| 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 and our results of operations could be materially adversely affected as a result of general economic and market 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. | The effects of COVID-19 and other potential future public health crises, epidemics, pandemics or similar events on our business, operating results, and cash flows are uncertain; |
| 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; |
| 8. | Our business and our results of operations could be materially adversely affected as a result of our inability to fulfill orders on a timely basis; |
| 9. | We are currently dependent on a limited number of distributor and retail partners in our Traditional segment 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. | Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our Company; |
| 26. | We cannot guarantee that our share repurchase program will be utilized to the full value approved, or that it will enhance long-term stockholder value and repurchases we consummate could increase the volatility of the price of our common stock and could have a negative impact on our available cash balance; 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, 2022, or the 2022 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 provide a more conscious and conflict-free fine jewelry experience for our customers. We are dedicated to blazing a more brilliant path forward with our Made, Not Mined™ gemstones and committed to creating fine jewelry with a conscience.
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 created 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.
We sell loose moissanite jewels, lab grown diamonds, and finished jewelry set with these gems through two operating segments: our Online Channels segment, which encompasses our digital properties components, comprised of our charlesandcolvard.com and moissaniteoutlet.com websites, e-commerce outlets, including marketplaces, drop-ship customers, and other pure-play, exclusively e-commerce customers; and our Traditional segment, which consists of domestic and international distributors and retail customers. We report segment information based on the “management” approach. This segment reporting approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of our operating and reportable segments.
We operate in an e-commerce environment characterized by both complexity in global markets and ongoing economic uncertainties in the U.S. and internationally. Our strategy is to build a globally revered and accessible brand of gemstones and finished fine jewelry products set with moissanite and lab grown diamonds. We believe that our goods appeal to a wide consumer audience and leverage our advantage of being the original and leading worldwide source of moissanite and purveyor of premium lab grown diamonds. We believe a direct relationship with consumers is an important component to this strategy, which entails delivering tailored educational content, engaging in interactive dialogue with our audience, and positioning our brand to meet the demands of today’s discerning consumer. A significant component of our strategy in this environment is to focus on our core products, improving the quality and predictability of the delivery of our products and services, and placing those products quickly into the hands of our U.S. and international customers at affordable prices. Moreover, recognizing today that our customers and vendors are resource constrained, we are endeavoring to develop and extend our portfolio of products in a disciplined manner with a focus on domestic markets close to our core capabilities, as well as growing our global marketplace sales. We continue to focus on affordability initiatives. We also expect to continue innovating and investing in lab created gemstone technologies to fulfill evolving product requirements for our customers and investing in our people so that we have the technical and production skills necessary to succeed without limiting our ability to build sound financial returns to our investors.
We believe our expanding application of an omni-channel sales strategy across the fine jewelry trade and to the end consumer with accessible gemstones and value branded finished jewelry featuring Charles & Colvard Created Moissanite® and Caydia® lab grown diamonds positions our products at the many touchpoints where consumers are when they are making their buying decisions – thereby continuing to create greater exposure for our brand and increasing consumer demand.
COVID-19 Update
The COVID-19 pandemic continues to present business challenges and we expect these to continue throughout the fiscal year ending June 30, 2023, or Fiscal 2023. We have reintroduced employees to the workplace, including in some cases permitting a hybrid blend of remote and onsite work for certain sectors of the workforce, as vaccine and related booster shot rates have increased and COVID-19 infection levels have decreased. We continue working with our customers and suppliers to minimize disruptions, including at times accelerating payments to key suppliers that are due by their terms in future periods. We expect to continue accelerating payments to our suppliers in some cases into Fiscal 2023.
The ultimate impact of COVID-19 on our operations and financial performance in future periods, including management’s ability to execute its 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 anticipate that the COVID-19 pandemic is likely to continue to impact our business, financial condition, results of operations, and cash flows in Fiscal 2023.
For additional risks to the Company related to the COVID-19 pandemic, see “Part I, Item 1A. Risk Factors”, contained in our 2022 Annual Report.
Fiscal 2023 Financial Outlook
Our strategic goals for Fiscal 2023 are centered on continuing to expand Charles & Colvard’s brand on a global scale and to increase the size of our business through top-line growth. As lab-created gemstones are being embraced by emerging generations, we believe our ability to establish moissanite and our lab grown diamonds along with the Charles & Colvard brand directly with conscious consumers is key to our future success and ability to fuel our growth. We plan to continue executing on our key Fiscal 2023 strategies with an ongoing commitment to spending judiciously and generating sustainable earnings improvement.
In October 2022, we celebrated the grand opening of the first Charles & Colvard Signature Showroom, which is the first location in connection with our showroom expansion initiative. We believe this expansion project can position us to be able to develop a nationwide footprint if future showrooms are opened to showcase our fine jewelry in a tangible way. Likewise, in October 2022, we hosted a private press event for community leaders and influencers, allowing them to experience the new broadcast studio located in our corporate headquarters. This studio is a digital extension of the sales team and a tool that our marketing team utilizes for video content production, live-stream shopping, designer and influencer interviews, and fashion photography. We believe our brick-and-mortar expansion and digital marketing capability will continue to further position and define our brand in what we believe is a rapidly evolving consumer landscape and allow us to compete more effectively and, we believe, increase our market share within the fine jewelry space. Also in October 2022, we announced our latest lab grown precious gemstones in color, which we believe represents another milestone for us and adds a colorful new dimension to our impressive Made, Not Mined™ fine jewelry repertoire. Featuring lab grown ruby, sapphire, and emerald gemstones, our new conscious color collection also includes Caydia® lab grown diamonds and showcases the above-ground stones with artistic silhouettes and higher carat designs.
As evidenced by our results for the first quarter of Fiscal 2023, domestic and global inflation and rising interest rates, coupled with ongoing fears of recession, continue to erode consumer confidence and present major challenges for the global retail and ecommerce industry. We are facing the same challenges as all retailers and those in the ecommerce space. At the same time, however, these same challenges are providing us the opportunity to reevaluate technologies, strategies, and talent to shape a new era of shopping. In many ways, we believe the pandemic and current global economic conditions have opened the door for what we believe may be a long-overdue reset within our industry that could help move retailers and those in the ecommerce space into more stable – and potentially more profitable – positions. We plan to continue to invest in our business and seize current challenges by turning them into opportunities for continued growth and improved profitability.
We discuss our strategic outlook and key strategies for Fiscal 2023 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 2022 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 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, 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 2022 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 three months of Fiscal 2023.
Results of Operations
The following table sets forth certain consolidated statements of operations data for the three months ended September 30, 2022 and 2021:
|
| Three Months Ended September 30, | |
|
| 2022 | | | 2021 | |
| Net sales |
| $ | 7,374,083 | | | $ | 10,280,311 | |
| Costs and expenses: |
| | | | | | | |
| Cost of goods sold |
| | 4,086,010 | | | | 5,016,550 | |
| Sales and marketing |
| | 3,107,946 | | | | 2,730,153 | |
| General and administrative |
| | 1,413,476 | | | | 1,584,275 | |
| Total costs and expenses |
| | 8,607,432 | | | | 9,330,978 | |
| (Loss) Income from operations |
| | (1,233,349 | ) | | | 949,333 | |
| Other income (expense): |
| | | | | | | |
| Interest income |
| | 40,201 | | | | 355 | |
| Loss on foreign currency exchange |
| | - | | | | (34 | ) |
| Total other income (expense), net |
| | 40,201 | | | | 321 | |
| (Loss) Income before income taxes |
| | (1,193,148 | ) | | | 949,654 | |
| Income tax benefit (expense) |
| | 302,956 | | | | (122,629 | ) |
| Net (loss) income |
| $ | (890,192 | ) | | $ | 827,025 | |
Consolidated Net Sales
Consolidated net sales for the three months ended September 30, 2022 and 2021 comprise the following:
| | Three Months Ended September 30, | | | Change | |
| | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 5,540,406 | | | $ | 5,686,287 | | | $ | (145,881 | ) | | | (3 | )% |
| Loose jewels | | | 1,833,677 | | | | 4,594,024 | | | | (2,760,347 | ) | | | (60 | )% |
| Total consolidated net sales | | $ | 7,374,083 | | | $ | 10,280,311 | | | $ | (2,906,228 | ) | | | (28 | )% |
Consolidated net sales were $7.37 million for the three months ended September 30, 2022 compared to $10.28 million for the three months ended September 30, 2021, a decrease of approximately $2.91 million, or 28%. The decrease in consolidated net sales for the three months ended September 30, 2022 was mainly due to weakness in demand for our moissanite jewels from our domestic distributors. These decreases resulted in lower loose jewel product net sales during the three months ended September 30, 2022 in our Traditional segment. Overall consumer confidence has weakened due to general economic uncertainties, coupled with domestic and worldwide inflation, including recessionary fears, and rising interest rates.
Sales of finished jewelry represented 75% of total consolidated net sales for the three months ended September 30, 2022, compared with 55% of total consolidated net sales for the corresponding period of the prior year. For the three months ended September 30, 2022, finished jewelry sales were $5.54 million compared to $5.69 million for the corresponding period of the prior year, a decrease of approximately $146,000, or 3%. This decrease in finished jewelry sales is relatively flat to the year ago period, despite current economic conditions.
Sales of loose jewels represented 25% of total consolidated net sales for the three months ended September 30, 2022, compared to 45% of total consolidated net sales for the corresponding period of the prior year. For the three months ended September 30, 2022, loose jewel sales were $1.83 million compared to $4.59 million for the corresponding period of the prior year, a decrease of approximately $2.76 million, or 60%. The decrease for the three months ended September 30, 2022 was primarily a result of lower demand 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, 2022, compared with 96% for the three-month period ended September 30, 2021. U.S. net sales decreased to $7.10 million, or 28%, in the three months ended September 30, 2022 compared to $9.82 million in the comparable quarter of 2021 as a result of decreased sales to U.S. customers in our Traditional segment.
Our largest U.S. customer during the three months ended September 30, 2022 was our second largest customer during the three months ended September 30, 2021 and accounted for 17% and 14% of total consolidated net sales during each of the respective periods then ended. Our largest U.S. customer during the three months ended September 30, 2021 accounted for 19% of total consolidated net sales during the period then ended. We did not have another U.S. customer account for 10% or more of total consolidated sales during the three months ended September 30, 2022 or 2021. 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 4% of total consolidated net sales during the quarters ended September 30, 2022 and 2021, respectively. International net sales decreased to $279,000, or 39%, during the first quarter of Fiscal 2023 compared to $456,000 in the first quarter of the year ended June 30, 2022, or Fiscal 2022. International sales decreased due to lower demand in our international distributor market due to shutdowns in the Asia Pacific region during the current period, coupled with the strength of the U.S. dollar against foreign currencies. In light of the effects of ongoing global economic conditions, we continue to evaluate these and other potential distributors in international markets to determine the best long-term partners. As a result, and in light of the ongoing worldwide pandemic and international trade challenges, we expect that 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, 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
Our total cost of goods sold for the three months ended September 30, 2022 and 2021 are as follows:
| | Three Months Ended September 30, | | | Change | |
| | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Finished jewelry | | $ | 2,606,699 | | | $ | 2,334,482 | | | $ | 272,217 | | | | 12 | % |
| Loose jewels | | | 825,623 | | | | 2,059,446 | | | | (1,233,823 | ) | | | (60 | )% |
| Total product line cost of goods sold | | | 3,432,322 | | | | 4,393,928 | | | | (961,606 | ) | | | (22 | )% |
| Non-product line cost of goods sold | | | 653,688 | | | | 622,622 | | | | 31,066 | | | | 5 | % |
| Total cost of goods sold | | $ | 4,086,010 | | | $ | 5,016,550 | | | $ | (930,540 | ) | | | (19 | )% |
Total cost of goods sold was $4.09 million for the three months ended September 30, 2022 compared to $5.02 million for the three months ended September 30, 2021, a decrease of approximately $931,000, or 19%. 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 decrease in total cost of goods sold for the three months ended September 30, 2022 compared to the same period in 2021 was primarily due to decreased sales of loose jewels during the three months ended September 30, 2022 in our Traditional segment as a result of lower product demand during the quarter.
The net increase in non-product line cost of goods sold for the three months ended September 30, 2022, comprises an approximate $58,000 increase in freight out principally from the rising costs of fuel and shipping overall during the period; an approximate $35,000 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; and a $51,000 increase in other inventory adjustments principally related to changes in production standard cost variances compared to those in the first three months of Fiscal 2022. These increases were partially offset by an approximate $113,000 decrease in inventory write-offs in the first three months of the Fiscal 2022, compared to those in the comparable prior year period.
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 months ended September 30, 2022 and 2021 are as follows:
|
| Three Months Ended September 30, |
|
| Change | |
|
| 2022 | | | 2021 |
|
| Dollars | | | Percent | |
| Sales and marketing |
| $ | 3,107,946 | | | $ | 2,730,153 |
|
| $ | 377,793 | | | | 14 | % |
Sales and marketing expenses were $3.11 million for the three months ended September 30, 2022 compared to $2.73 million for the three months ended September 30, 2021, an increase of approximately $378,000, or 14%.
The increase in sales and marketing expenses for the three months ended September 30, 2022 compared to the same period in 2021 was primarily due to a $162,000 increase in advertising and digital marketing expenses; an $80,000 increase in compensation expenses; a $58,000 increase in professional services principally comprising consulting services for marketing support in the current year period; a $41,000 increase in bank fees expenses, which are principally related to higher credit card transaction and payment platform fees; a $37,000 increase in general business taxes; and a $7,000 increase in employee-related recruiting and search fees for new hires. These increases were offset partially by a $6,000 decrease in travel expenses; and a $1,000 net decrease in general office-related expenses.
The increase in advertising and digital marketing expenses for the three months ended September 30, 2022 compared to the same period in 2021 was primarily due to a $94,000 increase in digital advertising spend; a $78,000 increase in cooperative advertising; an $80,000 increase in brand awareness marketing campaign expenditures in the current year period; a $37,000 increase in production related to photoshoots; and a $21,000 increase in outside agency fees. These increases were offset partially by a $133,000 decrease in expenses relating to our participation in the 2022 JCK Trade Show held in the prior year quarter in which we did not host a booth at for the 2023 JCK Trade show; a $14,000 decrease in print media expenses; and a $1,000 decrease in other general expenses.
The increase in compensation expenses for the three months ended September 30, 2022 compared to the same period in 2021 was primarily due to a $76,000 increase in salaries, commissions, and related employee benefits in the aggregate; and a $20,000 increase in bonus expense. These increases were partially offset by a $16,000 decrease in employee stock-based compensation expense.
General and Administrative
General and administrative expenses for the three months ended September 30, 2022 and 2021 are as follows:
|
| Three Months Ended September 30, |
|
| Change | |
|
| 2022 |
|
| 2021 |
|
| Dollars | |
| Percent | |
| General and administrative |
| $ | 1,413,476 |
|
| $ | 1,584,275 |
|
| $ | (170,799 | ) |
|
| (11 | )% |
General and administrative expenses were $1.41 million for the three months ended September 30, 2022 compared to $1.58 million for the three months ended September 30, 2021, a decrease of approximately $171,000, or 11%.
The decrease in general and administrative expenses for the three months ended September 30, 2022 compared to the same period in 2021 was primarily due to a $224,000 decrease in compensation expenses; a $70,000 decrease in bank fees due to
the fee structure of different banking arrangements in place in the current period versus
those in the year ago quarter;
a $32,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; a $14,000 decrease in professional services
; and a $7,000 net decrease in miscellaneous other general and administrative expenses. These decreases were partially offset by a $117,000 increase in general business taxes and licenses; a $33,000 increase in travel-related expenditures; a $14,000 increase in depreciation and amortization expense; and a $12,000 increase in software-related costs.
The decrease in compensation expenses for the three months ended September 30, 2022 compared to the same period in 2021 was primarily due to a $167,000 decrease in employee stock-based compensation expense; and a $155,000 decrease in bonus expense. These decreases were partially offset by a $98,000 net increase in salaries and related employee benefits.
Professional services expenses decreased for the three months ended September 30, 2022 compared to the same period in 2021 primarily due to a $24,000 decrease in legal fees associated with corporate governance matters; a $8,000 decrease in investor relations fees; and a $1,000 decrease in fees associated with audit and tax services. These decreases were partially offset by a $10,000 increase in consulting and other professional services primarily in connection with accounting department support in the current period and a $9,000 increase in broker commissions related to our stock repurchase program.
Interest Income
Interest income for the three months ended September 30, 2022 and 2021 is as follows:
| | | Three Months Ended September 30, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Interest income | | $ | 40,201 | | | $ | 355 | | | $ | 39,846 | | | | * | % |
* Not meaningful
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, 2022 and 2021, we earned interest from cash on deposit in this interest-bearing account. The increase in earned interest for the quarterly period ended September 30, 2022 reflects movement of invested funds into a higher-yield money market fund in late Fiscal 2022, coupled with the overall increase in interest rates during the first quarter of Fiscal 2023 compared with Fiscal 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 months ended September 30, 2022 and 2021 are as follows:
| | | Three Months Ended September 30, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | - | | | $ | 34 | | | $ | (34 | ) | | | (100 | )% |
During the three months ended September 30, 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 net decrease in these losses reflects the lower level of international sales denominated in foreign currencies during the three months ended September 30, 2022 compared with the same period in the prior year.
Provision for Income Taxes
For the three months ended September 30, 2022, our statutory tax rate was 22.98% and consisted of the federal income tax rate of 21% and a blended state income tax rate of 1.98%, net of the federal benefit. 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. 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, 2022 and 2021, our effective tax rate was 25.39% and 12.91%, respectively.
We recognized a net income tax benefit of approximately $303,000 for the quarter ended September 30, 2022, compared with a net income tax expense of approximately $123,000 for the quarter ended September 30, 2021.
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 September 30, 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 September 30, 2022, to conclude that it is more likely than not deferred tax assets of approximately $6.15 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 and sub-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 Debt
Short-Term Liquidity and Capital Structure
The Consolidated Appropriations Act, 2021, provides that employers who received a Paycheck Protection Program (“PPP”) loan may also qualify for the Employee Retention Credit, or ERC. Previously, pursuant to the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, taxpayers that received a PPP loan were not eligible for the ERC and this change is retroactive to March 27, 2020. We believe that we may qualify for certain employer-related tax benefits pursuant to the ERC and are currently working with an independent third-party tax credit firm to amend our applicable federal payroll tax returns for such benefit. Any benefit received in connection with available ERC credits will be recognized in the period such credits are received.
Long-Term 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.
Debt
We have no short- or long-term outstanding debt as of September 30, 2022.
Financing Activities
Long-Term Financing Activities
In accordance with authority granted by our Board of Directors on April 29, 2022, we can repurchase up to $5.00 million in shares outstanding of our common stock over the three-year period ending April 29, 2025. Pursuant to the terms of the repurchase authorization, the common stock share repurchases are generally at the discretion of management. As we repurchase our common shares, which have no par value, we report such shares held as treasury stock on our condensed consolidated balance sheets, with the purchase price recorded within treasury stock.
During the three-month period ended September 30, 2022, we repurchased approximately 358,000 shares of our common stock for an aggregate price of approximately $452,000 pursuant to the repurchase authorization. We repurchased no shares of our common stock during the three-month period ended 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, 2022, our principal sources of liquidity were cash
and cash equivalents
totaling $11.57 million, trade accounts receivable of $1.56 million, and net current inventory of $12.09 million, as compared to cash
and cash equivalents totaling $15.67 million, trade accounts receivable of $2.22 million, and net current inventory of $11.02 million as of June 30, 2022. We also had access during the three-month period ended September 30, 2022 to a $5.00 million cash collateralized line of credit facility, or the JPMorgan Chase Credit Facility, that we obtained effective July 9, 2021, as amended July 28, 2022, from
JPMorgan Chase Bank, N.A., or JPMorgan Chase.
During the three months ended September 30, 2022, our working capital decreased by approximately $4.13 million to $24.93 million from $29.06 million at June 30, 2022. As described more fully below, the decrease in working capital at September 30, 2022 is primarily attributable to an increase in our accounts payable, a decrease in our accounts receivables, an increase in our short-term operating lease liabilities, the classification of the note receivable as noncurrent as of September 30, 2022 as compared to current as of June 30, 2022, and a net decrease in our cash, cash equivalents, and restricted cash. These factors were offset partially by a decrease in our accrued expenses and other liabilities, 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, and an increase in our prepaid expenses and other assets. Our cash used for investing activities were principally for construction-in-process expenditures related to our retail expansion program and the construction of our first Signature Showroom and other leasehold improvements in our corporate offices. Our cash used for Financing Activities were principally for our share repurchase program.
During the three months ended September 30, 2022, approximately $3.67 million of cash was used by our operations. The primary drivers of our use of cash were an increase in inventory of $3.17 million to build inventory for the upcoming calendar year-end holiday season; a net loss in the amount of approximately $890,000; a decrease in accrued expenses and other liabilities of $599,000; and an increase in prepaid expenses and other assets of $37,000. These factors were offset partially by a decrease in accounts receivable of $695,000; and an increase in accounts payable of $317,000.
Accounts receivable decreased principally due to the decreased level of sales during the three months ended September 30, 2022, as compared with the sales during the period leading up to June 30, 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 $2.83 million and $2.43 million in loose jewels and $4.97 million and $4.43 million in finished jewelry, which includes the cost of the loose jewels and the purchase of precious metals and labor in connection with jewelry production, during the three months ended September 30, 2022 and 2021, respectively. 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 prices of gold and other precious metals are 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 September 30, 2022 and June 30, 2022, $24.48 million and $22.49 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 $1.99 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, 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 September 30, 2022, we also had a federal tax net operating loss carryforward of approximately $16.53 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 $19.77 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.
Short-Term Capital Resources
Line of Credit
Effective July 7, 2021, we obtained from JPMorgan Chase our $5.00 million cash collateralized 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. Effective July 28, 2022, the JPMorgan Chase Credit Facility was amended to, among other things, extend the maturity date to July 31, 2023, and append our obligations under the JPMorgan Chase Credit Facility to be guaranteed by our wholly owned subsidiaries, Charles & Colvard Direct, LLC, charlesandcolvard.com, LLC, and moissaniteoutlet.com, LLC.
Each advance under the JPMorgan Chase Credit Facility, as amended, accrues interest at a rate equal to the sum of JPMorgan Chase’s monthly secured overnight financing rate, or the SOFR rate, to which JPMorgan Chase is subject with respect to the adjusted SOFR rate as established by the U.S. Federal Reserve Board, plus a margin of 1.25% per annum and an unsecured to secured interest rate adjustment of 0.10% per annum. Prior to its amendment, each advance under the JPMorgan Chase Credit Facility would have accrued interest at a rate equal to JPMorgan Chase’s monthly LIBOR rate 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, 2022, we had not borrowed against the JPMorgan Chase Credit Facility.
Long-Term Capital Commitments
Contractual Agreement
On December 12, 2014, we entered into the Supply Agreement with 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 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 $24.75 million remains to be purchased as of September 30, 2022.
During the three months ended September 30, 2022 and 2021, we purchased approximately $1.80 million and $1.50 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 potential 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.
Liquidity and Capital Trends
We believe that our existing cash and cash equivalents and 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.
From a long-term perspective, we believe that our ongoing access to capital markets, including but not limited to the issuance of equity securities or even potential debt securities, coupled with cash provided by operating activities in future periods beyond the next twelve months, will continue to provide us with the necessary liquidity to meet our long-term working capital and capital expenditure requirements.
In connection with our short- and long-term capital resources, 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 future capital requirements and the adequacy of available funds will depend on many factors, including the ongoing uncertainty surrounding COVID-19 that could lead to further disruption and volatility in the global capital markets as well as its impact on our rate of sales growth; the expansion of our sales and marketing activities; the timing and extent of raw materials and labor purchases in connection with loose jewel production to support our moissanite jewels and lab grown diamond 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 2022 Annual Report on Form 10-K.
| 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 September 30, 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, 2022 and our Quarterly Report on Form 10-Q for the quarter September 30, 2022 various risks that may materially affect our business. There have been no material changes to such risks.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
| Period | | Total Number of Shares Purchased | | | Average Price Paid per share | | | Total Number of shares Purchased as Part of Publicly Announced Plans or Programs(1) | | | Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs | |
| July 1, 2022 – July 31, 2022 | | | 124,053 | | | $ | 1.30 | | | | 154,340 | | | $ | 4,800,995 | |
| August 1, 2022 – August 31, 2022 | | | 127,080 | | | $ | 1.32 | | | | 281,420 | | | $ | 4,633,303 | |
| September 1, 2022 – September 30, 2022 | | | 106,983 | | | $ | 1.15 | | | | 388,403 | | | $ | 4,510,021 | |
| Total | | | 358,116 | | | $ | 1.26 | | | | 388,403 | | | $ | 4,510,021 | |
| (1) | On May 5, 2022, we announced that our Board of Directors had approved a share repurchase program to permit us to repurchase up to $5.00 million worth of our issued and outstanding common stock over the three-year period ending April 29, 2025. |
The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:
| Exhibit No. |
| Description |
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| Line of Credit Note, dated as of July 28, 2022, by Charles & Colvard, Ltd., to JPMorgan Chase Bank, N.A. (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on August 2, 2022) |
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| 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 |
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| 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 |
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| 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 |
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| 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 |
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| 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. |
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| 101.SCH |
| Inline XBRL Taxonomy Extension Schema Document |
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| 101.CAL |
| Inline XBRL Taxonomy Extension Calculation Linkbase Document |
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| 101.DEF |
| Inline XBRL Taxonomy Extension Definition Linkbase Document |
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| 101.LAB |
| Inline XBRL Taxonomy Extension Label Linkbase Document |
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| 101.PRE |
| Inline XBRL Taxonomy Extension Presentation Linkbase document |
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| 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.
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| CHARLES & COLVARD, LTD. |
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| By: | /s/ Don O’Connell |
| November 3, 2022 |
| Don O’Connell |
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| President and Chief Executive Officer |
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| By: | /s/ Clint J. Pete |
| November 3, 2022 |
| Clint J. Pete |
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| Chief Financial Officer |
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| (Principal Financial Officer and Chief Accounting Officer) |
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