| 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. | We face intense competition in the worldwide gemstone and jewelry industry; |
| 4. | We have historically been dependent 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; |
| 5. | Constantly evolving privacy regulatory regimes are creating new legal compliance challenges; |
| 6. | Our information technology, or IT, infrastructure, and our network has been and may be impacted by a cyber-attack or other security incident as a result of the rise of cybersecurity events; |
| 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. | 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; |
| 16. | Governmental regulation and oversight might adversely impact our operations;
|
| 17. | 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; |
| 18. | The execution of our business plans could significantly impact our liquidity and we might not be able to continue as a going concern; |
| 19. | We are subject to arbitration, litigation and demands, which could result in significant liability and costs, and impact our resources and reputation; |
| 20. | 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; |
| 21. | Negative or inaccurate information on social media could adversely impact our brand and reputation; |
| 22. | 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; |
| 23. | 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; |
| 24. | Environmental, social, and governance matters may impact our business, reputation, financial condition, and results of operations; |
| 25. | If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer; |
| 26. | Our failure to maintain compliance with The Nasdaq Stock Market’s continued listing requirements could result in the delisting of our common stock; |
| 27. | Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our Company; and |
| 28. | 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, 2023, or the 2023 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 are 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 have manufactured, marketed, and distributed Charles & Colvard Created Moissanite® (which we refer to as moissanite or moissanite jewels) since introducing created moissanite to the world nearly three decades ago. After years of perfecting the process, Charles & Colvard debuted the world’s first colorless moissanite and its premium moissanite gemstone brand, Forever One™, in 2015. As an e-commerce and multi-channel destination for fine jewelry featuring lab grown gemstones, we believe the addition of lab grown diamonds is a natural progression for the Charles & Colvard brand. In September 2020, we announced our expansion into the lab grown diamond market with the launch of Caydia®, our brand of premium lab grown diamonds.
We offer gemstones and finished jewelry featuring our proprietary moissanite jewels, premium lab grown diamonds, and created color gemstones for sale in the worldwide fine jewelry market through two operating segments: our Online Channels segment, which encompasses our digital properties components, comprised of our charlesandcolvard.com, moissaniteoutlet.com, charlesandcolvarddirect.com, and madeshopping.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 our goods appeal to a broad 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 essential component of this strategy, which entails delivering tailored educational content, engaging in an 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, and 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.
Cybersecurity Event Update
On or about June 28, 2023, we identified a cybersecurity incident that temporarily disrupted the Company’s IT network and resulted in some limited downtime for certain systems. Upon discovery, we took immediate action to activate our incident response and business continuity protocols. We took immediate action to contain the incident and appropriate incident response professionals were engaged to assist in investigating the nature and scope of the event and to further harden the Company’s defenses. Through investigation, we confirmed that this event was related to an apparent ransomware attack involving the unauthorized encryption of some Company files and the deployment of malware.
Our investigation revealed no evidence that any sensitive customer data was compromised as a result of this incident, and our relationship with our customers has not been negatively impacted. We have worked closely with engaged security specialists to assist in the review and assessment of our information technology controls, and we implemented recommended strengthening of our access requirements, and improved our unauthorized access detection.
Additionally, we temporarily implemented manual processes to conduct our operations with as little disruption to production as possible. All major systems, including our enterprise resource planning, or ERP, financial systems and affected manufacturing and service operations, were restored as quickly as possible from available backups, and the incident did not have a material impact on the operations of our business operating segments. No payments were made to the ransomware threat actors.
We have incurred costs in the first nine months of the year ending June 30, 2024 or Fiscal 2024 of approximately $300,000 (of which $232,000 was paid directly by our insurance carrier in the three months ended March 31, 2024 which was previously accrued). In the first nine months of Fiscal 2024, these costs have been primarily comprised of various third-party consulting services, including forensic experts, restoration experts, legal counsel, and other information technology professional expenses, enhancements to our cybersecurity measures, costs to restore our systems and access our data, and employee-related expenses, including with respect to increased overtime. We do not expect to incur these and other additional costs related to this incident in the future.
Reverse Stock Split
On March 28, 2024, the Company filed a preliminary proxy statement with the U.S. Securities and Exchange Commission, for which a definitive proxy statement was filed on April 8, 2024, related to a special meeting of shareholders to be held on May 7, 2024, for: 1) the approval for an amendment to the restated articles of incorporation of the Company to effect a reverse stock split of the issued shares of common stock at a ratio within a range from any whole number between one-for-ten to one-for-fifteen, as determined by the Board of Directors in its sole discretion (the “Reverse Stock Split Proposal”); and 2) to approve one or more adjournments of the special meeting to a later date or dates, if necessary, to permit further solicitation of proxies in the event there are not sufficient votes in favor of the Reverse Stock Split Proposal or to constitute a quorum.
If approved by shareholders, the Reverse Stock Split Proposal will reduce the number of the Company’s shares of common stock outstanding in the condensed consolidated financial statements for the three and twelve months ending June 30, 2024, which reduction would increase the Company’s share price. The Company expects that an increase in the Company’s stock price due to the Reverse Stock Split Proposal will enable the Company to regain compliance with the minimum bid price requirement and continue to trade on the Nasdaq Capital Market. However, there can be no assurance that such action will achieve such result.
Fiscal 2024 Financial Outlook
Our strategic goals for Fiscal 2024 revolve around expanding Charles & Colvard’s brand globally and increasing the size of our business through top-line growth. As emerging generations embrace lab grown gems, we believe our ability to establish the superiority of our moissanite and lab grown diamonds, along with the Charles & Colvard brand directly with conscious consumers, is critical to our future success and ability to fuel our growth. We plan to continue executing our key Fiscal 2024 strategies with an ongoing commitment to spending judiciously with a long-term plan to generate sustainable earnings.
Our key strategic goals for Fiscal 2024 are as follows:
Global Brand Awareness
We plan to continue strengthening the fine jewelry brand we have been building for nearly three decades. As the consumer landscape continues to shift and factors beyond price, craftmanship, and origin drive purchase decisions, brand equity is more important than ever. We will continue investing in paid media campaigns targeting the trade and consumers as we reinforce our Made, not Mined™ provenance. We will also remain steadfast in our quest for sustained top-line organic growth as our brand messaging resonates with new audiences.
Diversified Product Categories
We will continue to evaluate opportunities for growth with synergistic brands, products, and verticals beyond our current offerings. Emerging consumer trends and data will inform new product lines, collections, and partnerships with designers and influencers. We will explore strategic alliances to fuel growth and deliver incremental long-term shareholder value while prioritizing our conscious practices and core values.
Innovative Technology
Evolving technology continues to shape how consumers discover, research, and ultimately purchase. We will continue to invest strategically in technology to service customers in existing and new outlets. Our investments in innovative technology, artificial intelligence, and predictive analytics are designed to further maximize our ability to be agile and efficient in our business. We will enhance our consumer experience through immersive virtual selling and fully customizable products driven by actionable data.
We will work to capitalize on these strategic goals to deliver top-line growth and strong financial results in this fiscal year. We believe that by implementing innovative technological solutions and developing operational efficiencies, we will position ourselves for scalability and sustained, disciplined growth in the years ahead. We plan to make additional investments in our internal technology-driven systems that lead to further operational efficiencies and improvements that we expect will drive down costs and help us deliver on our profitability targets. We will also remain cognizant of opportunistic strategic alliances and business arrangements that would lead to incremental long-term shareholder value.
As evidenced by our results for the first nine months of Fiscal 2024, domestic and global inflation and rising interest rates, coupled with ongoing fears of recession, continue to erode consumer confidence and present significant challenges for the global retail and e-commerce industry. We face the same challenges as all retailers and those in the e-commerce 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 e-commerce 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 2024 in Part I, Item 1, “Business,” and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contained in our 2023 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, 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 2023 Annual Report, and that disclosure should be read in conjunction with this Quarterly Report on Form 10-Q. There have been no significant changes in our critical accounting policies and estimates during the first nine months of Fiscal 2024.
Results of Operations
The following table sets forth certain consolidated statements of operations data for the three and nine months ended March 31, 2024 and 2023:
| | Three Months Ended March 31, | | | Nine Months Ended March 31, | |
| | 2024 | | | 2023 | | | 2024 | | | 2023 | |
| Net sales | | $ | 5,261,966 | | | $ | 6,641,799 | | | $ | 18,120,629 | | | $ | 24,382,003 | |
| Costs and expenses: | | | | | | | | | | | | | | | | |
| Cost of goods sold | | | 4,076,081 | | | | 4,493,125 | | | | 12,134,535 | | | | 14,650,910 | |
| Sales and marketing | | | 3,684,506 | | | | 3,267,436 | | | | 10,702,796 | | | | 10,715,066 | |
| General and administrative | | | 1,199,511 | | | | 1,053,357 | | | | 4,550,841 | | | | 3,654,788 | |
| Total costs and expenses | | | 8,960,098 | | | | 8,813,918 | | | | 27,388,172 | | | | 29,020,764 | |
| Loss from operations | | | (3,698,132 | ) | | | (2,172,119 | ) | | | (9,267,543 | ) | | | (4,638,761 | ) |
| Other income (expense): | | | | | | | | | | | | | | | | |
| Interest income | | | 74,528 | | | | 69,159 | | | | 244,207 | | | | 168,935 | |
| Interest and other expense | | | (9,103 | ) | | | - | | | | (14,672 | ) | | | - | |
| Total other income (expense), net | | | 65,425 | | | | 69,159 | | | | 229,474 | | | | 168,935 | |
| Loss before income taxes | | | (3,632,707 | ) | | | (2,102,960 | ) | | | (9,038,069 | ) | | | (4,469,826 | ) |
| Income tax expense | | | - | | | | (6,293,048 | )
| | | - | | | | (5,858,155 | ) |
| Net loss | | $ | (3,632,707 | ) | | $ | (8,396,008 | ) | | $ | (9,038,069 | ) | | $ | (10,327,981 | ) |
Consolidated Net Sales
Consolidated net sales for the three and nine months ended March 31, 2024 and 2023 comprise the following:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2024 | | | 2023 | | | Dollars | | | Percent | | | 2024 | | | 2023 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 4,884,498 | | | $ | 5,321,301 | | | $ | (436,803 | ) | | | (8 | )% | | | 16,577,110 | | | | 19,297,915 | | | $ | (2,720,805 | ) | | | (14 | )% |
| Loose jewels | | | 377,468 | | | | 1,320,498 | | | | (943,030 | ) | | | (71 | )% | | | 1,543,519 | | | | 5,084,088 | | | | (3,540,569 | ) | | | (70 | )% |
| Total consolidated net sales | | $ | 5,261,966 | | | $ | 6,641,799 | | | $ | (1,379,833 | ) | | | (21 | )% | | $ | 18,120,629 | | | $ | 24,382,003 | | | $ | (6,261,374 | ) | | | (26 | )% |
Consolidated net sales were $5.26 million for the three months ended March 31, 2024, compared to $6.64 million for the three months ended March 31, 2023, a decrease of approximately $1.38 million, or 21%. Consolidated net sales were $18.12 million for the nine months ended March 31, 2024, compared to $24.38 million for the nine months ended March 31, 2023, a decrease of approximately $6.26 million, or 26%. Overall, consumer confidence has continued to show signs of weakening due to general economic uncertainties, domestic and worldwide inflation, recessionary fears, and rising interest rates. These same general economic conditions also caused weakness in demand for moissanite jewels from our domestic and international distributors, resulting in lower loose jewel and jewelry product net sales during the three and nine months ended March 31, 2024, in both of our operating segments.
Sales of finished jewelry represented 93% and 91% of total consolidated net sales for the three and nine months ended March 31, 2024, respectively, compared to 80% and 79%, respectively, of total consolidated net sales for the corresponding periods of the prior year. For the three months ended March 31, 2024, finished jewelry sales were $4.88 million compared to $5.32 million for the corresponding period of the prior year, a decrease of approximately $437,000, or 8%. For the nine months ended March 31, 2024, finished jewelry sales were $16.58 million compared to $19.30 million for the corresponding period of the prior fiscal year, a decrease of $2.72 million, or 14%. These decreases for the three and nine month periods ended March 31, 2024 were due primarily to lower demand across all of our finished jewelry products as a result of adverse global and domestic general economic conditions and increased competition.
Sales of loose jewels represented 7% and 9% of total consolidated net sales for the three and nine months ended March 31, 2024, respectively, compared to 20% and 21%, respectively, of total consolidated net sales for the corresponding periods of the prior year. For the three months ended March 31, 2024, loose jewel sales were $377,000 compared to $1.32 million for the corresponding period of the prior year, a decrease of approximately $943,000, or 71%. For the nine months ended March 31, 2024, loose jewel sales were $1.54 million compared to $5.08 million for the corresponding period of the prior fiscal year, a decrease of $3.54 million, or 70%. The decrease for the three and nine month periods ended March 31, 2024 was due primarily 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 and increased competition coupled with continued downward pricing pressure on mined and lab grown diamonds and in line with our strategic shift to a more direct-to-consumer business model.
U.S. net sales accounted for approximately 99% and 98%, respectively, of total consolidated net sales for each of the three and nine months ended March 31, 2024, compared with 99% and 97% for the three and nine months ended March 31, 2023. U.S. net sales decreased to $5.19 million, or 21%, during the three months ended March 31, 2024 compared to $6.55 million in the comparable period of the prior fiscal year. U.S. net sales decreased to $17.7 million, or 25%, during the nine months ended March 31, 2024 from the corresponding period of the prior year. U.S. net sales decreased during the three and nine months ended March 31, 2024 primarily due to 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 nine months ended March 31, 2024 was also our largest customer during the three and nine months ended March 31, 2023, and accounted for 13% of total consolidated net sales during each of the three and nine month periods ended March 31, 2024 and 13% and 14% respectively, for the three and nine month periods ended March 31, 2023. We did not have another U.S. customer account for 10% or more of total consolidated sales during the three and nine months ended March 31, 2024 or 2023. We expect that we and 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 1% and 2%, respectively, of total consolidated net sales for the three and nine month periods ended March 31, 2024, and 1% and 3% for the three and nine month periods ended March 31, 2023. International net sales decreased 24% and 44% during the three and nine months ended March 31, 2024, respectively, compared to the respective periods in the prior year. International sales decreased due to lower demand in our international distributor market as a result of global general adverse macroeconomic conditions and increased competition coupled with continued downward pricing pressure on mined and lab grown diamonds. In light of the effects of ongoing global economic conditions, we continue to evaluate current and other potential distributors in international markets to determine the best long-term partners. As a result, and considering the ongoing international trade challenges, we expect that our sales in these markets may significantly fluctuate with each reporting period.
We did not have an international customer account for 10% or more of total consolidated sales during the three or nine months ended March 31, 2024 or 2023. 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 and nine months ended March 31, 2024 and 2023 are as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2024 | | | 2023 | | | Dollars | | | Percent | | | 2024 | | | 2023 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 2,718,053 | | | $ | 2,840,321 | | | | (122,268 | ) | | | (4 | )% | | $ | 8,595,736 | | | | 9,632,352 | | | | (1,036,616 | ) | | | (11 | )% |
| Loose jewels | | | 151,870 | | | | 645,259 | | | | (493,389 | ) | | | (76 | )% | | | 592,238 | | | | 2,342,133 | | | | (1,749,895 | ) | | | (75 | )% |
| Total product line cost of goods sold | | | 2,869,923 | | | | 3,485,580 | | | | (615,657 | ) | | | (18 | )% | | | 9,187,974 | | | | 11,974,485 | | | | (2,786,511 | ) | | | (23 | )% |
| Non-product line cost of goods sold | | | 1,206,158 | | | | 1,007,545 | | | | 198,613 | | | | 20 | % | | | 2,946,561 | | | | 2,676,425 | | | | 270,136 | | | | 10 | % |
| Total cost of goods sold | | $ | 4,076,081 | | | $ | 4,493,125 | | | | (417,044 | ) | | | (9 | )% | | $ | 12,134,535 | | | | 14,650,910 | | | | (2,516,375 | ) | | | (17 | )% |
Total cost of goods sold was $4.08 million for the three months ended March 31, 2024, compared to $4.49 million for the three months ended March 31, 2023, a decrease of approximately $417,000, or 9%. The total cost of goods sold was $12.13 million for the nine months ended March 31, 2024, compared to $14.65 million for the nine months ended March 31, 2023, a net decrease of approximately $2.52 million, or 17%. Product line cost of goods sold is defined as product cost of goods sold directly and excludes certain indirect supporting expenses from the manufacturing and production control departments, comprising personnel costs, allocations for depreciation, leases, utilities, and corporate overhead; freight; and period costs associated with inventory write-downs; 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 March 31, 2024, compared to the same period in 2023, was primarily due to decreased sales of loose jewels and finished jewelry during the three months ended March 31, 2024, in our Traditional and Online Channels as a result of lower product demand during the quarter, offset by an increase in non-product line cost of goods sold. Despite a decline in total cost of goods sold during the three months ended March 31, 2024, the significant increase in gold prices along with greater promotional pricing pressure amid a deeply discounted retail environment driving an increased sale cadence as compared to the same period in 2023, continued to erode profit margins.
The net increase in non-product line cost of goods sold for the three months ended March 31, 2024, comprises a $70,000 increase in freight principally from higher shipping costs during the period; a $76,000 increase in indirect manufacturing production control expenses; and a $53,000 increase in other inventory adjustments for production standard cost variances compared to those in the first three months of Fiscal 2023.
The decrease in total cost of goods sold for the nine months ended March 31, 2024 compared to the same period in 2023 was also primarily driven by the decreased sales of finished goods and loose jewels during the nine months ended March 31, 2024 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 nine month period despite the calendar year-end 2023 holiday season. We also and likewise saw lower loose jewel product demand in our Traditional segment throughout the nine month period.
The net increase in non-product line cost of goods sold for the nine months ended March 31, 2024, comprises a $274,000 increase in indirect manufacturing production control expenses and a $136,000 increase in other inventory adjustments principally related to production standard cost variances compared to those in the first nine months of 2023. These increases were partially offset by a $119,000 decrease in inventory valuation allowances in the first nine months of 2023, compared to those in the comparable prior year period, and a $22,000 decrease in freight out principally from decreased shipping volume during the nine 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 nine months ended March 31, 2024 and 2023 are as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2024 | | | 2023 | | | Dollars | | | Percent | | | 2024 | | | 2023 | | | Dollars | | | Percent | |
| Sales and marketing | | $ | 3,684,506 | | | $ | 3,267,436 | | | $ | 417,070 | | | | 13 | % | | $ | 10,702,796 | | | $ | 10,715,066 | | | $ | (12,270 | ) | | | 0 | % |
Sales and marketing expenses were $3.68 million for the three months ended March 31, 2024 compared to $3.27 million for the three months ended March 31, 2023, an increase of approximately $417,000, or 13%.
The increase in sales and marketing expenses for the three months ended March 31, 2024 compared to the same period in 2023 was primarily due to a $255,0000 increase in advertising and digital marketing expenses; a $115,000 increase in professional services and marketing support; a $54,000 increase in compensation expenses; a $51,000 increase in software-related costs incurred primarily in connection with software-related agreements; an $8,000 increase in bank fees; an $5,000 net increase in general office-related expenses; a $8,000 increase in telephone/fiber-related communications expenses; and a $3,000 increase in travel and entertainment. These increases were partially offset by a $75,000 decrease in general business taxes; and a $7,000 decrease in insurance costs.
The increase in advertising and digital marketing expenses for the three months ended March 31, 2024 compared to the same period in 2023 was primarily due to an increase in advertising expense of approximately $325,000; and a $5,000 increase in agency fees. These increases were offset partially by a $34,000 decrease in cooperative advertising; a $33,000 decrease in brand awareness activities; and an $8,000 decrease in print media expenses.
The increase in compensation expenses for the three months ended March 31, 2024 compared to the same period in 2023 was primarily due to a $52,000 increase in bonus expense; and a $13,000 increase in salaries and related employee benefits. These increases were partially offset by a $6,000 decrease in employee stock-based compensation; and a $5,000 decrease in severance expense.
The decrease in sales and marketing expenses for the nine months ended March 31, 2024 compared to the same period in 2023 was primarily due to a $200,000 decrease in general business taxes; a $157,000 decrease in compensation expenses; a $65,000 decrease in bank fees; a $23,000 decrease in insurance costs; a $9,000 decrease in depreciation and amortization expense; and a $4,000 decrease in travel expenses. These decreases were offset partially by a $181,000 increase in professional services principally comprising consulting services for marketing support in the current year period; a $109,000 increase in advertising and digital marketing expenses; a $68,000 increase in software-related costs incurred primarily in connection with new software-related agreements associated with upgraded sales-related operating systems; a $37,000 net increase in customer meetings and general office-related expenses; a $23,000 increase in employee-related recruiting and search fees for new hires; and a $28,000 increase in telephone/fiber-related communications expenses.
Compensation expenses for the nine months ended March 31, 2024 compared to the same period in 2023 decreased primarily as a result of a $91,000 decrease in salaries, commissions, and related employee benefits; a $36,000 decrease in bonus expense; a $28,000 decrease in employee stock-based compensation expense; and a $2,000 decrease in severance costs.
The increase in advertising and digital marketing expenses for the nine months ended March 31, 2024 compared to the same period in 2023 comprises a $379,000 increase in digital advertising expense; a $17,000 increase in agency fees; and a $10,000 increase in print media expenses. These increases were offset partially by a $191,000 decrease in sponsorships; an $81,000 decrease in cooperative advertising; and a decrease of $25,000 in trade show expenses.
General and Administrative
General and administrative expenses for the three and nine months ended March 31, 2024 and 2023 are as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2024 | | | 2023 | | | Dollars | | | Percent | | | 2024 | | | 2023 | | | Dollars | | | Percent | |
| General and administrative | | $ | 1,199,511 | | | $ | 1,053,357 | | | $ | 146,154 | | | | 14 | % | | $ | 4,550,841 | | | $ | 3,654,788 | | | $ | 896,053 | | | | 25 | % |
General and administrative expenses were $1.20 million for the three months ended March 31, 2024 compared to $1.05 million for the three months ended March 31, 2023, an increase of approximately $146,000, or 14%.
The increase in general and administrative expenses for the three months ended March 31, 2024 compared to the same period in 2023 was primarily due to a $122,000 increase in professional fees; a $45,000 increase in general business taxes and licenses; a $36,000 increase in travel-related expenditures; an $8,000 increase in bad debt expense; a $4,000 increase in depreciation and amortization expense; a $2,000 increase in overall rent expense; and a $2,000 increase in insurance expense. These increases were partially offset by a $24,000 decrease in bank fees; a $17,000 decrease in compensation-related expenses; and a net decrease of $32,000 in other administrative-related expenses.
The decrease in compensation expenses for the three months ended March 31, 2024 compared to the same period in 2023 was primarily due to a $78,000 decrease in salaries and benefits; and a decrease of $4,000 in severance expense. The decrease was partially offset by a $40,000 increase in employee stock-based compensation expense; and a $25,000 increase in bonus expense.
Professional services expenses increased for the three months ended March 31, 2024 compared to the same period in 2023 primarily due to a $121,000 increase in legal fees associated with various corporate matters; a $95,000 increase in fees associated with audit and tax services; and a $71,000 increase in temporary labor. These decreases were offset by a $151,000 decrease in other professional fees due to the payment of certain professional fees by our insurance carrier totaling $232,000 previously accrued related to the prior period cybersecurity event; and a $14,000 decrease in investor relations fees.
The increase in general and administrative expenses for the nine months ended March 31, 2024 compared to the same period in 2023 was primarily due to a $1.06 million increase in professional services expenses; a $125,000 increase in bad debt expense; a $66,000 increase in depreciation and amortization; and a $19,000 increase in insurance expense. These increases were partially offset by a $269,000 decrease in compensation-related costs; a $29,000 decrease in bank fees; a $36,000 decrease in travel and entertainment expense; a $29,000 net decrease in miscellaneous other general and administrative expenses; and an $11,000 decrease in overall rent expense.
Compensation expenses decreased for the nine months ended March 31, 2024, compared to the same period in 2023 principally due to a $221,000 net decrease in salaries and related employee benefits; a $63,000 decrease in bonus expenses; and a $4,000 decrease in severance expenses. These decreases were partially offset by a $19,000 increase in employee stock-based compensation expense.
Professional services fees increased for the nine months ended March 31, 2024, compared to the same period in 2023, primarily due to a $595,000 increase in legal fees associated with the cybersecurity event on June 28, 2023, and other corporate matters; a $164,000 increase in temporary labor; a $148,000 increase in fees associated with audit and tax services; a $111,000 increase in professional fees due to various strategic consulting projects and a pay versus performance analysis; and a $40,000 increase in investor relations fees.
Interest Income
Interest income for the three and nine months ended March 31, 2024 and 2023 is as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2024 | | | 2023 | | | Dollars | | | Percent | | | 2024 | | | 2023 | | | Dollars | | | Percent | |
| Interest income | | $ | 74,528 | | | $ | 69,159 | | | $ | 5,369 | | | | 7 | % | | $ | 244,146 | | | $ | 168,935 | | | $ | 75,211 | | | | 46 | % |
Certain cash balances in excess of operating needs are deposited into and maintained in an interest-bearing account with a federally insured commercial bank. Accordingly, during the three and nine months ended March 31, 2024 and 2023, we earned interest from cash on deposit in this interest-bearing account. The increase in earned interest for the three and nine month periods ended March 31, 2024 reflects the higher interest rates during the first three and nine month periods of Fiscal 2024 compared with Fiscal 2023.
Interest and Other Expense
Interest and other expense for the three and nine months ended March 31, 2024 and 2023 is as follows:
| | | Three Months Ended March 31, | | | Change | | | Nine Months Ended March 31, | | | Change | |
| | | 2024 | | | 2023 | | | Dollars | | | Percent | | | 2024 | | | | | | Dollars | | | Percent | |
| Interest and other expense | | $ | 9,103 | | | $ | - | | | $ | 9,103 | | | | 100 | % | | $ | 14,672 | | | $ | - | | | $ | 14,672 | | | | 100 | % |
Interest and other expense incurred for the three and nine months ended March 31, 2024 was primarily a result of the drawdown on the Company’s line of credit.
Provision for Income Taxes
For the three and nine months ended March 31, 2024, the Company’s statutory tax rate was 22.94% and consisted of the federal income tax rate of 21.00% and a blended state income tax rate of 1.94%, net of the federal benefit. For both the three and nine months ended March 31, 2024, the Company’s average effective tax rate was zero. For the three and nine months ended March 31, 2023, the Company’s effective tax rate was 11.24% and 18.37%, respectively. The Company’s effective income tax rate reflects the effect of federal and state income taxes on earnings and the impact of differences in book and tax accounting arising primarily from the permanent tax benefits associated with stock-based compensation transactions during the accounting period then ended.
The Company recognized zero net income tax benefit for the three and nine months ended March 31, 2024, compared with a net income tax expense of approximately $6.29 million and $5.86 million, driven by the establishment of the valuation allowance, for the three and nine months ended March 31, 2023, respectively.
As of each reporting date, the Company’s management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. As of March 31, 2024, the Company’s management determined that sufficient negative evidence continued to exist to conclude it was uncertain that the Company would have sufficient future taxable income to utilize its deferred tax assets, and therefore, the Company maintained a full valuation allowance against its deferred tax assets.
Liquidity and Capital Resources
Liquidity, Capital Resources and Going Concern
We have concluded that our existing cash and cash equivalents and availability of our short-term resources combined will not be sufficient to meet our working capital and capital expenditure needs over the next twelve months, and therefore, there is substantial doubt about the Company’s ability to continue as a going concern. A more detailed description of our going concern is included in Note 2 to our condensed consolidated financial statements in Part I, Item 1, “Financial Statements”, of this Quarterly Report on Form 10-Q.
Capital Structure and Debt
Long-Term Liquidity and Capital Structure
We have an effective shelf registration statement on Form S-3 on file with the SEC, with an expiration date of June 2, 2024, 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 twelve-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 rising inflation rates and fear of recession. Any capital raise is not assured and may not be at terms that would be acceptable to us.
In addition, on June 12, 2023, 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 had 180 calendar days, or until December 11, 2023, to regain compliance with the minimum $1.00 bid price per share requirement. We received notice on December 12, 2023 from the Nasdaq’s Listing Qualifications Department which resulted in an additional 180-day period, or until June 10, 2024, within which to regain compliance with the $1.00 minimum bid price requirement.
While we intend to engage in efforts to regain compliance, and thus maintain our listing, including by carrying out a reverse stock split, 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.
On March 28, 2024, we filed a preliminary proxy statement with the U.S. Securities and Exchange Commission, for which a definitive proxy statement was filed on April 8, 2024, related to a special meeting of shareholders to be held on May 7, 2024, for: 1) the approval for an amendment to our restated articles of incorporation to effect a reverse stock split of the issued shares of common stock at a ratio within a range from any whole number between one-for-ten to one-for-fifteen, as determined by the Board of Directors in its sole discretion (the “Reverse Stock Split Proposal”); and 2) to approve one or more adjournments of the special meeting to a later date or dates, if necessary, to permit further solicitation of proxies in the event there are not sufficient votes in favor of the Reverse Stock Split Proposal or to constitute a quorum.
The Reverse Stock Split Proposal, if approved by the shareholders, will reduce the number of our shares of common stock outstanding in the condensed consolidated financial statements for the three and twelve-months ending June 30, 2024, which reduction would increase our stock price. We expect that an increase in our share price due to the Reverse Stock Split Proposal will enable us to regain compliance with the minimum bid price requirement and continue to trade on the Nasdaq Capital Market, though there can be no assurance that such action will achieve such result.
Debt
We had $500,000 in short-term borrowings on our line of credit as of March 31, 2024. We have no long-term outstanding debt as of March 31, 2024.
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.
We repurchased no shares of our common stock during the three and nine month periods ended March 31, 2024. During the three month period ended March 31, 2023, we repurchased no shares of our common stock. During the nine month period ended March 31, 2023 we purchased approximately 358,000 shares of our common stock for an aggregate price of approximately $452,000 pursuant to the repurchase authorization.
Operating Activities and Cash Flows
We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of March 31, 2024, our principal sources of liquidity were cash and cash equivalents totaling $9.2 million, trade accounts receivable of $567,000, and net current inventory of $10.44 million, as compared to cash and cash equivalents totaling $10.4 million, trade accounts receivable of $380,000, and net current inventory of $7.48 million as of June 30, 2023. We also had access during the three month period ended March 31, 2024 to a $5.00 million cash collateralized line of credit facility, with an available balance of $4.5 million, or the JPMorgan Chase Credit Facility, that we obtained effective July 9, 2021, as amended July 28, 2022 and amended further effective June 21, 2023, from JPMorgan Chase Bank, N.A., or JPMorgan Chase.
During the nine months ended March 31, 2024, our working capital decreased by approximately $4.84 million to $12.67 million from $17.51 million at June 30, 2023. As described more fully below, the decrease in working capital at March 31, 2024 is primarily attributable to a net decrease in our cash, cash equivalents, and restricted cash, a decrease in our prepaid expenses and other assets, an increase in our accounts payable, and an increase in the current portion of our operating lease liabilities. These factors were offset partially by an increase in our allocation of inventory from long-term to short-term due to a higher expected sell through of inventory on hand in the upcoming period, an increase in our accounts receivables, and a decrease in our accrued expenses and other liabilities. Our cash used for investing activities were principally used for the purchase of property and equipment.
During the nine months ended March 31, 2024, approximately $6.06 million of cash was used in our operations. The primary drivers of our use of cash were a net loss in the amount of approximately $9.04 million; a $145,000 increase in accounts receivable; and a decrease in accrued expenses and other liabilities of approximately $650,000. These factors were offset partially by a decrease in inventory of $1.44 million; an increase in accounts payable of $1.08 million; non-cash expenditures of $678,000; and a $574,000 decrease in prepaid expense and other assets.
From time to time, we have offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers, the extension of which may not immediately increase liquidity as a result of ongoing current-period sales. 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 our net sales and profits would likely be adversely impacted.
We manufactured approximately $1.09 million and $5.08 million in loose jewels and $7.96 million and $10.57 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 nine months ended March 31, 2024 and 2023, respectively. We expect our purchases of precious metals and labor to fluctuate in conjunction with the levels of our finished jewelry business. In addition, the price of gold has 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 March 31, 2024 and June 30, 2023, $14.87 million and $19.28 million of our inventories were classified as long-term assets, respectively. 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 $110,000 and new raw material that we may 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 March 31, 2024, 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 June 30, 2023, we also had federal tax net operating loss carryforward of approximately $24.76 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 $20.01 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 $5.10 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. Effective June 21, 2023, the JPMorgan Chase Credit Facility was amended further to extend the maturity date to July 31, 2024.
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. 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.
The JPMorgan Chase Credit Facility is evidenced by a credit agreement, as amended, between us and JPMorgan Chase, or the JPMorgan Chase Credit Agreement, dated as of June 21, 2023, and customary ancillary documents, in the principal amount not to exceed $5.00 million at any one time outstanding and a line of credit note, or the JPMorgan Chase Line of Credit Note, in which we promise to pay on or before July 31, 2024, the amount of $5.00 million or so much thereof as may be advanced and outstanding. In the event of default, JPMorgan Chase, at its option, may accelerate the maturity of advances outstanding under the JPMorgan Chase Credit Facility. The JPMorgan Chase Credit Agreement and ancillary documents contain customary covenants, representations, fees, debt, contingent obligations, liens, loans, leases, investments, mergers, acquisitions, divestitures, subsidiaries, affiliate transactions, changes in control, as well as indemnity, expense reimbursement, and confidentiality provisions.
In connection with the JPMorgan Chase Credit Facility, effective July 7, 2021, we incurred a non-refundable origination fee in the amount of $10,000 that was paid in full to JPMorgan Chase upon execution of the JPMorgan Chase Credit Facility on July 12, 2021. There was no origination fee paid to JPMorgan Chase in connection with the amended JPMorgan Chase Credit Facility, dated July 28, 2022 and June 21, 2023.
Events of default under the JPMorgan Chase Credit Facility include, without limitation, a default, event of default, or event that would constitute a default or event of default (pending giving notice or lapse of time or both), of any provision of the JPMorgan Chase Credit Agreement, the JPMorgan Chase Line of Credit Note, or any other instrument or document executed in connection with the JPMorgan Chase Credit Agreement or with any of our indebtedness, liabilities, and obligations to JPMorgan Chase or would result from the extension of credit to us by JPMorgan Chase.
As of March 31, 2024, we had a $500,000 outstanding balance 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, provides for the exclusive production of our premium moissanite product, Forever One™, and provides 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 March 31, 2024.
During the nine months ended March 31, 2024 we made no purchases of SiC crystals. For the nine month period ended March 31, 2023 we purchased approximately $1.80 million of SiC crystals from Wolfspeed pursuant to the terms of the Supply Agreement, as amended.
On July 28, 2023, Wolfspeed initiated a confidential arbitration against us for breach of contract claiming damages, plus interest, costs, and attorneys’ fees. Wolfspeed has alleged that we failed to satisfy the purchase obligations provided in the Supply Agreement for Fiscal 2023 in the amount of $4.25 million and failed to pay for $3.30 million of SiC crystals Wolfspeed delivered to us. Wolfspeed further alleges that we intend to breach our remaining purchase obligations under the Supply Agreement, representing an additional $18.5 million in alleged damages.
While the Company is evaluating Wolfspeed’s claims, we dispute the amount sought, and we intend to vigorously defend our position, including by asserting rights and defenses that we may have under the Supply Agreement, at law and in equity. A hearing has been scheduled for September 30, 2024. The final determinations of liability arising from this matter will be made following comprehensive investigations, discovery and arbitration processes.
In connection with our short-term capital resources, we have an effective shelf registration statement on Form S-3 on file with the SEC, with an expiration date of June 2, 2024, 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 twelve-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 rising inflation and fears of recession 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. 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 rising inflation and fears of recession 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 2023 Annual Report.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Not applicable.
| Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
We routinely review our internal control over financial reporting and from time to time make changes intended to enhance the effectiveness of our internal control over financial reporting. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an ongoing basis and will take action as appropriate. During the three months ended March 31, 2024, 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
From time to time, we may be involved in legal proceedings or subject to claims incident to the ordinary course of business. The outcome of litigation is inherently uncertain, and there can be no assurances that favorable outcomes will be obtained. In addition, regardless of the outcome, such proceedings or claims can have an adverse impact on us because of defense and settlement costs, diversion of resources and other factors.
On July 28, 2023, Wolfspeed initiated a confidential arbitration against us for breach of contract claiming damages, plus interest, costs, and attorneys’ fees. Wolfspeed has alleged that we failed to satisfy the purchase obligations provided in the Supply Agreement for Fiscal 2023 in the amount of $4.25 million and failed to pay for $3.30 million of SiC crystals Wolfspeed delivered to us. Wolfspeed further alleges that we intend to breach our remaining purchase obligations under the Supply Agreement, representing an additional $18.5 million in alleged damages.
While the Company is evaluating Wolfspeed’s claims, we dispute the amount sought, and we intend to vigorously defend our position, including asserting rights and defenses that the Company may have under the Supply Agreement, at law and in equity. A hearing has been scheduled for September 30, 2024. The final determinations of liability arising from this matter will be made following comprehensive investigations, discovery and arbitration processes.
We discussed these in our Annual Report on Form 10-K for the fiscal year ended June 30, 2023. There have been no material changes to such risks, except as set forth below.
The execution of our business plans could significantly impact our liquidity and we might not be able to continue as a going concern. The execution of our business plans to expand our Online Channels segment and global market opportunities, as well as to create required inventory of our Forever One™, Moissanite by Charles &Colvard®, and Caydia® gemstones, requires significant investment of our resources, which may reduce our cash position. Should we fail to execute our business plans, we could see delays in the return of cash from our investments, resulting in a decrease in our liquidity. Under our$5.00 million cash collateralized line of credit facility, or the JPMorgan Chase Credit Facility that we obtained from JPMorgan Chase Bank, N.A., effective July 7, 2021,as amended July 28, 2022 and amended further effective June 21, 2023, failure to comply with the covenants and defaults contained in the JPMorgan Chase Credit Facility or any other instrument or document executed in connection with the JPMorgan Chase Credit Facility could restrict our ability to draw on such facility. In addition, we currently have an effective shelf registration statement on Form S-3 on file with the SEC that allows us to periodically offer and sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total of $25.00 million, 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. Further, if we would be unable to access the capital markets or issue equity securities on terms that are acceptable to us or at all, our cash, cash equivalents, and restricted cash and other working capital may be constrained to meet our working capital and capital expenditure needs. Given our current liquidity position, it is unlikely that we would not be able to draw on the JPMorgan Chase Credit Facility, as amended, which matures on July 31, 2024. There is no guarantee of extension or renewal in connection with the terms and conditions of the JPMorgan Chase Credit Facility.
Further, our condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of obligations in the normal course of business. However, for the nine months ended March 31, 2024, we had losses of $9.04 million and cash flow used in operations of $6.1 million. These factors raise substantial doubt about our ability to continue as a going concern for one year from the date the financial statements are issued.
We are continuing to work on plans to fund operations to alleviate the conditions that raise substantial doubt by evaluating our financing arrangements, implementing cost savings actions to reduce cash outflow, and evaluating our ability to liquidate and convert to cash certain of our existing inventory totaling $25.31 million as of March 31, 2024.
In view of these matters, continuation as a going concern is dependent upon our continued operations, which in turn is dependent upon our ability to meet our financial requirements and the success of our future operations. The financial statements do not include any adjustments to the amount or the classification of assets and liabilities that may be necessary should we not continue as a going concern.
We believe that these plans may provide an opportunity for us to meet our obligations for the twelve month period from the date the financial statements are issued and to continue as a going concern. If, however, we are unable to successfully implement these plans, it may have a material adverse effect on our business, results of operations, and financial condition.
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 June 12, 2023, 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 had 180 calendar days, or until December 11, 2023, to regain compliance with the minimum $1.00 bid price per share requirement. We received notice on December 12, 2023 from the Nasdaq’s Listing Qualifications Department which resulted in an additional 180-day period, or until June 10, 2024, within which to regain compliance with the $1.00 minimum bid price requirement.
While we intend to engage in efforts to regain compliance, and thus maintain our listing, including by carrying out a reverse stock split, 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.
On March 28, 2024, we filed a preliminary proxy statement with the U. S. Securities and Exchange Commission, for which a definitive proxy statement was filed on April 8, 2024, related to a special meeting of shareholders to be held on May 7, 2024, for: 1) the approval for an amendment to our restated articles of incorporation to effect a reverse stock split of the issued shares of common stock at a ratio within a range from any whole number between one-for-ten to one-for-fifteen, as determined by the Board of Directors in its sole discretion (the “Reverse Stock Split Proposal”); and 2) to approve one or more adjournments of the special meeting to a later date or dates, if necessary, to permit further solicitation of proxies in the event there are not sufficient votes in favor of the Reverse Stock Split Proposal or to constitute a quorum.
The Reverse Stock Split Proposal, if approved by the shareholders, will reduce the number of our shares of common stock outstanding in the condensed consolidated financial statements for the three and twelve-months ending June 30, 2024, which reduction would increase our stock price. We expect that an increase in our share price due to the Reverse Stock Split Proposal will enable us to regain compliance with the minimum bid price requirement and continue to trade on the Nasdaq Capital Market, though there can be no assurance that such action will achieve such result.
| 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 | |
| January 1, 2024 – January 31, 2024 | | | - | | | $ | - | | | | - | | | $ | 4,510,021 | |
| February 1, 2024 – February 29, 2024 | | | - | | | $ | - | | | | - | | | $ | 4,510,021 | |
| March 1, 2024 – March 31, 2024 | | | - | | | $ | - | | | | - | | | $ | 4,510,021 | |
| 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. |
During the three months ended March 31, 2024, no director or officer of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K.
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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| 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 |
May 6, 2024 |
| Don O’Connell |
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| President and Chief Executive Officer |
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| By: | /s/ Clint J. Pete |
| May 6, 2024 |
| 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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