts receivable, an increase in our allocation of inventory from long-term to short-term due to a higher expected sell through of inventory on hand in the upcoming period, a decrease in our accrued expenses and other liabilities, and an increase in our prepaid expenses and other assets.
During the three months ended September 30, 2021, approximately $2.14 million of cash was used by our operations. The primary drivers of our use of cash were an increase in inventory of $2.67 million; an increase in accounts receivable of $1.09 million; a decrease in accrued expenses and other liabilities of $717,000; and an increase in prepaid expenses and other assets of $303,000. These factors were offset partially by the favorable effect of net income in the amount of $827,000
, which was net of non-cash items that reduced net income in the amount of $833,000; and an increase in accounts payable of $979,000.
Accounts receivable increased principally due to the increased level of sales during the three months ended September 30, 2021, as compared with the sales during the period leading up to June 30, 2021. Throughout the course of the COVID-19 pandemic, from time to time we have offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers. Because of the ongoing impact of the pandemic on the global economy, the extension of these terms may not immediately increase liquidity as a result of ongoing current-period sales, which we expect may continue to be pressured due to the effects of the ongoing 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 we believe that if we ceased providing extended payment terms, we would be at a competitive disadvantage for some Traditional segment customers in the marketplace during this economic period and that our net sales and profits would likely be adversely impacted.
We manufactured approximately $4.43 million in finished jewelry and $2.43 million in loose jewels, which includes the cost of the loose jewels and the purchase of precious metals and labor in connection with jewelry production, during the three months ended September 30, 2021. We expect our purchases of precious metals and labor to increase as we increase our finished jewelry business. In addition, the price of gold has fluctuated significantly over the past decade, resulting in higher retail price points for gold jewelry. Because the market price of gold and other precious metals is beyond our control, the upward price trends could continue and have a negative impact on our operating cash flow as we manufacture finished jewelry.
Historically, our raw material inventories of SiC crystals had been purchased under exclusive supply agreements with a limited number of suppliers. Because the supply agreements restricted the sale of these crystals exclusively to us, the suppliers negotiated minimum purchase commitments with us that, when combined with reduced sales levels during prior periods in which the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As of September 30, 2021, $19.57 million 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 $1.68 million and new raw material that we purchase pursuant to the Supply Agreement.
Our
more detailed description of our inventories is included in Note 5 to our condensed consolidated financial statements in Part I, Item 1, “Financial Statements”, of this Quarterly Report on Form 10-Q.
As of September 30, 2021, all of our remaining federal income tax credits had expired or been utilized, and therefore, are not available to be carried forward to offset future income taxes. As of September 30, 2021, we also had a federal tax net operating loss carryforward of approximately $19.00 million expiring between 2034 and 2037, or that have no expiration, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $19.87 million expiring between 2023 and 2035; and various other state tax net operating loss carryforwards expiring between 2023 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, Inc., now known as Wolfspeed, Inc., or Wolfspeed. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Wolfspeed, and Wolfspeed 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 the raw materials used in 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 Wolfspeed 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 Wolfspeed 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 $31.35 million remains to be purchased as of September 30, 2021.
During the three months ended September 30, 2021, we purchased approximately $1.50 million of SiC crystals from Wolfspeed pursuant to the terms of the Supply Agreement, as amended. During the three months ended September 30, 2020, we did not purchase SiC crystals from Wolfspeed pursuant to the terms of the Supply Agreement, as amended. 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 our operating activities
to make purchases in accordance with the terms of the Supply Agreement, as amended.
Line of Credit
Effective July 7, 2021, we obtained from JPMorgan Chase our $5.00 million cash collateralized line of credit facility, or the JPMorgan Chase Credit Facility. The JPMorgan Chase Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions and certain additional indebtedness for borrowed money, installment obligations, and obligations under capital and operating leases. The JPMorgan Chase Credit Facility is secured by a cash deposit in the amount of $5.05 million held by JPMorgan Chase as collateral for the line of credit facility.
Each advance accrues interest at a rate equal to JPMorgan Chase’s monthly London Interbank Offered Rate, or LIBOR, multiplied by a statutory reserve rate for eurocurrency funding to which JPMorgan Chase is subject with respect to the adjusted LIBOR rate as established by the U.S. Federal Reserve Board, plus a margin of 1.25% per annum. Interest is calculated monthly on an actual/360-day basis and payable monthly in arrears. Principal outstanding during an event of default, at JPMorgan Chase’s option, accrues interest at a rate of 3% per annum in excess of the above rate. Any advance may be prepaid in whole or in part at any time.
As of September 30, 2021, we had not borrowed against the JPMorgan Chase Credit Facility.
Prior to obtaining the JPMorgan Chase Credit Facility, we and our wholly owned subsidiary, charlesandcolvard.com, LLC, collectively referred to as the Borrowers, had a $5.00 million asset-based revolving credit facility, or the White Oak Credit Facility, from White Oak Commercial Finance, LLC, or White Oak, which we terminated in accordance with its terms as of July 9, 2021. The effective date of the White Oak Credit Facility was July 13, 2018, and it was scheduled to mature on July 13, 2021.
The White Oak Credit Facility was available for general corporate and working capital purposes, including permitted acquisitions and was guaranteed by the Borrowers. Under the terms of the White Oak Credit Facility, the Borrowers were required to maintain at least $500,000 in excess availability at all times. The White Oak Credit Facility contained no other financial covenants.
Advances under the White Oak Credit Facility could have been either revolving or non-revolving. During the first year of the term of the White Oak Credit Facility, any revolving advances would have accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and any non-revolving advances would have accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins would have been reduced upon our achievement of a specified fixed charge coverage ratio. However, any advances were in all cases subject to a minimum interest rate of 5.50%. Interest would have been calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default, which did not occur during the term of the White Oak Credit Facility, would have accrued interest at a rate 2% in excess of the rate that would have been otherwise applicable.
We had not borrowed against the White Oak Credit Facility as of July 9, 2021, the date upon which we terminated the White Oak Credit Facility in accordance with its terms.
Liquidity and Capital Trends
Notwithstanding the adverse impact that the COVID-19 pandemic has had on the global economy and on our own business operations, we believe that it has not materially adversely impacted our liquidity position and we continue to generate operating cash flows to meet our short-term liquidity needs. We further believe that our existing cash, cash equivalents, and restricted cash and access to other working capital resources, including but not limited to, 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 and duration of the underlying pandemic 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 and lab grown diamonds 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 II, Item 1A of this Quarterly Report on Form 10-Q and in Part I, Item 1A of our 2021 Annual Report on Form 10-K. We may make investments in, or acquisitions of, complementary businesses, which could also require us to seek additional equity or debt financing.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
| Item 4. | Controls and Procedures |
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 the end of the period covered by this Quarterly Report on Form 10-Q. 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 the end of the period covered by this Quarterly Report on Form 10-Q, 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 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 September 30, 2021, 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.
PART II – OTHER INFORMATION
There are no material pending legal proceedings to which we are a party or to which any of our property is subject.
We discuss in our Annual Report on Form 10-K for the fiscal year ended June 30, 2021 and our Quarterly Report on Form 10-Q for the quarter September 30, 2021 various risks that may materially affect our business. There have been no material changes to such risks.
The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:
| Exhibit No. | | Description |
| | | |
| | Charles & Colvard, Ltd. Fiscal 2022 Senior Management Equity Incentive Program, effective July 1, 2021 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on September 15, 2021)+ |
| | | |
| 31.1 | | 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.INS | | Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. |
| | | |
| 101.SCH | | Inline XBRL Taxonomy Extension Schema Document |
| | | |
| 101.CAL | | Inline XBRL Taxonomy Extension Calculation Linkbase Document |
| | | |
| 101.DEF | | Inline XBRL Taxonomy Extension Definition Linkbase Document |
| | | |
| 101.LAB | | Inline XBRL Taxonomy Extension Label Linkbase Document |
| | | |
| 101.PRE | | Inline XBRL Taxonomy Extension Presentation Linkbase document |
| | | |
| 104 | | Cover Page Interactive Data File – the cover page XBRL tags are embedded within the Inline XBRL document contained in Exhibit 101 |
| | | |
| + | | Denotes management contract or compensatory plan or arrangement |
Pursuant to the requirements 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/ Don O’Connell |
| November 4, 2021 | | Don O’Connell |
| | | President and Chief Executive Officer |
| | | |
| | By: | /s/ Clint J. Pete |
| November 4, 2021 | | Clint J. Pete |
| | | Chief Financial Officer |
| | | (Principal Financial Officer and Chief Accounting Officer) |
