| 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. | Our failure to maintain compliance with The Nasdaq Stock market’s continued listing requirements could result in the delisting of our common stock; |
| 26. | Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our Company; and |
| 27. | 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. |
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, including end-consumers through our first Charles & Colvard Signature Showroom, which opened in October 2022. 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.
Fiscal 2023 Financial Outlook
Our strategic goals for the fiscal year ending June 30, 2023, or 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.
As we disclosed last quarter, in October 2022, we officially opened the first Charles & Colvard Signature Showroom located in our corporate headquarters in North Carolina’s Research Triangle Park. The opening of this new showroom provided local consumers in the Raleigh metropolitan area the ability to shop in person for our collections of fine luxury jewelry featuring moissanite and lab grown diamonds in time for the calendar year-end holiday season. During our fiscal quarter ended December 31, 2022, we took several steps to broaden available selections of finished jewelry, which features our exclusive brand of premium lab grown diamonds, with an expanded Couture Collection assortment of finished jewelry that showcases a combination of mixed cuts of our Caydia® lab grown diamonds and recycled precious metals featuring new designs of rings, earrings, and pendant styles that we believe is the future of Made, Not Mined™ fine jewelry. We believe this collection showcases a combination of mixed cut gemstones in single designs to create consumer interest. Also, during the second fiscal quarter, we expanded our Ouro Edition of fine jewelry to include Caydia® lab grown diamond fashion pieces. The Ouro Edition is our curation of polished recycled 14 karat gold jewelry pieces with a design focus on geometric shapes. We believe that Ouro – which is Portuguese for gold – will bring a fresh approach to our finished jewelry in modern dimensional styles in yellow gold to bring our fine luxury jewelry to the forefront of modern fashion. In addition, with the launch of our latest lab grown precious gemstones in color, which we announced last October, we are now offering a colorful new dimension of our Made, Not Mined™ fine jewelry repertoire featuring lab grown ruby, sapphire, and emerald gemstones. We further offered an expanded assortment of Caydia® lab grown diamonds to include higher total carat weight items adding finished jewelry featuring lab grown diamonds with total carat weights of up to and in some cases exceeding 4.0 carats. Previously, we focused primarily on smaller total carat weight items of finished jewelry featuring our Caydia® lab grown diamonds. Lastly, in December 2022, we expanded our bridal and engagement fine jewelry collections of styles featuring Forever One™ moissanite to continue to showcase and promote finished jewelry featuring our core product gemstone.
In early December 2022, we hosted a multiple-day private press event in New York City that included interviews with editors of numerous fashion and jewelry print and electronic media publications to showcase and promote our brand of fine jewelry. Throughout the fiscal quarter ended December 31, 2022, our finished jewelry products were featured in multiple national and local print and electronic media publications, such as InStyle, HuffPost, Forbes, AC Magazine, The Knot®, National Jeweler, WRAL, and the Triangle Business Journal. During the quarter, we also launched local print media public relations campaigns in Midtown Magazine and Raleigh Magazine to promote the opening of our Charles & Colvard Signature Showroom. Also in December, the popularity of our Made, Not Mined™ Caydia® lab grown diamonds was the subject of a proprietary news feature broadcast on Spectrum News Channel 1, which is a primary cable news channel network that is broadcast statewide throughout North Carolina. Lastly, and in conjunction with our community outreach programs, during the December year-end holiday season, we sponsored the 29th Annual Jingle Ball at the North Carolina Museum of Natural Science, which is hosted by Capital City Clauses, Inc., a federally registered 501(c)(3) nonprofit corporation whose mission is to enrich children’s lives in the Raleigh metropolitan area by providing toy gifting and basic needs to those who are underprivileged and in need during the Christmas holidays and beyond.
As evidenced by our results for the first six months 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 e-commerce industry. While American consumers spent more this holiday season to keep up with higher prices, consumer shopping lulls we experienced during the non-peak holiday weeks during the calendar year-end holiday season were deeper than we anticipated and we expect that consumers will continue to feel pressured financially, particularly during the first half of calendar year 2023. We are facing similar challenges to other retailers, including those in the e-commerce space, but particularly those in the luxury retail arena. At the same time, however, we believe these challenges are providing us the opportunity to continue reevaluating technologies and strategies that can help position us in a potentially more profitable position. We plan to continue to invest in our business and view current challenges as opportunities to help accelerate our growth trajectory and return to profitability.
Inflation
Heightened levels of inflation and the potential worsening of macro-economic conditions present a risk for us, our suppliers, and the stability of the broader retail and e-commerce industry. During the first six months of Fiscal 2023, we have experienced impacts to our labor and overhead rates and suppliers have signaled inflation related cost pressures, which will flow through to our costs and pricing. While we have seen some impact from inflation on our financial results in the first six months of Fiscal 2023, if inflation remains at current levels for an extended period, or increases, and we are unable to successfully mitigate the impact, our costs are likely to continue to increase, resulting in further pressure on our revenues, margins, and cash flows. In addition, inflation and the increases in the cost of borrowing from rising interest rates could constrain the overall purchasing power of our customers for our products and services, in particular in the near term to the extent inflation assumptions are less than current inflationary pressures. We remain committed to our ongoing efforts to increase the efficiency of our operations and improve the cost competitiveness and affordability of our products and services, which may, in part, offset cost increases and the adverse effects from inflation.
We discuss our strategic outlook, key strategies, and general economic and market conditions 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.
COVID-19
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.
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 six months of Fiscal 2023.
Results of Operations
The following table sets forth certain consolidated statements of operations data for the three and six months ended December 31, 2022 and 2021:
| | | Three Months Ended December 31, | | | Six Months Ended December 31, | |
| | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
| Net sales | | $ | 10,366,122 | | | $ | 13,753,135 | | | $ | 17,740,204 | | | $ | 24,033,446 | |
| Costs and expenses: | | | | | | | | | | | | | | | | |
| Cost of goods sold | | | 6,071,775 | | | | 7,033,946 | | | | 10,157,785 | | | | 12,050,496 | |
| Sales and marketing | | | 4,339,684 | | | | 4,079,035 | | | | 7,447,630 | | | | 6,809,187 | |
| General and administrative | | | 1,187,955 | | | | 1,189,559 | | | | 2,601,431 | | | | 2,773,835 | |
| Total costs and expenses | | | 11,599,414 | | | | 12,302,540 | | | | 20,206,846 | | | | 21,633,518 | |
| (Loss) Income from operations | | | (1,233,292 | ) | | | 1,450,595 | | | | (2,466,642 | ) | | | 2,399,928 | |
| Other income (expense): | | | | | | | | | | | | | | | | |
| Interest income | | | 59,574 | | | | 490 | | | | 99,776 | | | | 845 | |
| Loss on foreign currency exchange | | | - | | | | - | | | | - | | | | (34 | ) |
| Total other income (expense), net | | | 59,574 | | | | 490 | | | | 99,776 | | | | 811 | |
| (Loss) Income before income taxes | | | (1,173,718 | ) | | | 1,451,085 | | | | (2,366,866 | ) | | | 2,400,739 | |
| Income tax benefit (expense) | | | 131,937 | | | | (283,473 | ) | | | 434,893 | | | | (406,102 | ) |
| Net (loss) income | | $ | (1,041,781 | ) | | $ | 1,167,612 | | | $ | (1,931,973 | ) | | $ | 1,994,637 | |
Consolidated Net Sales
Consolidated net sales for the three and six months ended December 31, 2022 and 2021 comprise the following:
| | | Three Months Ended December 31, | | | Change | | | Six Months Ended December 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 8,436,208 | | | $ | 10,539,166 | | | $ | (2,102,958 | ) | | | (20 | )% | | $ | 13,976,614 | | | $ | 16,225,453 | | | $ | (2,248,839 | ) | | | (14 | )% |
| Loose jewels | | | 1,929,914 | | | | 3,213,969 | | | | (1,284,055 | ) | | | (40 | )% | | | 3,763,590 | | | | 7,807,993 | | | | (4,044,403 | ) | | | (52 | )% |
| Total consolidated net sales | | $ | 10,366,122 | | | $ | 13,753,135 | | | $ | (3,387,013 | ) | | | (25 | )% | | $ | 17,740,204 | | | $ | 24,033,446 | | | $ | (6,293,242 | ) | | | (26 | )% |
Consolidated net sales were $10.37 million for the three months ended December 31, 2022 compared to $13.75 million for the three months ended December 31, 2021, a decrease of approximately $3.39 million, or 25%. Consolidated net sales were $17.74 million for the six months ended December 31, 2022 compared to $24.03 million for the six months ended December 31, 2021, a decrease of approximately $6.29 million, or 26%. We had lower net sales in both operating business segments during the three- and six-month periods ended December 31, 2022. Overall consumer confidence has continued to show signs of weakening due to general economic uncertainties, coupled with domestic and worldwide inflation, including recessionary fears, and rising interest rates. Notwithstanding the year-end 2022 holiday shopping season, these conditions have brought about lower consumer demand for our finished jewelry products, which resulted in lower net sales in our Online Channels segment during the three and six months ended December 31, 2022. These same general economic conditions also caused weakness in demand for moissanite jewels from our domestic distributors, which in turn resulted in lower loose jewel product net sales during the three- and six-month periods ended December 31, 2022 in our Traditional segment.
Sales of finished jewelry represented 81% and 79% of total consolidated net sales for the three and six months ended December 31, 2022, respectively, compared to 77% and 68%, respectively, of total consolidated net sales for the corresponding periods of the prior year. For the three months ended December 31, 2022, finished jewelry sales were $8.44 million compared to $10.54 million for the corresponding period of the prior year, a decrease of approximately $2.10 million, or 20%. For the six months ended December 31, 2022, finished jewelry sales were $13.98 million compared to $16.23 million for the corresponding period of the prior fiscal year, a decrease of approximately $2.25 million, or 14%. These decreases in finished jewelry sales for the three- and six-month periods ended December 31, 2022 were due to lower demand across all of our finished jewelry products as a result of adverse global and domestic general economic conditions.
Sales of loose jewels represented 19% and 21% of total consolidated net sales for the three and six months ended December 31, 2022, respectively, compared to 23% and 32%, respectively, of total consolidated net sales for the corresponding periods of the prior fiscal year. For the three months ended December 31, 2022, loose jewel sales were $1.93 million compared to $3.21 million for the corresponding period of the prior year, a decrease of $1.28 million, or 40%. For the six months ended December 31, 2022, loose jewel sales were $3.77 million compared to $7.81 million for the corresponding period of the prior fiscal year, a decrease of $4.04 million, or 52%. The decrease in loose jewel sales for the three- and six-month periods ended December 31, 2022 was principally due to lower sales of loose jewels through our distribution network in our Online Channels segment and Traditional segment, as a result of global and domestic general adverse macroeconomic conditions.
U.S. net sales accounted for approximately 96% of total consolidated net sales for each of the three- and six-month periods ended December 31, 2022, compared to 95% of total consolidated net sales for each of the corresponding periods of the prior year. U.S. net sales decreased to $9.99 million, or 23%, during the three months ended December 31, 2022 from the corresponding period of the prior fiscal year. U.S. net sales decreased to $17.09 million, or 25%, during the six months ended December 31, 2022 from the corresponding period of the prior year. U.S. net sales decreased during the three and six months ended December 31, 2022 primarily as a result of decreased sales to U.S. customers in both our Online Channels segment and Traditional segment for the same reasons outlined above.
Our largest U.S. customer during the three and six months ended December 31, 2022 accounted for 12% and 14% of total consolidated net sales during each respective period. This same customer was also our largest U.S. customer during the three and six months ended December 31, 2021 when this customer accounted for 16% and 15% of total consolidated net sales during each of the respective three- and six-month periods. Our second largest U.S. customer during the six months ended December 31, 2021, accounted for 11% of total consolidated net sales during the period then ended. Other than our U.S. customers noted above during the three- and six-month periods ended December 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% of total consolidated net sales for each of the three- and six-month periods ended December 31, 2022, respectively, compared to 5% of total consolidated net sales for each of the corresponding periods of the prior year. International net sales decreased 49% and 45% during the three and six months ended December 31, 2022, respectively, from the corresponding periods of the prior fiscal year 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 impact from 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 and six months ended December 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 six months ended December 31, 2022 and 2021 are as follows:
| | | Three Months Ended December 31, | | | Change | | | Six Months Ended December 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 4,185,331 | | | $ | 4,703,976 | | | $ | (518,645 | ) | | | (11 | )% | | $ | 6,792,031 | | | $ | 7,038,459 | | | $ | (246,428 | ) | | | (4 | )% |
| Loose jewels | | | 871,250 | | | | 1,434,565 | | | | (563,315 | ) | | | (39 | )% | | | 1,696,873 | | | | 3,494,011 | | | | (1,797,138 | ) | | | (51 | )% |
| Total product line cost of goods sold | | | 5,056,581 | | | | 6,138,541 | | | | (1,081,960 | ) | | | (18 | )% | | | 8,488,904 | | | | 10,532,470 | | | | (2,043,566 | ) | | | (19 | )% |
| Non-product line cost of goods sold | | | 1,015,194 | | | | 895,405 | | | | 119,789 | | | | 13 | % | | | 1,668,881 | | | | 1,518,026 | | | | 150,855 | | | | 10 | % |
| Total cost of goods sold | | $ | 6,071,775 | | | $ | 7,033,946 | | | $ | (962,171 | ) | | | (14 | )% | | $ | 10,157,785 | | | $ | 12,050,496 | | | $ | (1,892,711 | ) | | | (16 | )% |
Total cost of goods sold was $6.07 million for the three months ended December 31, 2022 compared to $7.03 million for the three months ended December 31, 2021, a net decrease of approximately $962,000, or 14%. Total cost of goods sold was $10.16 million for the six months ended December 31, 2022 compared to $12.05 million for the six months ended December 31, 2021, a net decrease of approximately $1.89 million, or 16%. 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 December 31, 2022 compared to the same period in 2021 was primarily driven by decreased sales of finished jewelry and loose jewels during the three months ended December 31, 2022 in both our Online Channels segment and Traditional segment. We experienced lower demand in our Online Channels segment as a result of lower finished jewelry product demand during the quarter despite the calendar year-end 2022 holiday season where we saw consumer shopping lulls during the non-peak holiday shopping weeks that were deeper than we expected. Likewise, we experienced lower loose jewel product demand in our Traditional segment throughout the quarter.
The net increase in non-product line cost of goods sold for the three months ended December 31, 2022, comprises an approximate $270,000 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. This increase was partially offset by an approximate $107,000 decrease in freight out principally from decreased shipping volume during the three-month period and a $44,000 decrease in other inventory adjustments principally related to changes in production standard cost variances compared to those in the first three months of Fiscal 2022.
The decrease in total cost of goods sold for the six months ended December 31, 2022 compared to the same period in 2021 was also primarily driven by the decreased sales of finished goods and loose jewels during the six-months ended December 31, 2022 in both of our Online Channels segment and Traditional segment. We experienced lower demand in our Online Channels segment as a result of lower finished jewelry product demand during the six-month-period despite the calendar year-end 2022 holiday season and likewise saw lower loose jewel product demand in our Traditional segment throughout the six-month period.
The net increase in non-product line cost of goods sold for the six months ended December 31, 2022, comprises an approximate $305,000 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 an approximate $8,000 increase in other inventory adjustments principally related to changes in production standard cost variances compared to those in the first six months of Fiscal 2022. These increases were partially offset by an approximate $113,000 decrease in inventory write-offs in the first six months of the Fiscal 2022, compared to those in the comparable prior year period, and an approximate $48,000 decrease in freight out principally from decreased shipping volume during the six-month 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 and six months ended December 31, 2022 and 2021 are as follows:
| | | Three Months Ended December 31, | | | Change | | | Six Months Ended December 31, | | | Change | |
| | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Sales and marketing | | $ | 4,339,684 | | | $ | 4,079,035 | | | $ | 260,649 | | | | 6 | % | | $ | 7,447,630 | | | $ | 6,809,187 | | | $ | 638,443 | | | | 9 | % |
Sales and marketing expenses were $4.34 million for the three months ended December 31, 2022 compared to $4.08 million for the three months ended December 31, 2021, an increase of approximately $261,000, or 6%. Sales and marketing expenses were $7.45 million for the six months ended December 31, 2022 compared to $6.81 million for the six months ended December 31, 2021, an increase of approximately $638,000, or 9%.
The increase in sales and marketing expenses for the three months ended December 31, 2022 compared to the same period in 2021 was primarily due to an $85,000 increase in compensation expenses; an $81,000 increase in general business taxes; a $31,000 increase in software-related costs incurred primarily in connection with new software-related agreements associated with upgraded sales-related operating systems; a $26,000 increase in bank fees expenses, which are principally related to higher credit card transaction and payment platform fees; a $24,000 increase in professional services principally comprising consulting services for marketing support in the current year period; an $8,000 increase in telephone-related communications expenses; a $6,000 increase in depreciation and amortization expense principally related to new sales-related systems hardware and software; a $6,000 increase in charitable contributions; a $2,000 increase in insurance expense related to increased premiums; a $2,000 increase in travel expenses; and a $5,000 net increase in general office-related expenses. These increases were offset partially by a $15,000 net decrease in advertising and digital marketing expenses.
The net decrease in advertising and digital marketing expenses for the three months ended December 31, 2022 compared to the same period in 2021 was primarily due to a $172,000 decrease in cooperative advertising in connection with lower sales from a retail customer with whom we have a cooperative advertising arrangement that is based on sales volume; a $29,000 decrease in brand awareness marketing campaign expenditures in the current year period; and an $11,000 decrease in print media expenses. These decreases were offset partially by a $178,000 increase in digital advertising spend and a $19,000 increase in outside agency fees.
Compensation expenses for the three months ended December 31, 2022 compared to the same period in 2021 increased primarily due to a $121,000 increase in salaries, commissions, and related employee benefits in the aggregate. This increase was partially offset by a $31,000 decrease in bonus expense and a $5,000 decrease in employee stock-based compensation expense.
The increase in sales and marketing expenses for the six months ended December 31, 2022 compared to the same period in 2021 was primarily due to a $165,000 increase in compensation expenses; a $147,000 increase in advertising and digital marketing expenses; a $118,000 increase in general business taxes; an $81,000 increase in professional services principally comprising consulting services for marketing support in the current year period; a $66,000 increase in bank fees expenses, which are principally related to higher credit card transaction and payment platform fees; a $28,000 increase in software-related costs incurred primarily in connection with new software-related agreements associated with upgraded sales-related operating systems; a $15,000 increase in charitable contributions; a $9,000 increase in telephone-related communications expenses; a $7,000 increase in employee-related recruiting and search fees for new hires; and a $7,000 increase in depreciation and amortization expense principally related to new sales-related systems hardware and software. These increases were offset partially by a $3,000 decrease in travel expenses and a $2,000 net decrease in general office-related expenses.
Compensation expenses for the six months ended December 31, 2022 compared to the same period in 2021 increased primarily as a result of a $198,000 increase in salaries, commissions, and related employee benefits in the aggregate. This increase was partially offset by a $21,000 decrease in employee stock-based compensation expense and a $12,000 decrease in bonus expense.
The increase in advertising and digital marketing expenses for the six months ended December 31, 2022 compared to the same period in 2021 comprises a $272,000 increase in digital advertising spend; an $81,000 increase in brand awareness marketing campaign expenditures in the current year period; and a $40,000 increase in outside agency fees. These increases were offset partially by a $127,000 decrease in expenses relating to our participation in the 2021 JCK Trade Show held in the prior year period for which we did not host a booth in the 2022 JCK Trade show held during the current year period; a $94,000 decrease in cooperative advertising; and a $25,000 decrease in print media expenses.
General and Administrative
General and administrative expenses for the three and six months ended December 31, 2022 and 2021 are as follows:
| | | Three Months Ended December 31, | | | Change | | | Six Months Ended December 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| General and administrative | | $ | 1,187,955 | | | $ | 1,189,559 | | | $ | (1,604 | ) | | | (0 | )% | | $ | 2,601,431 | | | $ | 2,773,835 | | | $ | (172,404 | ) | | | (6 | )% |
General and administrative expenses were $1.19 million for the three months ended December 31, 2022 compared to $1.19 million for the three months ended December 31, 2021, a decrease of approximately $2,000, or less than 1%. General and administrative expenses were $2.60 million for the six months ended December 31, 2022 compared to $2.77 million for the six months ended December 31, 2021, a decrease of approximately $172,000, or 6%.
The decrease in general and administrative expenses for the three months ended December 31, 2022 compared to the same period in 2021 was primarily due to a $55,000 decrease in bank fees resulting from the revised fee structure associated with different banking arrangements in place in the current period versus those in the year ago quarter; a $35,000 decrease in general business taxes and licenses; a $25,000 decrease in compensation expenses; a $22,000 decrease in employee-related recruiting and search fees for new hires; a $20,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; and a $6,000 net decrease in miscellaneous other general and administrative expenses. These decreases were partially offset by a $55,000 increase in depreciation and amortization expense related to general office leasehold improvements associated with the lease on our corporate headquarters and business expansion related to the opening of our new Charles & Colvard Signature Showroom also located in our headquarters campus; a $50,000 increase in travel and expense-related expenditures as we returned to more traditional business travel patterns; a $30,000 increase in professional services; a $12,000 increase in insurance expense, principally related to increased premiums; a $9,000 increase in software-related costs; and a $5,000 increase in rent expense, primarily related to our corporate headquarters operating lease.
The decrease in compensation expenses for the three months ended December 31, 2022 compared to the same period in 2021 was primarily due to a $106,000 decrease in employee stock-based compensation expense; and a $14,000 decrease in bonus expense. These decreases were partially offset by a $95,000 net increase in salaries and related employee benefits.
Professional services fees increased for the three months ended December 31, 2022 compared to the same period in 2021 primarily due to a $20,000 increase in fees associated with audit and tax services; a $19,000 increase in legal fees associated with corporate governance matters; and a $6,000 increase in broker commissions related to our stock repurchase program. These increases were partially offset by a $15,000 decrease in investor relations fees.
The decrease in general and administrative expenses for the six months ended December 31, 2022 compared to the same period in 2021 was primarily due to a $249,000 decrease in compensation expenses; a $126,000 decrease in bank fees resulting from the revised fee structure associated with different banking arrangements in place in the current period versus those in the year ago period; a $52,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; and a $24,000 decrease in employee-related recruiting and search fees for new hires. These decreases were partially offset by a $92,000 increase in general business taxes and licenses; a $69,000 increase in depreciation and amortization expense related to general office leasehold improvements associated with the lease on our corporate headquarters and business expansion related to the opening of our new Charles & Colvard Signature Showroom also located in our headquarters campus; a $65,000 increase in travel and expense related expenditures as we returned to more traditional business travel patterns; a $17,000 increase in software-related costs; a $16,000 increase in professional services; a $15,000 increase in insurance expense, principally related to increased premiums; a $2,000 increase in rent expense, primarily related to our corporate headquarters operating lease; and a $3,000 net increase in miscellaneous other general and administrative expenses.
Compensation expenses decreased for the six months ended December 31, 2022 compared to the same period in 2021 principally due to a $274,000 decrease in employee stock-based compensation expense; and a $168,000 decrease in bonus expense. These decreases were partially offset by a $193,000 net increase in salaries and related employee benefits.
Professional services fees increased for the six months ended December 31, 2022 compared to the same period in 2021 primarily due to a $25,000 increase in broker commissions primarily related to our stock repurchase program and a $19,000 increase in fees associated with audit and tax services. These increases were partially offset by a $24,000 decrease in investor relations fees and a $4,000 decrease in legal fees associated with corporate governance matters.
Interest Income
Interest income for the three and six months ended December 31, 2022 and 2021 is as follows:
| | | Three Months Ended December 31, | | | Change | | | Six Months Ended December 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Interest income | | $ | 59,574 | | | $ | 490 | | | $ | 59,084 | | | | * | % | | $ | 99,776 | | | $ | 845 | | | $ | 98,931 | | | | * | % |
* 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- and six-month periods ended December 31, 2022 and 2021, we earned interest from cash on deposit in this interest-bearing account. The increase in earned interest for the three and six months ended December 31, 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 six months of Fiscal 2023 compared with the same period in Fiscal 2022.
Loss on Foreign Currency Exchange
Losses on foreign currency exchange related to foreign sales transacted in functional currencies other than the U.S. dollar for the three and six months ended December 31, 2022 and 2021 are as follows:
| | | Three Months Ended December 31, | | | Change | | | Six Months Ended December 31, | | | Change | |
| | | 2022 | | | 2021 | | | Dollars | | | Percent | | | 2022 | | | 2021 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | - | | | $ | - | | | $ | - | | | | - | % | | $ | - | | | $ | 34 | | | $ | (34 | ) | | | (100 | )% |
During the six months ended December 31, 2021, we had international sales transactions denominated in currencies other than the U.S. dollar that resulted in foreign currency exchange net losses. There were no such international sales transactions denominated in foreign currencies during the six-month period ended December 31, 2022.
Provision for Income Taxes
For each of the three and six months ended December 31, 2022, the Company’s average effective tax rate was 20.46% which consisted of the federal income tax rate of 21.00% and a blended state income tax rate benefit of 0.54%, net of the federal benefit. For each of the three and six months ended December 31, 2021, our statutory tax rate was 22.24% which 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 six months ended December 31, 2022 and 2021, our effective tax rate was 18.37% and 16.92%, respectively.
We recognized a net income tax expense of approximately $132,000 and $435,000 for the three and six months ended December 31, 2022, respectively, compared with a net income tax expense of approximately $283,000 and $406,000 for the three and six months ended December 31, 2021, respectively.
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 December 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 December 31, 2022, to conclude that it is more likely than not deferred tax assets of approximately $6.29 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
Our business depends on consumer demand for our products and could be adversely impacted by unfavorable general economic conditions, declines in consumer confidence and consumer disposable income, rising energy and fuel prices, increasing freight costs, rising inflation rates, recession and fears of recession, consumer debt levels, increased interest rates, and higher tax rates. The full effect of these factors on the global and domestic economy remains uncertain. In addition, the full impact of the ongoing COVID-19 pandemic on our business remains uncertain as well at this time. Accordingly, we remain increasingly focused on the general macroeconomic conditions outlined herein as well as on the COVID-19 pandemic. We are continually evaluating their potential effect on our business and liquidity and capital resources.
Capital Structure and Long-Term Debt
Short-Term Liquidity and Capital Structure
The Consolidated Appropriations Act, 2021, provides that employers who received a Paycheck Protection Program, or PPP, loan may also qualify for the Employee Retention Credit, or ERC. Previously, pursuant to the Coronavirus Aid, Relief, and Economic Security Act, or 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 macroeconomic effects of the COVID-19 pandemic. Any capital raise is not assured and may not be at terms that would be acceptable to us.
In addition, on December 19, 2022, we received a notification letter from Nasdaq’s Listing Qualifications Department indicating that we are not in compliance with applicable Nasdaq Listing Rules because the minimum bid price of our common stock on the Nasdaq Capital Market has closed below $1.00 per share for 30 consecutive business days. In accordance with further Nasdaq Listing Rules, we have 180 calendar days, or until June 19, 2023, to regain compliance with the minimum $1.00 bid price per share requirement. To regain compliance, any time before June 19, 2023, the bid price of our common stock must close at $1.00 per share or more for a minimum of 10 consecutive business days. Under certain circumstances, if we have not regained compliance at that time, we may be provided by Nasdaq with an additional 180 calendar day compliance period to regain compliance. While we intend to engage in efforts to regain compliance, and thus maintain our listing, there can be no assurance that we will be able to regain such compliance during the applicable time periods set forth above. If we fail to continue to meet all applicable listing requirements in the future and Nasdaq determines to delist our common stock, the delisting could substantially decrease trading in our common stock, adversely affect the market liquidity of our common stock, and adversely affect our ability to raise capital under the shelf registration statement, if at all.
Debt
We have no short- or long-term outstanding debt as of December 31, 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 six-month period ended December 31, 2022, we repurchased 358,116 shares of our common stock for an aggregate price of $451,815 pursuant to the repurchase authorization. We repurchased no shares of our common stock during the three-month period ended December 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 December 31, 2022, our principal sources of liquidity were cash and cash equivalents of $11.96 million, trade accounts receivable of $2.09 million, and net current inventory of $13.09 million, as compared to cash and cash equivalents of $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 six-month period ended December 31, 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 six months ended December 31, 2022, our working capital decreased by approximately $2.74 million to $26.32 million from $29.06 million at June 30, 2022. As described more fully below, the decrease in working capital at December 31, 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 December 31, 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 Charles & Colvard Signature Showroom and other leasehold improvements in our corporate offices. Our cash used for financing activities was principally for our share repurchase program.
During the six months ended December 31, 2022, approximately $3.05 million of cash was used by our operations. The primary drivers of our use of cash were a net loss in the amount of approximately $1.93 million; an increase in inventory of $1.60 million to build inventory in preparation for the calendar year-end holiday season; a decrease in accrued expenses and other liabilities of $529,000; and an increase in accounts receivable of $293,000. These factors were offset partially by an increase in accounts payable of $460,000; a decrease in prepaid expenses and other assets of $247,000; and the favorable impact of approximately $595,000 of non-cash expenses.
Accounts receivable decreased principally due to the decreased level of sales on credit during the three months ended December 31, 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 $8.77 million in finished jewelry and $4.89 million in loose jewels, which includes the cost of the loose jewels and the purchase of precious metals and labor in connection with jewelry production, during the six months ended December 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 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 December 31, 2022 and June 30, 2022, $21.90 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 $1.46 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 December 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 December 31, 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 December 31, 2022, we had not borrowed against the JPMorgan Chase Credit Facility.
Long-Term Capital Commitment
Contractual Agreement
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 $24.75 million remains to be purchased as of December 31, 2022.
During the six months ended December 31, 2022 and 2021, we purchased approximately $1.80 million and $3.00 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 our operating activities to make purchases in accordance with the terms of 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. As outlined above under the caption, Long-Term Liquidity and Capital Structure, 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 macroeconomic effects of the COVID-19 pandemic and the risks associated with the potential delisting of our common stock on the Nasdaq Capital Market if we fail to regain compliance with applicable Nasdaq Listing Rules within the periods of time described therein. Accordingly, any capital raise is not assured and these conditions may adversely affect our ability to raise capital under the shelf registration statement, if at all.
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 December 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, 2022 and our Quarterly Reports on Form 10-Q for the quarter ended September 30, 2022 various risks that may materially affect our business. There have been no material changes to such risks, except as set forth below.
Our business and our results of operations could be materially adversely affected as a result of general economic and market conditions. Our business, including our sales volumes and overall profitability, depends on consumer demand for our products and could be adversely impacted further by unfavorable general economic conditions, declines in consumer confidence and consumer disposable income, rising energy and fuel prices, increasing freight costs, rising inflation rates, recession and fears of recession, consumer debt levels, increased interest rates, and higher tax rates. Our business could also be adversely impacted by possible disruptions in global financial markets, including severely diminished liquidity and credit availability, declines in economic growth, increased unemployment levels, and uncertainty about economic stability, including the increased risk of global trade tensions and geopolitical unrest such as the ongoing conflict between Russia and Ukraine, and domestic political and geopolitical instability. We are unable to predict the likely duration and severity of the effects of these disruptions in the financial markets and the adverse domestic and global economic conditions, and if these economic conditions deteriorate, our business and results of operations could be materially and adversely affected.
Ongoing unfavorable economic conditions may continue to lead consumers to further delay or reduce purchases of our products and services and projected consumer demand for our products and services may not grow as we expect. The consequences of such adverse effects could also include interruptions or delays in our suppliers’ performance of our contracts, reductions and delays in customer purchases, delays in or the inability of customers to obtain financing to purchase our products, and bankruptcy of customers or suppliers. Prolonged or pervasive economic downturns could also slow the pace of any planned future showroom openings that we may have going forward.
Luxury products, such as fine jewelry, are discretionary purchases for consumers. Recessionary economic cycles, higher interest rates, higher tax rates, higher fuel and energy costs, higher freight costs, higher inflation rates, higher levels of unemployment, adverse conditions in the residential real estate and mortgage markets, tighter access to consumer credit, increased consumer debt levels, unsettled financial markets, and other economic factors that may affect consumer spending or buying habits could materially and adversely affect demand for our products. In addition, volatility in the financial markets has had and may continue to have a negative impact on consumer spending patterns. A reduction in consumer spending or disposable income may affect us more significantly than companies in other industries and could have a material adverse effect on our business, results of operations, and financial condition.
Our future financial performance depends upon increased consumer acceptance, growth of sales of our products, and operational execution of our strategic initiatives. We believe that most consumers are not generally aware of the existence and attributes of moissanite jewels and lab grown diamonds and that the consumer market for moissanite jewels, lab grown diamonds, and finished jewelry featuring both moissanite and lab grown diamonds remains in the early stages of development and consumer acceptance. The degree of future market acceptance and demand is subject to a significant amount of uncertainty. Our future financial performance will depend, in part, upon greater consumer acceptance of moissanite jewels and lab grown diamonds as an ethically sourced, affordable, luxurious alternative to other gemstones, such as a mined diamond, and our ability to develop brands and execute strategic initiatives, particularly in our Online Channels segment, to grow our sales and operating income. As we execute our strategy to build and reinvest in our business, significant expenses and investment of cash will be required going forward and this may adversely affect our operating income. If we are unable to execute and achieve desired revenue levels, we may adjust our strategic initiatives in response to the results of our investments.
In addition, consumer acceptance may be affected by retail jewelers’ and jewelry manufacturers’ acceptance of moissanite jewels, lab grown diamonds, and finished jewelry featuring both moissanite and lab grown diamonds. The quality, design, and workmanship of the jewelry settings, whether manufactured by us or other manufacturers, could affect both consumers’ perception and acceptance of our products and costs incurred by returns and markdowns.
Therefore, as other competitors enter the moissanite and lab grown diamond market, we could face market share and pricing pressures for our own products. In addition, the lower quality of competitors’ gemstones could negatively impact consumer perception of moissanite jewels and lab grown diamonds, and in turn, acceptance of our jewels.
Thus, our future financial performance may be affected by:
| • | Our ability to develop and promote the Charles & Colvard brands, such as Forever One™, Moissanite by Charles & Colvard®, and Caydia®, all of which are used in finished jewelry featuring moissanite and lab grown diamonds, which may in part drive interest and demand for moissanite and lab grown diamond jewelry at the consumer level; |
| • | Our ability to differentiate Charles & Colvard Created Moissanite® and Caydia® from competing products, including competitive moissanite and the rapidly emerging lab grown diamond industry; |
| • | Our ability to operationally execute our digital marketing strategy for our Online Channels segment; |
| • | Our continued ability and the ability of manufacturers, designers, and retail jewelers to select jewelry settings that encourage consumer acceptance of and demand for our moissanite jewels, lab grown diamonds, and finished jewelry; |
| • | Our ability to understand our consumer market segment and effectively market to them a compelling value proposition that leads to converted customers; |
| • | Our ability to continue our relationship with Wolfspeed in order to sustain our supply of high-quality SiC crystals; |
| • | The continued willingness and ability of our jewelry distributors and other jewelry suppliers, manufacturers, and designers to market and promote Charles & Colvard Created Moissanite® and Caydia® to the retail jewelry trade; |
| • | The continued willingness of distributors, retailers, and others in our distribution channels to purchase loose Forever One™, Moissanite by Charles & Colvard®, and Caydia® as well as their continued willingness of manufacturers, designers, and retail jewelers to undertake setting of the loose jewels; |
| • | Our continued ability and the ability of jewelry manufacturers and retail jewelers to set loose moissanite jewels and lab grown diamonds in finished jewelry with high-quality workmanship; and |
| • | Our continued ability and the ability of retail jewelers, including that of our internal retail jewelry marketing team in connection with the Charles & Colvard Signature Showroom, which is our first retail jewelry brick-and-mortar location that we opened in October 2022, to effectively market and sell finished jewelry featuring moissanite and lab grown diamonds to consumers. |
Our failure to maintain compliance with Nasdaq’s continued listing requirements could result in the delisting of our common stock. Our common stock is currently listed on The Nasdaq Capital Market. In order to maintain this listing, we must satisfy minimum financial and other requirements. On December 19, 2022, we received a notification letter from Nasdaq’s Listing Qualifications Department indicating that we are not in compliance with Nasdaq Listing Rule 5550(a)(2), because the minimum bid price of our common stock on the Nasdaq Capital Market has closed below $1.00 per share for 30 consecutive business days. The notification letter has no immediate effect on the Nasdaq listing or trading in our common stock. In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we have 180 calendar days, or until June 19, 2023, to regain compliance with the minimum $1.00 bid price per share requirement. To regain compliance, any time before June 19, 2023, the bid price of our common stock must close at $1.00 per share or more for a minimum of 10 consecutive business days. On June 19, 2023, if we meet the continued listing requirement for market value of publicly held shares and all other initial listing standards for The Nasdaq Capital Market (except for the minimum bid price requirement), and we notify Nasdaq of our intent to cure the deficiency, we may be provided with an additional 180 calendar day compliance period to regain compliance. If we are not eligible for an additional compliance period at that time, Nasdaq will provide us with written notification that our common stock will be subject to delisting. Upon such notice, we may appeal Nasdaq’s delisting determination to a Nasdaq hearing panel. There can be no assurance that, if we appeal Nasdaq’s determination, such appeal would be successful.
While we intend to engage in efforts to regain compliance, and thus maintain our listing, there can be no assurance that we will be able to regain compliance during the applicable time periods set forth above. If we fail to continue to meet all applicable listing requirements in the future and Nasdaq determines to delist our common stock, the delisting could substantially decrease trading in our common stock and adversely affect the market liquidity of our common stock; adversely affect our ability to obtain financing on acceptable terms, if at all; and may result in the potential loss of confidence by investors, suppliers, customers, employees, and fewer business development opportunities. Additionally, the market price of our common stock may decline further and shareholders may lose some or all of their investment.
| 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 | |
| October 1, 2022 – October 31, 2022 | | | - | | | $ | - | | | | | | | $ | | |
| November 1, 2022 – November 30, 2022 | | | - | | | $ | - | | | | | | | $ | | |
| December 1, 2022 – December 31, 2022 | | | - | | | $ | - | | | | | | | $ | | |
| Total | | | - | | | $ | - | | | | | | | $ | 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 |
| | |
| 10.1+ | Charles & Colvard, Ltd. Fiscal 2023 Senior Management Equity Incentive Program, effective July 1, 2022 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on November 9, 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 |
+ | Denotes management contract or compensatory plan or arrangement |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | CHARLES & COLVARD, LTD. |
| | | |
| | By: | /s/ Don O’Connell |
February 2, 2023 | | Don O’Connell |
| | | President and Chief Executive Officer |
| | | |
| | By: | /s/ Clint J. Pete |
February 2, 2023 | | Clint J. Pete |
| | | Chief Financial Officer |
| | | (Principal Financial Officer and Chief Accounting Officer) |
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