| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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:
| 1. | Our business, 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; |
| 3. | Our business and our results of operations could be materially adversely affected as a result of general economic and market conditions; |
| 4. | We face intense competition in the worldwide gemstone and jewelry industry; |
| 5. | Our information technology, or IT, infrastructure, and our network may be impacted by a cyber-attack or other security incident as a result of the rise of cybersecurity events; |
| 6. | Constantly evolving privacy regulatory regimes are creating new legal compliance challenges; |
| 7. | We are subject to certain risks due to our international operations, distribution channels and vendors; |
| 7. | 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 for the sale of our products; |
| 10. | We may experience quality control challenges from time to time that can result in lost revenue and harm to our brands and reputation; |
| 11. | Seasonality of our business may adversely affect our net sales and operating income; |
| 12. | Our operations could be disrupted by natural disasters; |
| 13. | Sales of moissanite and lab grown diamond jewelry could be dependent upon the pricing of precious metals, which is beyond our control; |
| 14. | Our current customers may potentially perceive us as a competitor in the finished jewelry business; |
| 15. | We depend on a single supplier for substantially all of our silicon carbide, or 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; |
| 16. | 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; |
| 17. | Governmental regulation and oversight might adversely impact our operations; |
| 18. | The execution of our business plans could significantly impact our liquidity; |
| 19. | 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; |
| 20. | Negative or inaccurate information on social media could adversely impact our brand and reputation; |
| 21. | 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; |
| 22. | 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; |
| 23. | Environmental, social, and governance matters may impact our business, reputation, financial condition, and results of operations; |
| 24. | If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer; |
| 25. | Our loan, pursuant to the Paycheck 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, was forgiven in full and may be subject to review for compliance with applicable SBA requirements for six years from the date the loan was forgiven; |
| 26. | Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our Company; and |
| 27. | Our failure to maintain compliance with The Nasdaq Stock Market’s continued listing requirements could result in the delisting of our common stock. |
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 following discussion is designed to provide a better understanding of our unaudited condensed 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 the unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2021, or the 2021 Annual Report. Historical results and percentage relationships related to any amounts in the condensed consolidated financial statements are not necessarily indicative of trends in operating results for future periods.
Overview
Our Mission
At Charles & Colvard, Ltd., our mission is to redefine the definition of real within the jewelry industry and for consumers everywhere. We believe fine jewelry can be accessible, beautiful, and conscientious.
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), is a globally recognized fine jewelry company specializing in lab grown gemstones. We manufacture, market, and distribute Charles & Colvard Created Moissanite® (which we refer to as moissanite or moissanite jewels) and in September 2020, we announced our expansion into the lab grown diamond market with the launch of Caydia®, an exclusive brand of premium lab grown diamonds. We offer gemstones and finished jewelry featuring our proprietary moissanite jewels and premium lab grown diamonds for sale in the worldwide fine jewelry market. Charles & Colvard is the original source of created moissanite, and in 2015, we debuted Forever One™, our premium moissanite gemstone brand. As an e-commerce and multi-channel destination for fine jewelry featuring lab grown gemstones, we believe that the addition of lab grown diamonds is a natural progression for the Charles & Colvard brand.
One of our unique differentiators, moissanite – The World’s Most Brilliant Gem® – is core to our ambition to create a movement around environmentally and socially responsible fine jewelry. 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 moissanite jewels with responsibly sourced precious metals, we are delivering a uniquely positioned product line for the conscientious consumer. Our Caydia® lab grown diamonds are hand selected by our Gemological Institute of America, or GIA, certified gemologists to meet Charles & Colvard’s uncompromising standards and validated by independent third-party experts. Our Caydia® lab grown diamonds are available currently in E, F, and G color grades (based on the GIA’s color grading scale) with a minimum clarity in accordance with the GIA’s VS1 clarity classification along with excellent polish and symmetry. All of our Caydia® lab grown diamonds are set with mostly recycled precious metals.
Our strategy is to build a globally revered brand of lab grown gemstones and finished jewelry that appeals to a wide consumer audience. We believe this strategy leverages our advantages of being the original and leading worldwide source of Charles & Colvard Created Moissanite® and offering a curated assortment of jewelry featuring Caydia® lab grown diamonds, which together we believe offers an ideal combination of quality and value. We also 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.
COVID-19
The evolving COVID-19 pandemic continues to present unprecedented worldwide economic and business challenges. During the first nine months of the fiscal year ending June 30, 2022, or Fiscal 2022, we have experienced impacts on our business related to the COVID-19 pandemic, primarily in increased coronavirus-related costs, including at times using accelerated payments to our suppliers that are due by their terms in future periods. We expect to continue accelerating payments to certain suppliers through at least the fourth quarter of Fiscal 2022. Moreover, we are also continuing to see a sharp increase in international and domestic freight costs, with limited availability and long delays causing disruption in the global supply chain. Accordingly, we are taking steps where possible to mitigate such potential delays in supplier deliveries by accelerating orders and increasing order quantities. We have also taken measures to protect the health and safety of our employees, work with our customers and suppliers to minimize disruptions, and support our community in addressing the challenges posed by the ongoing COVID-19 pandemic and its evolving viral variants.
Following the government mandated shut down during the early days of the pandemic, work in our production and distribution facilities has continued throughout 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, 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 encourage all employees to be fully vaccinated and to provide evidence of vaccination status 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 during the nine month period ended March 31, 2022, 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 boosters, 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, including changes in consumer-level spending as a result of the pandemic, could adversely impact our business, financial condition, results of operations and/or cash flows in 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.
Fiscal 2022 Financial Outlook
Our key strategic initiatives during Fiscal 2022 have been designed to increase brand awareness and to drive expansion of our favorable brand equity. As we enter the fourth quarter of Fiscal 2022, we believe that we remain on a strong trajectory toward accomplishing our goal for continued and sustained top line growth and remain poised to broaden our consumer reach and maximize product value through our brand- and performance-based marketing strategy. During the first half of Fiscal 2022, we made significant investments to strengthen the Charles & Colvard brand through our marketing strategy, which included brand marketing campaigns across multiple digital platforms, social media outlets, earned media, and media placements as well as placements with key consumer-based influencers. We believe that to continue the growth of our business, we must continue to acquire new customers and retain existing customers in a cost-effective manner.
During the quarter ended March 31, 2022, we made significant progress on our first Charles & Colvard Signature Showroom, which we believe will complement and expand our omnichannel brand strategy in the fine jewelry space. This showroom, which we expect to open during the fourth quarter of Fiscal 2022, will be the first location of our retail showroom expansion program and is located in our corporate headquarters in North Carolina’s Research Triangle Park. We believe that our retail showroom expansion program will allow us to develop a nationwide footprint to showcase our patented Signature Collection designs as well as a wide assortment of Forever One™ moissanite and Caydia® lab grown diamond fine jewelry. We also expect to begin streaming live content during the fourth quarter of Fiscal 2022 from the newly constructed innovative broadcast studio in our corporate headquarters. The studio will be a digital extension of the sales team and a tool that our marketing team will utilize for video content production, live-stream shopping, designer and influencer interviews, and fashion photography. We believe this digital marketing capability will continue to further position and define our brand in what we believe is a rapidly evolving consumer landscape and better meet the consumer’s current appetite for digital content. We believe these capabilities will provide incremental sales channels for our direct-to-consumer business and allow us to compete more effectively and to increase our market share within the fine jewelry space by engaging with consumers wherever they are shopping. We continually develop and scale our investment in dynamic marketing strategies to optimize our messaging and advertising spend across multiple channels in an effort to drive strategic customer acquisition and to increase fine jewelry sales from new customers and repeat orders from existing customers.
Also during the quarter ended March 31, 2022, we hosted a social media platform-based engagement ring sweepstakes program that was designed to promote our “Made not Mined” marketing campaign. The engagement ring that was given away featured our Forever One™ moissanite gemstones. Also, during the quarter we launched our Signature Star Series line of finished jewelry featuring Caydia® lab grown diamonds set in unisex fine fashion jewelry styles and expanded our Moissanite by Charles & Colvard product styles with our dropship business partners. As a result of our brand awareness expansion programs, we received positive press coverage during the quarter for our fashion jewelry product lines on several major online shopping and fashion-related websites, such as Vogue.com, Brides.com, TheKnot.com, WWD.com, MensHealth.com, and Byrdie.com. We also received finished jewelry related press coverage on national online news outlet websites, such as CNN.com and NewsBreak.com. Lastly, during the quarter ended March 31, 2002, we curated an assortment of fine fashion jewelry featuring our Forever One™ moissanite gemstones and Caydia® lab grown diamonds that are being used for the filming of the upcoming seasons of the ABC television network’s series of The Bachelor and The Bachelorette.
While we are in the early stages of expanding our geographic footprint, we believe these strategies will combine to help drive future and sustained growth and to present our brand and gemstone product lines to a broader range of consumers in the fine jewelry space. We further believe that we remain well-positioned to meet current marketing-level trends within the jewelry industry, where consumers are increasingly more aware of the products they purchase and seek brands that stand for sustainability and social and environmental responsibility.
We discuss our strategic outlook and key strategies for Fiscal 2022 in Part I, Item 1, “Business” and in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, contained in our 2021 Annual Report.
Critical Accounting Policies and Estimates
Our 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, or U.S. GAAP. The future effects of the COVID-19 pandemic on our results of operations, cash flows, and financial position 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 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, including the impact of the COVID-19 pandemic and the related responses, those actual results of operations may materially differ. The most significant estimates impacting our consolidated financial statements relate to the valuation and classification of inventories, accounts receivable reserves, deferred tax assets, stock-based compensation, 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.
We have disclosed our critical accounting policies and estimates in our 2021 Annual Report, and that disclosure should be read in conjunction with this Quarterly Report on Form 10-Q. There have been no significant changes in our critical accounting policies and estimates during the first nine months of Fiscal 2022.
Results of Operations
The following table sets forth certain consolidated statements of operations data for the three and nine months ended March 31, 2022 and 2021:
| | | Three Months Ended March 31, | | | Nine Months Ended March 31, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Net sales | | $ | 9,751,835 | | | $ | 9,436,056 | | | $ | 33,785,281 | | | $ | 29,509,140 | |
| Costs and expenses: | | | | | | | | | | | | | | | | |
| Cost of goods sold | | | 5,296,530 | | | | 5,093,452 | | | | 17,347,026 | | | | 15,457,215 | |
| Sales and marketing | | | 2,932,587 | | | | 2,211,350 | | | | 9,741,774 | | | | 6,339,854 | |
| General and administrative | | | 1,106,850 | | | | 1,092,683 | | | | 3,880,684 | | | | 3,278,246 | |
| Total costs and expenses | | | 9,335,967 | | | | 8,397,485 | | | | 30,969,484 | | | | 25,075,315 | |
| Income from operations | | | 415,868 | | | | 1,038,571 | | | | 2,815,797 | | | | 4,433,825 | |
| Other income (expense): | | | | | | | | | | | | | | | | |
| Interest income | | | 1,120 | | | | 540 | | | | 1,964 | | | | 5,126 | |
| Interest expense | | | - | | | | (2,412 | ) | | | - | | | | (7,318 | ) |
| Loss on foreign currency exchange | | | - | | | | - | | | | (34 | ) | | | (603 | ) |
| Total other income (expense), net | | | 1,120 | | | | (1,872 | ) | | | 1,930 | | | | (2,795 | ) |
| Income before income taxes | | | 416,988 | | | | 1,036,699 | | | | 2,817,727 | | | | 4,431,030 | |
| Income tax expense | | | (78,480 | ) | | | (472 | ) | | | (484,582 | ) | | | (1,460 | ) |
| Net income | | $ | 338,508 | | | $ | 1,036,227 | | | $ | 2,333,145 | | | $ | 4,429,570 | |
Consolidated Net Sales
Consolidated net sales for the three and nine months ended March 31, 2022 and 2021 comprise the following:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 7,420,591 | | | $ | 6,219,892 | | | $ | 1,200,699 | | | | 19 | % | | $ | 23,646,044 | | | $ | 18,820,428 | | | $ | 4,825,616 | | | | 26 | % |
| Loose jewels | | | 2,331,244 | | | | 3,216,164 | | | | (884,920 | ) | | | (28 | )% | | | 10,139,237 | | | | 10,688,712 | | | | (549,475 | ) | | | (5 | )% |
| Total consolidated net sales | | $ | 9,751,835 | | | $ | 9,436,056 | | | $ | 315,779 | | | | 3 | % | | $ | 33,785,281 | | | $ | 29,509,140 | | | $ | 4,276,141 | | | | 14 | % |
Consolidated net sales were $9.75 million for the three months ended March 31, 2022 compared to $9.44 million for the three months ended March 31, 2021, an increase of $316,000, or 3%. Consolidated net sales were $33.79 million for the nine months ended March 31, 2022 compared to $29.51 million for the nine months ended March 31, 2021, an increase of $4.28 million, or 14%. The increase in consolidated net sales for the three months ended March 31, 2022 was due to strong Valentine’s Day sales during February 2022. The increase in consolidated net sales for the nine-month period ended March 31, 2022 was the result of our strong third quarter sales coupled with robust calendar year-end holiday sales during our fiscal quarter ended December 31, 2021. These higher sales for the three- and nine-month periods ended March 31, 2022, were also related 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 and nine months ended March 31, 2022 in our Online Channels segment and Traditional segment. The increases in our Online Channels segment net sales in the three months ended March 31, 2022 were partially offset by lower net sales in our Traditional segment driven by lower loose jewels sales and decreased international sales during the three months ended March 31, 2022.
Sales of finished jewelry represented 76% and 70% of total consolidated net sales for the three and nine months ended March 31, 2022, respectively, compared to 66% and 64%, respectively, of total consolidated net sales for the corresponding periods of the prior year. For the three months ended March 31, 2022, finished jewelry sales were $7.42 million compared to $6.22 million for the corresponding period of the prior year, an increase of approximately $1.20 million, or 19%. For the nine months ended March 31, 2022, finished jewelry sales were $23.65 million compared to $18.82 million for the corresponding period of the prior year, an increase of approximately $4.83 million, or 26%. The increase in finished jewelry sales for the three- and nine-month periods ended March 31, 2022 was due primarily to higher finished jewelry sales of Forever One™ and Moissanite by Charles & Colvard® in our Online Channels segment as well as in our Traditional segment and higher finished jewelry sales of Caydia® lab grown diamond jewelry in our Online Channels segment.
Sales of loose jewels represented 24% and 30% of total consolidated net sales for the three and nine months ended March 31, 2022, respectively, compared to 34% and 36%, respectively, of total consolidated net sales for the corresponding periods of the prior year. For the three months ended March 31, 2022, loose jewel sales were $2.33 million compared to $3.22 million for the corresponding period of the prior year, a decrease of $885,000, or 28%. For the nine months ended March 31, 2022, sales of loose jewels were $10.14 million compared to $10.69 million for the corresponding period of the prior year, a decrease of $549,000, or 5%. The decrease in sales of loose jewels for the three-month and nine-month periods ended March 31, 2022 was due primarily to a lower level of sales through the distribution network in our Traditional segment.
U.S. net sales accounted for approximately 96% and 95% of total consolidated net sales for the three and nine months ended March 31, 2022, respectively, compared to 95% and 94% of total consolidated net sales for the corresponding periods in the prior year. U.S. net sales increased $422,000, or 5%, during the three months ended March 31, 2022 from the corresponding period of the prior fiscal year. U.S. net sales increased $4.38 million, or 16%, during the nine months ended March 31, 2022 from the corresponding period of the prior year. U.S. net sales increased during the three and nine months ended March 31, 2022 primarily as a result of increased sales to U.S. customers in our Online Channels segment.
Our largest U.S. customer during the three and nine months ended March 31, 2022 accounted for 13% and 14% of total consolidated net sales during each respective period. This same customer was our largest customer during the three and nine months ended March 31, 2021 when this customer accounted for 15% and 13% of total consolidated net sales during each of the respective three- and nine-month periods. Our second largest U.S. customer during the three and nine months ended March 31, 2021 accounted for 13% and 11% of total consolidated net sales during each of the respective three- and nine-month periods. Other than our U.S. customers noted above during the three- and nine-month periods ended March 31, 2022 and 2021, 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 for the three and nine months ended March 31, 2022, respectively, compared to 5% and 6% of total consolidated net sales for the corresponding periods of the prior year. International net sales decreased 23% and 6% during the three and nine months ended March 31, 2022, respectively, from the corresponding periods of the prior fiscal year due to somewhat lower demand in our international distributor market coupled with a slight increase in demand in our direct-to-consumer international 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 adapt to 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 and nine months ended March 31, 2022 or 2021. 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 three and nine months ended March 31, 2022 and 2021 are as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 3,709,864 | | | $ | 3,051,936 | | | $ | 657,928 | | | | 22 | % | | $ | 10,748,323 | | | $ | 8,808,372 | | | $ | 1,939,951 | | | | 22 | % |
| Loose jewels | | | 1,013,986 | | | | 1,468,338 | | | | (454,352 | ) | | | (31 | )% | | | 4,507,997 | | | | 5,017,863 | | | | (509,866 | ) | | | (10 | )% |
| Total product line cost of goods sold | | | 4,723,850 | | | | 4,520,274 | | | | 203,576 | | | | 5 | % | | | 15,256,320 | | | | 13,826,235 | | | | 1,430,085 | | | | 10 | % |
| Non-product line cost of goods sold | | | 572,680 | | | | 573,178 | | | | (498 | ) | | | 0 | % | | | 2,090,706 | | | | 1,630,980 | | | | 459,726 | | | | 28 | % |
| Total cost of goods sold | | $ | 5,296,530 | | | $ | 5,093,452 | | | $ | 203,078 | | | | 4 | % | | $ | 17,347,026 | | | $ | 15,457,215 | | | $ | 1,889,811 | | | | 12 | % |
Total cost of goods sold was $5.30 million for the three months ended March 31, 2022 compared to $5.09 million for the three months ended March 31, 2021, a net increase of approximately $203,000, or 4%. Total cost of goods sold was $17.35 million for the nine months ended March 31, 2022 compared to $15.46 million for the nine months ended March 31, 2021, an increase of approximately $1.89 million, or 12%. 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 product line cost of goods sold for the three and nine months ended March 31, 2022 compared to the same period in 2021 was primarily driven by increased sales of finished jewelry, which reflect higher material and labor costs, in our Online Channels segment as a result of strong demand during the calendar year-end 2021 holiday season and Valentine’s Day season. Our finished jewelry products cost more to produce due to higher material and labor costs when compared to the production of loose jewels.
The non-product line cost of goods sold for the three months ended March 31, 2022 compared to the same period in 2021 was flat.
The net increase in non-product line cost of goods sold for the nine months ended March 31, 2022, comprises an approximate $293,000 increase in freight out principally from increased shipments resulting from Online Channels segment sales growth during the nine months ended March 31, 2022, as well as a reflection of the rising costs of freight overall during the period; an approximate $104,000 increase in inventory write-offs primarily related to increases in obsolescence reserves in the first three months of the nine month-period ended March 31, 2022, compared to those in the comparable prior year period; and an approximate $121,000 increase in non-capitalized manufacturing production control expenses principally related to the timing of when work-in-process goods are received into inventory and overhead costs are allocated. These increases were partially offset by a $58,000 decrease in other inventory adjustments principally related to changes in production standard cost variances compared to those in the nine-month period ended March 31, 2021.
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
Sales and marketing expenses for the three and nine months ended March 31, 2022 and 2021 are as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Sales and marketing | | $ | 2,932,587 | | | $ | 2,211,350 | | | $ | 721,237 | | | | 33 | % | | $ | 9,741,774 | | | $ | 6,339,854 | | | $ | 3,401,920 | | | | 54 | % |
Sales and marketing expenses were $2.93 million for the three months ended March 31, 2022 compared to $2.21 million for the three months ended March 31, 2021, an increase of approximately $721,000, or 33%. Sales and marketing expenses were $9.74 million for the nine months ended March 31, 2022 compared to $6.34 million for the nine months ended March 31, 2021, an increase of approximately $3.40 million, or 54%.
The increase in sales and marketing expenses for the three months ended March 31, 2022 compared to the same period in 2021 was primarily due to a $543,000 increase in advertising and digital marketing expenses; a $63,000 increase in professional services principally comprising consulting services for marketing support in the current year period; a $59,000 increase in bank fees, which are principally related to higher credit card transaction fees from increased online sales levels; a $46,000 increase in compensation expenses; a $35,000 increase in software-related costs incurred primarily in connection with new software-related agreements associated with upgraded operating and cybersecurity systems; an $8,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed in January 2021; and a $6,000 increase in travel expenses as we returned to more traditional business travel patterns following cut-backs relating to the COVID-19 pandemic and related cost-control measures in the prior year period. These increases were offset partially by an $18,000 decrease in recruiting and employment agency fees, a $10,000 decrease in depreciation and amortization expense relating to capitalized costs associated with information technology-related upgrades, and an $11,000 net decrease in general office-related expenses.
The increase in advertising and digital marketing expenses for the three months ended March 31, 2022 compared to the same period in 2021 comprises a $360,000 increase in digital advertising spend; a $34,000 increase in cooperative advertising; a $149,000 increase in brand awareness marketing campaigns; and a $6,000 increase in outside agency fees. These increases were offset partially by a $6,000 decrease in print media expenses. During 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.
Compensation expenses for the three months ended March 31, 2022 compared to the same period in 2021 increased primarily due to an $8,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $27,000 increase in bonus expense; and an $11,000 increase in employee stock-based compensation expense. The increases in bonus and employee stock-based compensation expenses reflect the impact of our performance-based bonus plans and stock compensation-related benefits.
The increase in sales and marketing expenses for the nine months ended March 31, 2022 compared to the same period in 2021 was primarily due to a $2.75 million increase in advertising and digital marketing expenses; a $191,000 increase in compensation expenses; a $170,000 increase in professional services principally comprising consulting services for marketing support in the current year period; a $140,000 increase in bank fees expenses, which are principally related to higher credit card transaction fees from increased online sales levels; an $80,000 increase in software-related costs incurred primarily in connection with new software-related agreements associated with upgraded sales-related operating and cybersecurity systems; a $51,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed in January 2021; a $31,000 increase in travel expenses as we returned to more traditional business travel patterns following cut-backs relating to the COVID-19 pandemic and related cost-control measures in the prior year period; and a $9,000 increase in depreciation and amortization expense relating to capitalized costs associated with information technology-related upgrades. These increases were offset partially by an $18,000 decrease in recruiting and employment agency fees and a $1,000 net decrease in general office-related expenses.
The increase in advertising and digital marketing expenses for the nine months ended March 31, 2022 compared to the same period in 2021 comprises a $2.20 million increase in digital advertising spend; a $245,000 increase in cooperative advertising; a $137,000 increase in expenses relating to our participation in the 2021 JCK Trade Show (the JCK Trade Show organization did not hold an event in the prior year due to restrictions related to the COVID-19 pandemic); a $129,000 increase in brand awareness marketing campaign expenditures in the current year period; a $23,000 increase in print media expenses; and a $16,000 increase in outside agency fees.
Compensation expenses for the nine months ended March 31, 2022 compared to the same period in 2021 increased primarily as a result of a $94,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $57,000 increase in employee stock-based compensation expense; and a $42,000 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 and nine months ended March 31, 2022 and 2021 are as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| General and administrative | | $ | 1,106,850 | | | $ | 1,092,683 | | | $ | 14,167 | | | | 1 | % | | $ | 3,880,684 | | | $ | 3,278,246 | | | $ | 602,438 | | | | 18 | % |
General and administrative expenses were $1.11 million for the three months ended March 31, 2022 compared to $1.09 million for the three months ended March 31, 2021, an increase of approximately $14,000, or 1%. General and administrative expenses were $3.88 million for the nine months ended March 31, 2021 compared to $3.28 million for the nine months ended March 31, 2022, an increase of approximately $602,000, or 18%.
The increase in general and administrative expenses for the three months ended March 31, 2022 compared to the same period in 2021 was primarily due to a $97,000 increase in compensation expenses; a $28,000 increase in housing allowances and travel-related expenditures as we returned to more normal business travel patterns following cut-backs relating to the COVID-19 pandemic in the prior year period; a $12,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed in January 2021; and a $26,000 increase in insurance expenses principally related to higher renewal premiums. These increases were partially offset by a $74,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy in connection with the decrease in accounts receivable, compared with the prior period; a $33,000 decrease in bank-related fees principally in connection with the Company’s prior credit facility that was terminated in accordance with its terms in July 2021; a $24,000 decrease in depreciation and amortization expense, principally related to fully depreciated assets when compared to those in prior periods; and an $18,000 decrease in professional services.
The increase in compensation expenses for the three months ended March 31, 2022 compared to the same period in 2021 comprises a $93,000 increase in employee stock-based compensation expense, which reflects improved operating results that impact our performance-based compensation-related benefits, and a $28,000 net increase in salaries and related employee benefits. These increases were partially offset by a $24,000 decrease in bonus expense.
Professional services fees decreased for the three months ended March 31, 2022 compared to the same period in 2021 primarily due to a $44,000 decrease in legal fees associated with corporate governance matters in the prior year period, and a $14,000 net decrease in consulting and other professional services in the current year period. These decreases were partially offset by a $40,000 increase in fees associated with audit and tax services, principally related to a discrete income tax-related project.
The increase in general and administrative expenses for the nine months ended March 31, 2022 compared to the nine-month period ended March 31, 2021 was primarily due to a $481,000 increase in compensation expenses; a $95,000 increase in housing allowances and travel-related expenditures as we returned to more normal business travel patterns following cut-backs relating to the COVID-19 pandemic in the prior year period; a $67,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed in January 2021; a $39,000 increase in employee-related recruiting and search fees for new hires; a $47,000 increase in insurance expenses principally related to higher renewal premiums; a $29,000 increase in professional services; and a $9,000 increase in business taxes and licenses. These increases were partially offset by a $70,000 decrease in depreciation and amortization expense, principally related to fully depreciated assets when compared to those in prior periods; a $67,000 decrease in bank-related fees principally in connection with the Company’s prior credit facility that was terminated in accordance with its terms in July 2021; and a $28,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy in connection with the decrease in accounts receivable, compared with the prior period.
Compensation expenses increased for the nine months ended March 31, 2022 compared to the same period in 2021 primarily due to a $307,000 increase in employee stock-based compensation expense; a $158,000 increase in bonus expense; and a $16,000 net increase in salaries and related employee benefits in the aggregate. The increases in employee stock-based compensation and bonus expenses reflect improved operating results that impact these performance-based compensation-related benefits.
Professional services fees increased for the nine months ended March 31, 2022 compared to the nine-month period ended March 31, 2021 primarily due to a $78,000 increase in fees associated with audit and tax services, principally related to a discrete income tax-related project. This increase was partially offset by a $6,000 net decrease in consulting and other professional services; and a $43,000 decrease in legal fees associated with corporate governance matters.
Interest Income
Interest income for the three and nine months ended March 31, 2022 and 2021 is as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Interest income | | $ | 1,120 | | | $ | 540 | | | $ | 580 | | | | 107 | % | | $ | 1,964 | | | $ | 5,126 | | | $ | (3,162 | ) | | | (62 | )% |
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 and nine months ended March 31, 2022 and 2021, we earned interest from cash on deposit in this interest-bearing account. The decrease in earned interest for the nine months ended March 31, 2022 reflects adverse changes in interest rates during Fiscal 2022 compared with Fiscal 2021.
Interest Expense
Interest expense for the three and nine months ended March 31, 2022 and 2021 is as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Interest expense | | $ | - | | | $ | 2,412 | | | $ | (2,412 | ) | | | (100 | )% | | $ | - | | | $ | 7,318 | | | $ | (7,318 | ) | | | (100 | )% |
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, including the related accrued and unpaid interest, was forgiven by the U.S. Small Business Administration.
We had no outstanding debt during the nine months ended March 31, 2022.
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 and nine months ended March 31, 2022 and 2021 are as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | - | | | $ | - | | | $ | - | | | | - | % | | $ | 34 | | | $ | 603 | | | $ | (569 | ) | | | (94 | )% |
During the three and nine months ended March 31, 2022 and 2021, 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 and nine months ended March 31, 2022, compared with the same period in the prior year, coupled with fluctuations in foreign currency exchange rates during the nine months ended March 31, 2022.
Provision for Income Taxes
For each of the three and nine months ended March 31, 2022, 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 each of the three and nine months ended March 31, 2021, 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-based compensation transactions during the quarter. For the nine months ended March 31, 2022, our effective tax rate was 17.20%.
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 expectations 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 the 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 $78,000 and $485,000 for the three and nine months ended March 31, 2022, respectively, compared with a net income tax expense of approximately $500 and $1,000 for the three and nine months ended March 31, 2021, respectively. With the reduction of our valuation allowance during the fiscal year ended June 30, 2021, we recognized deferred income tax expense during the three and nine months ended March 31, 2022 in the amount of approximately $78,000 and $483,000, respectively. 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 March 31, 2022 and 2021, respectively, and approximately $1,500 for each of the nine months ended March 31, 2022 and 2021, respectively.
As of March 31, 2022, we determined that our expectations 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 the deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence existed as of March 31, 2022, to conclude that it is more likely than not deferred tax assets of approximately $5.87 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.
Our weighted average shares outstanding on a diluted basis were 31.27 million shares for each of the three and nine months ended March 31, 2022, compared to 30.53 million shares and 29.67 million shares for the three and nine months ended March 31, 2021, respectively. The increases in our weighted average shares outstanding in the current year periods were driven by an increase in option exercises since the prior year periods presented herein.
We had no outstanding debt as of March 31, 2022.
Operating Activities and Cash Flows
We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of March 31, 2022, our principal sources of liquidity were cash, cash equivalents and restricted cash totaling $21.91 million, trade accounts receivable of $1.57 million, and net current inventory of $13.44 million, as compared to cash, cash equivalents, and restricted cash totaling $21.45 million, trade accounts receivable 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 nine months ended March 31, 2022, our working capital increased by approximately $2.32 million to $32.46 million from $30.14 million at June 30, 2021. As described more fully below, the increase in working capital at March 31, 2022 is primarily attributable to 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, an increase in our prepaid expenses and other assets, a decrease in our accrued expenses and other liabilities, and a net increase in our cash, cash equivalents, and restricted cash. These factors were offset partially by an increase in our accounts payable, a decrease in our accounts receivable, and an increase in our short-term operating lease liabilities. Our cash used for investing activities for construction in-process expenditures related to our retail expansion program and the construction of our first Charles & Colvard Signature Showroom, or Signature Showroom, and other leasehold improvements in our corporate offices was offset by cash provided by financing and operating activities.
In accordance with the terms of the lease agreement for our corporate headquarters, or Lease Agreement, and the location for our first Signature Showroom, the Lease Agreement includes an allowance for leasehold improvements offered by the landlord in an amount not to exceed approximately $545,000. During the three months ended March 31, 2022, we were reimbursed approximately $506,000 by the landlord for qualified leasehold improvements in accordance with the terms of the Lease Amendment. This reimbursement by the landlord reduced the remaining ROU asset by the same amount and will be recognized prospectively over the remaining term of the lease.
For more detailed information about the allowance for leasehold improvements contained within the Lease Agreement, see Note 9 to our condensed consolidated financial statements in Item 1, “Financial Statements”, of this Quarterly Report on Form 10-Q.
During the nine months ended March 31, 2022, approximately $1.10 million of cash was provided by our operating activities. The primary drivers of our cash flow from operations were the favorable effect of net income in the amount of $2.33 million, which also included $1.74 million of non-cash expenses; an increase in accounts payable of $356,000; a decrease in accounts receivable of $92,000; a decrease in prepaid expenses and other assets of $641,000; and an increase in accrued income taxes of $1,400. These factors were offset partially by an increase in inventory of $3.56 million; and an increase in accrued expenses and other liabilities of $504,000.
Accounts receivable decreased principally due to collection efforts to ensure customers made timely payments. Throughout the course of the COVID-19 pandemic and through the current period ended March 31, 2022, 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 $13.86 million in finished jewelry, which includes the cost of the loose jewels, the purchase price of precious metals, and cost of labor and overhead in connection with jewelry production, and $6.93 million in loose jewels, which includes the purchase of raw materials and labor in connection with gemstone production, during the nine months ended March 31, 2022. 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, upward price trends could 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 March 31, 2022, $19.06 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 $1.69 million and new raw material that we purchase pursuant to the Supply Agreement.
With our investment in the lab grown diamond product line in recent periods, the level of our lab grown diamond inventory, which has a higher carrying value, has increased to support the business and expected product sales. This has contributed to the growth in our overall inventory levels compared with prior periods.
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 March 31, 2022, 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 March 31, 2022, 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 $28.35 million remains to be purchased as of March 31, 2022.
During the nine months ended March 31, 2022 and 2021, we purchased approximately $4.49 million and $2.28 million, respectively, of 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 operating activities to finance our purchase commitment under 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, which is scheduled to mature on July 31, 2022, 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 March 31, 2022, 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, in Part II, Item 1A of our Quarterly Reports on Form 10-Q for the quarters ended September 30, 2021 and December 31, 2021, 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 |
Not applicable.
| 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 March 31, 2022, 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 ended December 31, 2021 various risks that may materially affect our business. There have been no material changes to such risks, except as set forth below.
Our information technology, or IT, infrastructure, and our network may be impacted by a cyber-attack or other security incident as a result of the rise of cybersecurity events. Our business operations rely on the secure processing, storage, and transmission of
certain confidential, sensitive, proprietary, and other information, as well as
personal information about our customers and employees
. Cyber
-attacks, including those associated with the current
conflict in Eastern Europe, are rapidly evolving as
cyber criminals have become increasingly sophisticated and carry out direct large-scale, complex
, and automated attacks against
companies or through
their vendors.
Breaches of our technology systems, whether from circumvention of security systems, denial-of-service attacks or other cyber-attacks, hacking, “phishing” attacks, computer viruses, ransomware or malware, employee or insider error, malfeasance, social engineering, vendor software supply chain compromises, physical breaches or other actions, have and may result in manipulation or corruption of sensitive data, material interruptions or malfunctions in our websites, applications, data processing and certain products and services, or disruption of other business operations. Furthermore, any such breaches could compromise the confidentiality and integrity of material information held by us (including information about our business, employees, or customers), as well as sensitive information, the disclosure of which could lead to identity theft. Breaches of our product services that rely on technology and internet connectivity can expose us to product and other liability risk and reputational harm. Measures that we take to avoid, detect, mitigate, or recover from material incidents, may be insufficient, circumvented, or may become ineffective.
We are not able to anticipate or prevent all such cyber-attacks and, to the extent a cyber-attack or other security incident results in a breach of the above-described information, it could disrupt our business operations, harm our reputation, compel us to comply with applicable data breach notification laws, subject us to litigation, regulatory investigation, or otherwise subject us to liability under laws, regulations and contractual obligations. This could result in increased costs to us and result in significant legal and financial exposure and/or reputational harm.
We have invested and continue to invest in risk management and information security and data privacy measures in order to protect our systems and data, including employee training, organizational investments, incident response plans, table-top exercises, and technical defenses.
The cost and operational consequences of implementing, maintaining, and enhancing data or system protection measures could increase significantly to overcome intense, complex, and sophisticated global cyber threats.
In addition, we and certain of our third-party vendors receive and store
certain 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
. 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.
Constantly evolving privacy regulatory regimes are creating new legal compliance challenges. Domestic and international privacy and data security laws are complex and changing rapidly. There are a variety of laws and regulations, including regulation by federal government agencies, including the Federal Trade Commission, or FTC, and state and local agencies. In addition to federal laws such as §5 of the Federal Trade Commission Act, the Gramm-Leach-Bliley Act, and the Fair Credit Reporting Act, certain states have also enacted laws regulating companies’ collection, use, and disclosure of personal information and requiring the implementation of reasonable data security measures. Various laws across states and U.S. territories also require businesses to notify affected individuals, governmental entities, and/or credit reporting agencies of certain security breaches affecting personal information. International privacy laws, including in Canada and the European Union, pose further challenges. These domestic and international laws are not consistent, and compliance with these laws in the event of a widespread data breach would be complex and costly.
In addition, privacy advocates and industry groups have regularly proposed, and may propose in the future, self-regulatory standards by which we are legally or contractually bound. If we fail to comply with these obligations or standards, we may face substantial liability or fines.
Despite our efforts to comply with all applicable data protection laws and regulations, any actual or perceived non-compliance could result in litigation and proceedings against us by governmental entities, customers, or others, fines and civil or criminal penalties, limited ability or inability to operate our business, offer services, or market our business in certain jurisdictions, negative publicity and harm to our brand and reputation, and reduced overall demand for our products and services. Such occurrences could adversely affect our business, financial condition, and results of operations.
Environmental, social, and governance matters may impact our business, reputation, financial condition, and results of operations. Increasingly, companies are being measured by their performance on a variety of environmental, social, and governance, or ESG, matters, which are considered to contribute to the long-term sustainability of companies’ performance. Recently, many investors, including large institutional investors, have publicly emphasized the importance of ESG measures to their investment decisions.
Our assessments on ESG matters include, among others, the Company’s efforts and impacts, including impacts associated with our suppliers or other business partners, on environmentally and socially responsible fine jewelry, climate change, diversity, ethics, and compliance with applicable regulations.
There can be no certainty that we will manage such ESG matters successfully, or that we will successfully meet investors’ expectations as to our proper role, or our own ESG goals and values. This could lead to risk of litigation or reputational damage relating to our ESG policies or performance. Further, our decisions regarding ESG matters may not be consistent with our short-term financial expectations and may not ultimately produce the long-term benefits that we expect, in which case our business, reputation, financial condition, and operating results may be adversely impacted.
The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:
| Exhibit No. | Description |
| | |
| 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 |
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 |
May 5, 2022 | | Don O’Connell |
| | | President and Chief Executive Officer |
| | | |
| | By: | /s/ Clint J. Pete |
May 5, 2022 | | Clint J. Pete |
| | | Chief Financial Officer |
| | | (Principal Financial Officer and Chief Accounting Officer) |
