UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
☒ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended June 30, 20192021
OR
☐ Transition report pursuant to Section 13 of 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number: 000-23329
Charles & Colvard, Ltd.
(Exact name of registrant as specified in its charter)
| North Carolina | | 56-1928817 |
| (State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
170 Southport Drive Morrisville, North Carolina | | 27560 |
| (Address of principal executive offices) | | (Zip Code) |
(919) 468-0399
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common Stock, no par value per share | CTHR | The Nasdaq Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☐ |
| | | | |
| Non-accelerated filer | ☒ | Smaller reporting company | ☒ |
| | | | |
| | | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of its effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes☐ No ☒ ☒
As of December 31, 2018,2020, the aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates of the registrant was $15,818,991$31,375,932 based on the closing sales price as reported on The Nasdaq Capital Market.
As of August 29, 2019,27, 2021, there were 28,983,06929,913,095 shares of the registrant’s common stock, no par value per share, outstanding.
DOCUMENT INCORPORATED BY REFERENCE
Certain portions of the Proxy Statement for the registrant’s 20192021 Annual Meeting of Shareholders to be held on November 21, 201918, 2021 are incorporated by reference into Part III of this Annual Report on Form 10-K.
CHARLES & COLVARD, LTD.
FORM 10-K
For the Fiscal Year Ended June 30, 20192021
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Item 1. | | 2 |
Item 1A. | | 2120 |
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Item 4. | | 29
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| PART II | | |
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Item 6. | | 3031 |
Item 7. | | 31
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Item 7A. | | 52
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Item 8. | | 5352 |
Item 9. | | 8384 |
Item 9A. | | 8384 |
Item 9B. | | 8485 |
Item 9C. | | 85 |
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| PART III | | |
Item 10. | | 8485 |
Item 11. | | 8485 |
Item 12. | | 8485 |
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| PART IV | | |
Item 15. | | 8586 |
Item 16. | | 88
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K 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, (1) our dependence onbusiness, financial condition and results of operations could continue to be adversely affected by an ongoing COVID-19 pandemic and related global economic conditions; (2) our future financial performance depends upon increased consumer acceptance, growth of sales of our products, and operational execution of our strategic initiatives; (3) our business and our results of operations could be materially adversely affected as a result of general and economic conditions; (4) we face intense competition in the impact of the executionworldwide gemstone and jewelry industry; (5) a failure of our information technology infrastructure or a failure to protect confidential information of our customers and our network against security breaches could adversely impact our business plans onand operations; (6) we are subject to certain risks due to our liquidity;international operations, distribution channels and vendors; (7) our abilitybusiness and our results of operations could be materially adversely affected as a result of our inability to fulfill orders on a timely basis; intense competition in the worldwide jewelry industry; the financial difficulties or insolvency of one or more of our major customers and their willingness and ability to market our products; dependence(8) we are currently dependent on a limited number of distributor and retail partners in our Traditional segment; dependence on our exclusive supply agreement with Cree, Inc., or Cree,segment for the supplysale of our silicon carbide, or SiC, crystals for the foreseeable future; general economic and market conditions, including the current economic environment; risks of conducting business in foreign countries; inaccuracies in assumptions, estimates and dataproducts; (9) we use to calculate certain of our key operating metrics; our ability to maintain compliance with The Nasdaq Stock Market’s continued listing requirements;may experience quality control challenges from time to time that can result in lost revenue and harm to our brands and reputation; the potential impact(10) seasonality of seasonality on our business; the impactbusiness may adversely affect our net sales and operating income; (11) our operations could be disrupted by natural disasters; (12) sales of natural disastersmoissanite and other events beyond our control on our operations;lab grown diamond jewelry could be dependent upon the pricing of precious metals, which is beyond our control; (13) our current customers’ potential perception ofcustomers may potentially perceive us as a competitor in the finished jewelry business; (14) we depend on an exclusive supply agreement, or the impactSupply Agreement, with Cree, Inc., or Cree, for substantially all of significantour 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; (15) if the e-commerce opportunity changes in dramatically or if e-commerce opportunities, technology or models;providers change their models, our results of operations may be adversely affected; (16) governmental regulation and oversight might adversely impact our operations; (17) the risk of a failureexecution of our information technology infrastructurebusiness plans could significantly impact our liquidity; (18) the financial difficulties or a failure to protect confidential information against security breaches;insolvency of one or more of our major customers or their lack of willingness and ability to protectmarket our intellectual property; the potential adverse impact ofproducts could adversely affect results; (19) negative or inaccurate information on social media;media could adversely impact our brand and reputation; (20) 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; (21) we may not be able to adequately protect our intellectual property, which could harm the failurevalue of our products and brands and adversely affect our business; (22) if we fail to evaluate, implement, and integrate strategic opportunities; possible adverse effects of governmental regulationacquisition or disposition opportunities successfully, our business may suffer; (23) our loan, pursuant to the Paycheck Protection Program, or the PPP Loan, under the Coronavirus Aid, Relief, and oversight;Economic Security Act, or the CARES Act, as administered by the U.S. Small Business Administration, or the SBA, was forgiven in full and may be subject to review for compliance with applicable SBA requirements for six years from the impact ofdate the loan was forgiven; (24) some anti-takeover provisions included inof our charter documents may delay or prevent a takeover of our company; and (25) our failure to maintain compliance with The Nasdaq Stock Market’s continued listing requirements could result in the delisting of our common stock, in addition to the other risks and uncertainties described in more detail in “Risk Factors” in Part I, Item 1A, of this Annual Report on Form 10-K. 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.
EXPLANATORY NOTE REGARDING THIS ANNUAL REPORT
As previously reported, we changed our fiscal year end to June 30 from December 31, effective July 1, 2018. This annual report is for the twelve-month period from July 1, 2018 to June 30, 2019. References in this report to “fiscal year” refer to the year ended June 30. References in this report to “transition period” refer to the six-month transition period from January 1, 2018 to June 30, 2018. References in this report to “calendar year” refer to the year ended December 31.
PART I
Overview
Our Mission
At Charles & Colvard, Ltd., we believe luxury can be both beautiful and conscientious. With innovative technology and sustainable practices, our goalmission is to lead a revolution inredefine the definition of real within the jewelry industry – delivering a brilliant product at extraordinary value balanced with environmental and social responsibility.for consumers everywhere. We believe fine jewelry can be accessible, beautiful, and conscientious.
About Charles & Colvard
Charles & Colvard, Ltd., a North Carolina corporation founded in 1995 (which may be referred to as Charles & Colvard, we, us, or our), manufactures, marketsis a globally recognized fine jewelry company specializing in lab created gemstones. We manufacture, market, and distributesdistribute 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 gemstonejewels 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 OurForever One™, our premium moissanite gemstone brand. As an e-commerce and multi-channel destination for fine jewelry featuring lab grown gemstones, we believe that the addition of lab grown diamonds is a natural progression for the Charles & Colvard brand.
One of our unique differentiator,differentiators, moissanite – The World’s Most Brilliant Gem® – is core to our ambition to create a movement around beautiful, environmentally and socially responsible fine jewelry and fashion jewelry. Charles & Colvard is the originator of lab-created moissanite, and weWe believe that we are leading the way in delivering the premium moissanite brand through technological advances in gemstone manufacturing, cutting, polishing, and setting. By coupling what we believe to be unprecedented gemstonesmoissanite jewels with responsibly-sourcedresponsibly sourced precious metals, we are delivering a uniquely-positioneduniquely positioned product line for the conscientious consumer. Our Caydia® lab grown diamonds are hand selected by our Gemological Institute of America, or GIA, certified gemologists to meet Charles & Colvard’s uncompromising standards and validated by independent third-party experts. Our Caydia® lab grown diamonds are available currently in E, F, and G color grades (based on the GIA’s color grading scale) with a minimum clarity in accordance with the GIA’s VS1 clarity classification along with excellent polish and symmetry. All of our Caydia® lab grown diamonds are set with mostly recycled precious metals.
Our strategy is to build a globally revered brand of lab created gemstones and finished jewelry that appealsappeal to a wide consumer audience andaudience. We believe this strategy leverages our advantageadvantages of being the original and leading worldwide source of moissanite.Charles & Colvard Created Moissanite® and offering a curated assortment of jewelry featuring Caydia® lab grown diamonds, which together we believe offers an ideal combination of quality and value. We also believe a direct relationship with consumers is important to this strategy, which entails delivering tailored educational content, engaging in dialogue with our audience, and positioning our brand to meet the demands of today’s discerning consumer. In June 2019, we successfully completed
We believe our expanding application of an underwritten public offering of 6,250,000 shares of our common stock, which, togetheromni-channel sales strategy across the jewelry trade and to the end consumer with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July, resulted in total gross proceeds of approximately $11.01 million, before deducting the underwriting discountaccessible lab created gemstones and fees and expenses of approximately $1.02 million. The timing of this financing event is critical given the growing worldwide acceptance of lab-created gemstones with emerging generations of consumers. These proceeds, which we intend to use for marketing and for general corporate and working capital purposes, will enable us to focus efforts on expanding thevalue branded finished jewelry featuring Charles & Colvard globalmoissanite and lab grown diamonds positions our goods at the many touchpoints where consumers are when they are making their buying decisions – thereby creating greater exposure for our brand awareness with our targetand increasing consumer and further develop our global omni-channel sales strategy with a primary focus on top line growth. For more detailed information about our planned use of targeted funds for reinvestment into our business, see Marketing to the Online Channels Segment below.demand.
We sell loose moissanite jewels, lab grown diamonds, and finished jewelry set with these gems through two operating segments: our Online Channels segment, which comprisesencompasses our digital properties components, comprised of our charlesandcolvard.com website,and moissaniteoutlet.com websites, e-commerce outlets, including marketplaces, drop-ship customers, and other pure-play, exclusively e-commerce customers; and our Traditional segment, which consists of domestic and international distributors and retail customers.
We report segment information based on the “management” approach. This segment reporting approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of our operating and reportable segments. For more information about our operating segments, see Note 3 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
We believe our expanding application2
Our Market Opportunity
As a result of the COVID-19 pandemic, we have witnessed a shift in e-commerce shopping, and we have seen this change in consumer behavior continue through June 2021. According to an Adobe Digital Economy Index Report, from Adobe Analytics, as of the quarter ended March 31, 2021, global e-commerce and online retail spending in the U.S. have surged over the past year, with year-over-year growth of 39% and 49%, respectively. We believe that there is evidence to suggest that many brick-and-mortar retail stores have migrated sales to online platforms this past year. In their same Adobe Digital Economy Index Report, as of March 31, 2021, Adobe Analytics is projecting that global e-commerce sales are on pace to hit $4.2 trillion for calendar year-end 2021.
By 20202025, the global onlinevalue of the worldwide fashion jewelry market is expected to drive $45approximately $300 billion in worldwide sales which is expectedaccording to represent 15%a November 2020 report from Statista, a global provider of the global jewelryretail market and global online fine jewelry is projectedconsumer driven data. We continue to represent a staggering $30 billion ofbelieve that the global jewelry market according to Forbes.com and McKinsey & Company. We believe this convergence of the online jewelry shopper andconsumer, coupled with the emergence of lab-created gemstones, asis a solution to the underserved, ethically-minded value consumer shapes a bright and sizeable future opportunity for Charles & Colvard and jewelry designed with our exceptional gemstone.
Our Strategic Transformation
As consumers, and particularly those in the Millennial and emerging Gen-Z generations, have shifted to significant levels of online shopping and buying patterns, we transformed our go-to-market strategy in a relatively short period. Our historical business was that of a gemstone manufacturer, and as such, we created gemstones, and leveraged our distributor network as the primary method for delivering our goods to market. That meant relying on our Traditional segment partners to generate interest and sales for our gemstone, while they were doing the same for other gemstones and jewelry across the industry. Consequently, we believe there was a substantial lack of market awareness for moissanite and the Charles & Colvard brands.
In February 2016, we made the strategic decision to explore a potential divestiture of our direct-to-consumer home party business previously operated through our Charles & Colvard Direct, LLC (dba Lulu Avenue®) subsidiary. After careful analysis of our core competencies, market strategies, and intent to advance toward profitability, we determined a divestiture of this distribution channel to be in our best interest and that of our shareholders. In March 2016, we and Charles & Colvard Direct, LLC, entered into an asset purchase agreement with Yanbal USA, Inc., or Yanbal, under which Yanbal purchased certain assets related to our direct-to-consumer home party business for $500,000 and assumed certain liabilities related to such assets.
In October 2016, we re-launched Charles & Colvard with the intent to position both Charles & Colvard and its innovative moissanite products as a premium gemstone and jewelry brand. During this pivotal time, we launched the charlesandcolvard.com website as our primary storefront, established our brand across key social media properties, and began a significant digital marketing campaign. The purpose of this strategy was to gain exposure, build brand awareness, and begin the journey of establishing a lifetime relationship with consumers that are seeking an alternative luxury brand that aligns with their buying preferences.
The calendar year ended December 31, 2017, was a year of growth and optimization of our branding initiatives. Over the course of 2017, we executed our strategic plan with new innovations in our Forever OneTM product line and finished jewelry offerings. We invested in key retail and online partnerships, as evidenced by our brick-and-mortar expansion into nearly all Helzberg Diamonds stores and our achievement of the authorized Seller-Fulfilled Prime status on Amazon.com. We believe that we improved the charlesandcolvard.com customer’s experience with our brand by offering free shipping and introducing a 60-day free returns policy.
During the transition period ended June 30, 2018, we delivered on several key initiatives that we believe helped create a strong underpinning for our business. Among these achievements, we entered into an amendment to our exclusive Supply Agreement with Cree for the supply of SiC materialsethically minded consumer that extends the agreement by five years with our unilateral option, subjectcontinues to certain conditions, for renewal for an additional two-year period. The amendment also allows us under certain conditions to purchase alternative SiC material whose standards fall outside of Forever OneTM specifications. We also introduced Moissanite by Charles & Colvard®, a value line of gemstones that offers the cost-conscious consumer a competitively-priced option for moissanite jewels. We expanded key retail relationships that we believe will be instrumental in expanding the Charles & Colvard brand and positioning our products with other luxury brand options. We invested in new cooperative marketing relationships that we believe will be essential for proliferating the Charles & Colvard brand into new and innovative marketing channels. Finally, we signed new international e-commerce agreements that will make it easier for us to sell and ship our products globally. Finally, we significantly expanded our media exposure into nationally-recognized fashion-related print media.
During June and July 2018, we negotiated and entered into a $5.00 million asset-based revolving credit facility with White Oak Commercial Finance, LLC, or White Oak. The annual borrowing fees associated with this credit facility are lower than those in connection with our previous credit facility with a commercial bank, and moreover, we believe the borrowing terms and financial covenants underlying this credit facility are less restrictive than those under our previous credit arrangement. Accordingly, we believe our current credit facility will continue to enable us to be more nimble when executing our strategic plans.
In June 2019, as described above, we successfully completed an underwritten public offering of 6,250,000 shares of our common stock at a price of $1.60 per share, which, together with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July, resulted in net proceeds of approximately $9.99 million, net of underwriting discount and fees and expenses. We intend to use these proceeds for marketing and for general corporate and working capital purposes. As evidenced bypresent what we believe is a votesizeable opportunity for the Charles & Colvard brand.
Our Strategic Outlook
The COVID-19 pandemic continues to present business challenges in 2021 and we expect those challenges to continue into our fiscal year ending June 30, 2022, or Fiscal 2022. The full extent of confidence by our shareholders and the ultimate impact of the COVID-19 pandemic on our operational and financial successperformance remains uncertain and continues to depend on many factors outside of our underwrittencontrol, including, without limitation: the timing, extent, trajectory and duration of the pandemic; the development and availability of effective treatments and the long-term impacts of the global vaccine rollout; the imposition of protective public offering, we willsafety measures; and the impact of the pandemic on the global economy and demand for consumer products. Due to the potentially significant impact on our operations as a result of the COVID-19 pandemic, including governmental responses to prevent further outbreak of the virus, coupled with the severity of its evolving variants, current period results are not necessarily indicative of expected performance for our full Fiscal 2022. We anticipate that the COVID-19 pandemic could continue to executehave an adverse impact on our digital marketing strategy to buildbusiness, results of operations, and reinvest in our business.financial condition during Fiscal 2022.
DuringAdditional risks to the fiscal year ended June 30, 2019, we achieved four consecutive quarters of net income. We believe this strong financial performance positions us with a strong foundation on whichCompany related to apply and achieve the maximum benefit from the net proceeds of our recent public offering. We finished fiscal 2019 with more than half of our business derived from our Online Channels segment, which serves our direct-to-consumer customer, or DTC, presence. We believe this growth continues to establish our leadership position as a DTC brand. Also, during fiscal 2019, we forged new inroads into numerous international markets, where we believe that we have key growth opportunities. Accordingly, we launched several marketplaces including but not limited to Amazon sitesCOVID-19 pandemic are included in Australia, Germany, Italy, France, Spain and, Japan. Concurrently, we continued to support cross-border trade, or CBT, efforts to drive international customers to our U.S.-based website with enhanced international shopping features. Lastly, we leveraged our regional distribution network in certain international regions, such as China, that will require a significant local presence and use of resources. We feel confident in our agile international growth model and plan to continue these efforts into fiscal 2020.
Throughout fiscal 2019, we expanded our product selections to meet market demand, including expanding the footprint of our Moissanite by Charles & Colvard® product line and introducing our Signature Collection, a patent-pending line of exclusive jewelry featuring our unique floret logo. We saw strong sales performance of these new product lines, which we believe is an indication of the recognition and adoption of our brand by consumers. Finally, we continued to grow our presence with key retail partners, such as with Helzberg Diamonds stores with the addition of incremental product styles and an expanded case line presence in nearly all doors. In October 2018, we announced the establishment of a new relationship with Macy’s, with whom we continue to build a significant and growing online presence. We plan to continue evolving our retail strategy as we optimize our strategic partnership arrangements.
Part I, Item 1A. “Risk Factors.” A more detailed description of our achievements during the fiscal year ended June 30, 2019,actions we have taken, and are taking, in response to the transition period ended June 30, 2018, and the calendar year ended December 31, 2017,COVID-19 pandemic is included in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Our Strategic Outlook
Ourstrategic focus for the fiscal year ending June 30, 2020Fiscal 2022 is centered on the continued expansion of Charles & Colvard’s brand on a global scale.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 the Charles & Colvard brand directly with consumers is key to our future success and ability to fuel our growth. We will execute on our key strategies with a continued commitment to spending judiciously and generating sustainable earnings improvement.
Our key strategiesstrategic goals for fiscal 2020Fiscal 2022 are as follows:
Expansion of Brand AwarenessPresence. We plan to utilize digitalcontinue focusing on conversion-based advertising channels and other marketing strategies such as influencer marketing programs involving brand advocates to drive messaging to larger marketscampaigns by way of large social media followings,capitalizing on our existing digital platform and Over-the-Top, or OTT, advertising platforms that include subscription video-on-demand, or SVOD, services like Netflix and Hulu. Through these channels, wetransactional website, charlesandcolvard.com. We believe that we will findalso have the ability to utilize new and compelling waystechnological functionality to engage our social media audience on Facebook, Instagram, and YouTube, among others, by showcasing our products in real time through available existing online video streaming and live stream broadcasting platforms. In furtherance of our brand presence, we expect to continue our quest to reach all customers where they shop. To accomplish this, we plan to explore opportunities to develop retail showrooms in order to display and showcase the target consumer that is not yet familiarstyles in our exclusive Signature Collection, which will allow those consumers – who want to see, touch, and feel our jewelry in person – an opportunity to engage with our brand.products. We planbelieve these initiatives are the natural progression of our omnichannel marketing strategy and that these programs will continue to expand our brand footprint onpresence, increase customer engagement, expand our product offerings, and bolster our top-line growth. We believe that the expansion of our brand presence is a global scale – engaging the consumer everywhere she shops.
International Sales Reach. We intend to balance our omni-channel sales strategy with regional-specific marketing programs, online channels growth initiatives, and through relationships with select retail and distribution partners. We believe that expanded product offerings will ensure a variety of goods to meet the demands of today’s discerning consumers. We also plan to deploy distribution channels, marketing programs, and geographically-aligned curations to attract consumers and drive regional sales. Additionally, cross-border trade promotions will remain a key strategy that we believe will drive global customers to Charles & Colvard’s corporate transactional site where we can offer the most comprehensive and brand-immersive experience.
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| • | Enhanced Customer Engagement. We plan to further develop and expand our existing content production capabilities by building a broadcast studio in our Research Triangle Park, North Carolina, headquarters. We expect a new studio will provide the setting for live streaming capability on our website as well as other social media broadcast channels. We believe a key element of accomplishing this goal during Fiscal 2022 is our arrangement with and the implementation of Bambuser, a leading live streaming global platform with innovative hosting and broadcasting capabilities. This innovative technology will allow us to host live shows and broadcast events for special initiatives and introducing new product collections. We’re excited to join Bambuser’s list of brands such as LVMH, a leading global luxury products group that includes its Louis Vuitton®, Moët & Chandon©, and Hennessy® family of brands. In addition, Bambuser’s list of participating associates also includes such well-known consumer brands as Clarins®, Samsung©, and Adidas®. We expect this relationship to add a new sales channel opportunity for our direct-to-consumer business and encourage personal interaction with our online customer base, while also providing a platform to explore and engage celebrity and social media influencers. |
| • | Product Development. We intend to explore product development opportunities during Fiscal 2022 to bring forward new product offerings that align with our exclusive brand and core values, just as we did in our fiscal year ended June 30, 2021, or Fiscal 2021, with Caydia®, our premium brand of lab grown diamonds. We plan to develop and move forward with new proprietary product offerings, styles, and collections as well as an increased breadth of product categories to further meet the needs of existing and new customers. We expect to also continue focusing on the use of recycled metals and employing sustainable practices in order to serve today’s environmentally aware and conscientious consumer. |
Product EvolutionDisciplined Growth. Being responsiveWe remain aware of the ongoing challenges and economic uncertainties facing the U.S. and global economies as a result of the COVID-19 pandemic. However, we intend to customer preferences has played a pivotal role in the risecontinue developing and expanding our technological capabilities to make informed data-driven decisions across all areas of our Online Channels segment as the high-growth component of our business. We employ what we believe to be an agile product development philosophy that ensures a swift and fluid stream of new finished jewelry and gemstones that are responsive to customer demand. As we expand our reach to international locations – and as our Millennial and Gen-Z audiences mature – we will listen intently to market demand, measure carefully the costs and opportunities for our business and strive to deliver the products that are responsive to our audiences’ choices.
Enhanced Customer Experience. We plan to evolve our technology platform and services to support a continually-enhanced customer experience. We will use analytics to make data-driven decisions that offer deeper personalization and more immersive shopping experiences. We plan to drive customer engagement, encourage repeat buyers, and grow our customer loyalty program, all of which we believe will support our ability to deliver an exemplary worldwide customer service experience.
Corporate Social Responsibility. We believe that we have the responsibility to be a good corporate citizen, and in practice, to have a business model that helps us be socially accountable to our stakeholders. During fiscal 2019, we elevated our use of recycled precious metals in more than 95% of all the finished jewelry we sourced. Going forward, we are working toward utilizing only recycled precious metals in our production lines. We also plan to carefully measure the environmental impact of our business operations with a goal toward improving our overall environmental footprint. We also want to positively impact the communities where we work and live – which we will continue to support through philanthropic programs that advocate positive social change. We plan to create a higher level of transparency regarding these corporate social responsibility practices so that our customers and stakeholders will be able to track our efforts and hold us accountable to be an even better corporate citizen.
Our Guiding Principles
One of the most critical factors in implementing our strategies and achieving success is our team of employees. We carefully develop, support and reward our team members, making sure they know our fundamental mission, which is to lead a revolution in the jewelry industry – delivering a brilliant product at an extraordinary value balanced with environmental and social responsibility. We have set forth Guiding Principles that set the tone for everything we do – from structuring our interactions with strategic partners, customers and shareholders to the way we operate our business, and the products we bring to market.
Following are the principles that guide our actions:
Catalyze. Build positive momentum with customers and influencers by being thoughtful and trustworthy in every interaction;
Innovate. Disrupt the jewelry industry through use of technology – in gemstone and jewelry design, business processes and engagement with our audience;
Aspire. Be socially conscious, economically informed and environmentally responsible. Strive to build a sustainable business and give back through community acts;
Obsess. Think like a consumer, act like a friend. Constantly seek ways to reduce friction between the brand and our audience;
Achieve. Focus attention on the interdependent successes of individual, brand and shareholder; and
Enrich. Promote personal growth and the ability to effect positive change in the business by cultivating a culture of critical thinking and creativity.
Our Audience
Our consumer audience is in transition. Prior to our product brand re-launch in 2016, our audience largely comprised Baby Boomers and Generation X – which we consider an older set of consumers. Today, our market research, which is based on charlesandcolvard.com customer analytics, indicates that more than half of our audience comprises Millennial and emerging Gen-Z consumers. Regardless of demographic, our research indicates that our audience is driven by three distinct motivating factors: (i) Beauty – the innate brilliance of our gemstone and jewelry selection; (ii) Value – the “bang for the buck” possible with moissanite, and the ability to buy luxury items while saving money for other things in life; and (iii) Conscientiousness – having a positive impact on the world by buying a brand that is ethically-oriented and socially responsible.
While these common motivating factors transcend demographics, we believe that we are seeing trends that lend themselves to highly targeted marketing programs. Most distinctly, conscious consumerism has become a reality in today’s competitive retail environment. Increasingly, consumers are seeking brands that do business for good and are making a conscious effort to control their impact on the environment. This is a common characteristic among Millennial and Gen-Z audiences, whom we believe are more socially and ethically minded than previous generations.
In addition to moving toward conscientious consumerism, it is becoming increasingly evident that today’s consumer desires a direct and more personal relationshipplatforms. Consistent with the brands from which he or she chooses to purchase. According to a recent market research study cited by the Interactive Advertising Bureau, a trade group that empowers the media and marketing industries to thrive in today’s digital economy, two-thirdsplanned expansion of consumers expect direct brand connectivity. Further, according to a recent survey by Astound Commerce, a global digital commerce agency, 59% of respondents preferred to do research directly on brand sites, with 55% preferring to buy directly from brands. With more than half of our fiscal year 2019 revenue being generated from our Online Channels segment, we believe it’s clear that our customers are responding positively to our direct connection with consumers. This benefits the Charles & Colvard brand, as it empowerswe also intend to continue exploring strategic alliance relationships with businesses in the retail and fine jewelry industry where we believe that we would be able to capitalize on existing market synergies and likeminded product brands to help us to control our brand message and voice withachieve desired market growth. In the consumer. For these pointed reasons,meantime, we plan to continue our focus on direct-to-consumer outreach and deep customer engagement. Our marketing programs will be driven by the above understanding of our audience and their motivating factors. Their mindset will drive the segmented messages we deliver, define the partners and kindred brands we select and co-promote with, and determine the channels and means by which we engage our audience.
In summary, we believe our beautiful, high value, ethically-sourced product aligns directly with the principles and purchasing requirements of our primary target – the Millennial and Gen-Z audiences.
Marketing to the Online Channels Segment
Driven by continuously updated knowledge of our audience, through e-commerce and web analytics as well as research through social media and customer service channels, we proactively engage our consumersbuilding an organic growth strategy through a multi-channel digital marketing strategy. Our goal is to continue growing our direct relationship with the consumer, which we believe will drive interest across all of our selling channels. Despite capital constraints in recent years, we have successfully built a growing consumer following and an effective marketing engine that combined have contributeddedication to our recent growth. Targeted application of proceeds from our recent public offeringexisting core product market and providing ongoing exemplary customer service. We will be focused on digital marketing efforts, which we believe will ultimately drive topline growth due to expanding brand awareness across the globe.
Our approach for marketing directly to the consumer includes the following types of communication channels and content types:
Communication Channels
Following are the myriad of connected channels we use to promote our brand and products:
Organic Social Media. To reinforce and support our position as the leading source of ethically-sourced, lab-created moissanite, our marketing team manages several social media initiatives that target current and future jewelry consumers to support the promotion and sale of Charles & Colvard Created Moissanite®. Our campaigns are focused on driving a consistent message emphasizing the socially responsible aspects of our jewels and finished jewelry, their everlasting beauty, and overall value. Our social media efforts include owned posts and engagements (our own profiles and activities). We concentrate on the following six main social media platforms based on the demographics and psychographics of their users: Facebook, Instagram, Pinterest, Twitter, YouTube and LinkedIn.
Paid Advertising (Including, But Not Limited To, Search Engine Marketing, Display Ads, Video Ads, and Social Media Advertising). Approximately 81% of consumers begin their buying journeys by using a web search to discover new products and services, according to a recent research study by Synchrony Financial, formerly known as GE Capital Retail Bank. In short, we believe the typical buyer’s journey is a digital one. Digital marketing encompasses the myriad of ways we can be a part of that journey from resources such as Search Engine Marketing (based on keyword buys and ads), digital display (banner ads and product re-targeting ads), video pre-roll (ads playing before and during third-party YouTube videos), native advertising (long-form content produced in conjunction with digital-media and entertainment outlets), and social media advertising (specifically on social media platforms such as Facebook, Instagram, and Pinterest). We are using and continually optimizing available digital marketing channels. And we will also continue to monitor new forms of paid media as they arise – assessing whether they will be effective in helping us connectengage with our target audiences.
Email. We know that people who subscribeshareholder base to help create value for our emails are 35% more likely to purchase than visitors toshareholders. To accomplish our website who are not subscribed (based on analytics from Google and Marketo, an Adobe Company, a global marketing analytics firm). Therefore, we target some of our paid advertising on specifically driving email subscriptions, and we have used technology to incorporate website elements that encourage signing-up. In addition, when potential customers do subscribe, we have much better data with which to personalize communications with these customer prospects through direct email and our website content.
Public Relations. Earned brand mentions – cultivated by a comprehensive outreach program and powerful connections within beauty, fashion and cultural media outlets – is highly important to our brand-building efforts. By inclusion in articles, gift guides, and other pieces in known online magazines like InStyle, Town & Country, Refinery29, and others, we reach our target audiences in a way that allows us to “borrow” the authority of the media outlet. During the calendar year that ended December 31, 2018, we generated a meaningful number of mentions in consumer-related publications and blogs. Each of those mentions generated new online traffic to our website, sparked social media mentions, and grew our overall consumer audience.
Influencers. According to a recent study by the Digital Marketing Institute, a global digital marketing research firm, almost half of all consumers depend on influencer recommendationslong-term strategy for product and brand purchases. Similarly, according to the Influencer Marketing 2020 report published by Influencer Intelligence, in association with Econsultancy, a leading U.S. influencer marketing authority, up to 61% of Millennial consumers say they have been swayed in their purchasing decisions by digital marketing influencers. This is a clear indicator of what marketers have already come to accept, which is that people trust other people’s opinion more than they trust a brand’s advertising. However, we believe there is a caveat – the influencers with whom a brand partners must truly be aligned together in mindset. We do not believe that we can simply find someone with millions of followers, pay them to post about our brand and product, and expect to see results. Instead, we believe we must find influencers who embody the same mindset as our brand and believe as we do in the products that we bring to market. This kind of long-term influencer reach takes time and commitment to develop and we plan to continue to build this type of influencer network throughout fiscal 2020.
Our Website. Along with the primary purpose of making sales, our website is a critical communication channel within the buyers’ journey. We use our site to educate new visitors on the origin, benefits, and beauty of moissanite. We create specific landing pages to support our different buyers’ journeys – whether through an engagement ring buyer’s guide or assistance with gift buying for men. It is the home for information on how we give back to our local community and other organizations.
Content Types
Following are the varied mediums that we use across the communication channels listed above:
Photography. We believe in the importance of amazing photography when marketing a visually-driven product such as jewelry. We are continually creating new photos to support our ecommerce channels and to keep our marketing on all channels targeted and fresh. We create lifestyle photography for use in advertising, organic social media posts and more. Those photos also allow shoppers on our site to see the product in context, which illustrates style and scale far better than product shots on white background. We plan to continually explore new styles of photography to better market our products and engage our audiences in conversation.
Videos. According to Cisco Systems, Inc., more than 80% of all content consumed on the Internet is expected to be video by 2020. In addition, according to Simply Measured, a Sprout Social company that empowers enterprises to do more with their social media strategy, video social media posts generate 12-times the shares as a post with text and images combined. Accordingly, we have dramatically increased our use of video on all channels mentioned above. Over the past year, we have created an educational Style Guide video series that gives tips on how to pair certain engagement and wedding bands, to mix different metals, or to detail the distinctions in our different gemstone cuts. We have also created a Q&A Video series, giving customers easily communicated answers to commonly asked questions. We have also released multiple video ad series during this past fiscal year for the Calendar Year-End Holidays, Valentine’s Day, and Mother’s Day to drive higher sales. Within a few months of release, these video series were viewed thousands of times. Accordingly, we believe the video medium will be a growing communication channel across all of our lines of business andgrowth, we intend to continue focusing on video-related resources going forward.
Interactive and Immersive Experiences. Throughout fiscal 2019, we expanded our use of custom landing pages, featuring immersive experiences, focused on highly specific audiences (e.g., men exploring engagement rings), campaigns (e.g., Mother’s Day) and partnerships (e.g., our sponsorship of the North Carolina Courage, a professional women’s soccer team based in Raleigh, North Carolina, a member of the National Women’s Soccer League, or NWSL, and the reigning NWSL 2018 National Champions). These landing pages allow us to target specific messages to audiences looking for specific information, which drives them to spend more time on our website and increases the shopper’s chance to purchase and return to our website more often. As we increase our ability to personalize content through today’s technology, we intend to expand the use of landing pages featuring interactive and immersive content to drive consumer engagement.
User Generated Content. We believe that our greatest sales people are our satisfied customers – our fans. The more content our fans create – in the form of reviews or feedback on our website and social media posts on their own profiles – the more brand awareness we generate. When we engage with people who have posted, and then re-post their images and stories, we believe that we receive the highest level of social media engagement. Along with cultivating those posts through one-on-one engagement with our satisfied customers on social media, our renewed Loyalty Program that was launched in July 2019 will encourage more and more people to post their positive personal reviews and stories.
Distributing to the Online Channels Segment
Driven by continuously updated knowledge of our audience, through e-commerce and web analytics as well as research through social media and customer service channels, we proactively engage our consumers through a multi-channel digital marketing strategy. Our goal is to continue growing our direct relationship with the consumer, which we believe will drive interest across all of our selling channels.
Our approach for marketing directly to the consumer in our Online Channels segment includes the following types of communication channels: (i) organic social media; (ii) paid advertising (including, but not limited to, search engine marketing, display ads, video ads, and social media advertising); (iii) email; (iv) public relations; (v) product and style influencers; (vi) digital content creators; and (vii) our own website. In addition, our marketing approach comprises the following types of content types: (i) photography; (ii) videos; (iii) interactive immersive experiences (including but not limited to, online personal concierge shopping assistance and streaming live broadcast events and video shopping opportunities); and (iv) user-generated content.
Equally as important to us as marketing to our direct consumer audience is movingencouraging our customers to move through the process of engaging with our brand – and eventually converting them into a lifetime Charles & Colvard customer. Throughout the aboveour marketing tactics, we employ calls to action that drive the consumer to the many placesvirtual and actual locations where they can view our products, initiate, and complete their purchase.purchases. We utilize a centralized distribution and fulfillment facility in Morrisville,Research Triangle Park, North Carolina, to fulfill Online Channels segment orders.
Following are our primaryprincipal online transactional channels:
charlesandcolvard.com. Throughout the transition period ended June 30, 2018 and fiscal year ended June 30, 2019, weWe believe that we significantly enhancedcontinue to enhance our primary transactional website to optimize the platform for the online mobile consumer – whether shopping on a computer at home or a mobile device – and to reduce friction betweenimprove our brand and the shopper.customers’ experiences. Programs such as free shipping, a 60-day returns policy, and an enhanced and optimizedpersonalized shopping experience werehave been and will continue to be improved and rolled out.out over time. With data collected through web analytics, and through user surveys that reveal how consumers use the site, we are in a continual state of optimizing the buying experience – making it easier for shoppers to browse, sort, and compare. WeWhere possible, we utilize these data to inform the selection of new, leading-edgeinnovative technologies to further enhance our users’ experience, including technologies provided by such partners as Amazon Pay, Affirm, Inc., and PayPal Holdings, Inc., or PayPal, for financing purchases, Braintree, a service of PayPal, for ease of transfer, and Flow Commerce, Inc., or Flow, which is a company that specializes in facilitating cross-border global trade and e-commerce services. Our goal is to remain continually focused on improving our customers’ experience.
moissaniteoutlet.com. On March 16, 2021, we launched our secondary direct-to-consumer website, moissaniteoutlet.com, which is a product disposition channel that we believe complements our global positioning and dominance in the moissanite gemstone market. Our website, moissaniteoutlet.com, is an e-commerce shopping destination that caters to the opportunistic and bargain-seeking consumer base for our moissanite products. We believe this new online property allows us to monetize substantially all our raw material and finished goods inventory, thus minimizing product shrinkage and waste. As a unique online shopping destination with a very different product offering strategy, we believe moissaniteoutlet.com rounds out our product offerings with quality discounted jewelry products allowing us to serve a broader range of demographics and consumers. Our product assortment on moissaniteoutlet.com includes moissanite rings, earrings, pendants, and bracelets, as well as jewelry set with colored moissanite, and other lab created colored gemstones. From time to time, we plan to continue featuring daily pricing deals and flash product sales on moissaniteoutlet.com to encourage consumers to take advantage of favorable pricing opportunities.
Cross-Border Trade. With 84% of global e-commerce sales predicted to take place outside of Europe and North America by 2020, according to statistics from Statista.com (based on data from Shopify Inc., a global cloud-based, multi-channel commerce platform), we are combining regionalized marketing efforts in new geographies with promotional campaigning to drive international consumers to our charlesandcolvard.com web property. Through the ongoing application of market-leadingcross-border trade, or CBT, technology, such as building our relationship with Flow, we believe CBT to becontinues being a significant opportunity in fiscal 2020Fiscal 2022 and beyond. For example, Flow is widely considered the next-generation for CBT e-commerce transactions and is known worldwide to be revolutionizing how merchants go global.We believe that Flow’s technological platform helps such global enterprises create a positive and localized shopping experience for their international customers while helping to ensureprovide a complete and accurate record of CBT transactions for the enterprise.
| • | Marketplaces. AWe continue seeing a large majority of buyers start their online shopping experience withutilizing a worldwide web search. In fact, according to jumpshot®, a global content management and digital intelligence firm that tracks marketplace data, more than 50% of those web searches begincontinue to originate on Amazon. That number skewscontinues skewing even higher within the Millennial demographic in that Amazon is the web search brand Millennials continue to identify as most relevant based on a finding by the Pew Research Center, a renowned nonpartisan factfact-based think tank. Therefore, we have made a point to bemaintain a prominent presence on Amazon, achieving Seller-Fulfilled Prime status, in 2017, which means we have the option of fulfilling orders with the same benefits of Amazon Prime. This enablescontinues to enable us to be positioned more prominently in Amazon’s search platform and to take advantage of their negotiated shipping rates and service levels that, in turn, lowerlowers our overall shipping costs. This status is available by Amazon to only those sellers who have a history of fulfilling orders quickly and maintaining appropriate levels of stock. In fiscal 2019, we expanded ourOur marketplace relationship with Amazon includes, in addition to include manydomestic websites, international locations, including websites in the U.K., Europe, Australia, and Japan. We also continue to have a market presence on eBay and a multitude of other specialty marketplaces, allowing us to meet our customers when and where they want to buy. OurAs the world and its economy is beginning to recover from the pandemic, our goal isremains to continue to optimizeoptimizing our presence on these marketplaces and to expandcontinue expanding into new untapped regions and platforms where we have identified cost-effective opportunities. |
Pure-Play E-tailers. FTI Consulting, a global business advisory firm, estimatescontinues to project that at least 25% of total retail sales will become e-commerce centric by 2030. As consumers continue maintaining an online shopping presence and become more digitally savvy, new businesses have gained traction by tailoring their product, services, and experiences to specific consumer preferences. We believe that these pure-play e-tailers offer unique opportunities for Charles & Colvard to feature our gemstones and connect with their loyal audiences. As our fiscal 2020 strategy evolves, we plan to focus on expanding these relationships and forge new partnerships that enable us to reach broader audiences.
Drop Ship Retail. In an effort to smartly expand their product offerings and assortments, many retailers utilize direct fulfillment from their vendors to their consumers, or drop-ship, as it enables them to offer a more robust assortment online without having to physically take ownership of the goods in their warehouse. These retailers are consistently seekingoften seek socially and environmentally responsible brands to serve the growing demand for conscientious product selection from their audiences. Since we began direct-to-consumer drop-shipping products in 2013, we have refined our digital information technology and operations capabilities to support these partnershippartnering arrangements in multiple ways, including fully integrated electronic data interchange, or EDI, solutions for inventory management, order processing, and invoicing. Operationally, we maintaincontinue maintaining in-stock rates and leverageleveraging our centralized distribution and fulfillment facility to meet partner service-level agreements, or SLAs, for shipments and returns. We plan to continue seeking new partnership arrangementsand strategic alliance relationships as well as optimizeoptimizing existing arrangements throughout fiscal 2020Fiscal 2022 and beyond.
MarketingDistributing to the Traditional Channels Segment
The Traditional Channels segment is our legacy segment – represented by such outlets as manufacturers, distributors, and brick-and-mortar retailers. Going forward, these market channels remain important avenues for Charles & Colvard to drive product to market and be present in the many places the consumer takes his or her shopping journey.
| • | Trade Advertising. Throughout the transition period ended June 30, 2018 and the fiscal year ended June 30, 2019, we continued to target the trade with print advertisements featuring moissanite, with specific emphasis on our Forever OneTM moissanite jewels and finished jewelry featuring the Forever OneTM jewel in leading trade publications. We intend to continue to deliver meaningful promotion of Forever OneTM as we further expand this product line into the distribution network within our Traditional segment. In May 2018, we introduced a new grade of moissanite, Moissanite by Charles & Colvard®, which delivers to the trade a price-sensitive moissanite product that competes with other comparable value-based products making their way to market. Additionally, we utilize a Partner Portal on our website into which authorized distributor and retail partners can gain secured access to our logos, branding materials, and other marketing-related guidelines.
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Our approach for marketing to customers and strategic partners within our Traditional segment includes the following types of communication channels: (Industry Associations. iWe maintain relationships with major jewelry) trade advertising; (ii) industry organizationsassociations; (iii) trade shows; and jewelry trade publications as an opportunity to communicate with our peers on a consistent basis through media coverage, trade shows, and charitable events, among others.
(Trade Shows. ivOur attendance at leading jewelry trade shows as a sponsor, an exhibitor, or a participant has helped us extend our outreach to customers. During the transition period ended June 30, 2018 and the fiscal year ended June 30, 2019, we attended major domestic and international jewelry industry trade shows including JCK, North America’s largest annual jewelry trade event in Las Vegas, and the Hong Kong Gem and Jewellery Fair. We intend to continue investing in these important industry events in fiscal 2020.
Cooperative Advertising. We sometimes participate in the) cooperative advertising programs of our distributor and retail partners, subject to the customer adhering to our branding guidelines and other conditions. In these programs, we subsidize a portion of their marketing costs in order to create awareness of and exposure for our gemstones and jewelry.
Distributing to the Traditional Channels Segmentadvertising.
We utilize a centralized distribution and fulfillment facility in Morrisville,Research Triangle Park, North Carolina, to fill bulk orders to manufacturer, distributor, and retail customers.
Retail. In order to create awareness and exposure for our gemstones, jewelry, and brands, we sell loose moissanite jewels and finished jewelry featuring moissanite at wholesale prices to nationally recognized and emerging retail customers through a broad range of channels including jewelry chains and department stores. Wholesale orders are received by way of purchase orders and fulfilled from our centralized fulfillment center. In many cases, we have placed loose moissanite jewels and finished jewelry inventory in stores on a consignment basis. Under this consignment model, in accordance with our revenue recognition accounting policy, we recognize the revenue for these transactions after the retail partner has sold an item to a consumer or other contractual conditions are met. In other cases, a retailer purchases the goods, or a portion of the goods, under what we call an asset purchase model. Under theour asset model, we recognize the sale and related revenue upon transfer of the goods to the retailer. Due to the maturity of certain retail relationships, we have recently migrated select brick-and mortar partners to a blended asset and consignment model account structure, which affords us more favorable customer payment terms that result in more favorable cash flow. We will continue to evolve our retail channel strategy as we optimize our methods and partnershippartnering arrangements.
Domestic Manufacturers and Distributors. In order to service the vast number of independent jewelers, jewelry stores, and smaller jewelry chains, we sell our loose moissanite jewels and finished jewelry to domestic wholesale distributors and finished jewelry manufacturers at distributor prices, that in turn resell the loose jewels or finished jewelry at a markup to independent jewelers and jewelry stores – whether brick-and-mortar, online, or both. In limited circumstances, we have placed loose moissanite jewels and finished jewelry inventory with select domestic distributors on a consignment basis. We continue to evaluate our channel strategy for domestic distributors, which may result in a change to our historical domestic distributor methods and partners.
International Manufacturers and Distributors. In order to create global awareness and exposure for our lab created gemstones, jewelry, and brands, we sell loose moissanite jewels and lab created diamond gems, as well as finished jewelry featuring moissanitethese gemstones, to international wholesale distributors and finished jewelry manufacturers at distributor prices, that in turn sell the actual loose jewels or set the loose jewels in mountings and sell the finished jewelry to brick-and-mortar and online retailers. We currently have numerous international wholesale distributors based in Australia, Canada, Hong Kong, India, Japan, the Netherlands, Russia, Singapore, and South Africa, and the United Arab Emirates.Africa. Some of these distributors typically sell into neighboring countries and the extended geographic regions where they may be located. Additionally, from time to time, we have placed loose moissanite jewels and finished jewelry inventory with select international distributors on a consignment basis. WeNotwithstanding the impact of the ongoing worldwide pandemic, we continue to evaluate our channel strategy for international distributors, which may result in a change to our historical international distributor methods and strategic partners. A portion of our international sales consists of finished jewels sold internationally that may be re-imported to U.S. retailers.
For a discussion of our largest customers for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017,2020, see Note 1314 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Seasonality
Sales in the retail jewelry industry are typically seasonal due to increased consumer purchases during the calendar year-end holiday season.season and during other holiday periods such as Valentine’s Day, St. Patrick’s Day, and Mother’s Day. Because historically we have primarily sold our loose moissanite jewels and finished jewelry featuring moissanite, and now more recently sell gemstones and finished jewelry featuring our premium lab grown diamonds, at wholesale pricing to distributors, manufacturers, and retailers, our sales to support the holiday season have largely taken place during the third and beginning of the fourth calendar quarters, depending on the sales channel and the level of advanced planning and production our customers undertook. However, the effect of seasonality on our business is also impacted by the timing of orders we receive to support new or expanded distribution and the level of current inventory positions held by our customers. In recent years, we have experiencedexperience a higher degree of seasonality in the fourth calendar quarter than we have experienced in prior years primarily as a result of the increased calendar year-end holiday season sales to end consumers through our Online Channels segment. In future periods, as direct to consumer sales of our finished jewelry featuring both moissanite and lab grown diamonds increase to retailers and directly to consumers,– both in dollars and as a percentage of total sales – we anticipate a seasonality trend more typical with the retail jewelry industry, and these factors may significantly affect our results of operations in a given quarter.
In connection with the change in our fiscal year-end, the results of our fiscal quarters (three-month periods ended March 31, June 30, September 30 and December 31 of each year) are expected to reflect the same effects of the seasonal trends on jewelry industry-related revenues discussed above, except that fiscal year-end periods beginning after June 30, 2018, are expected to reflect increased distributor, manufacturer and retailer sales activities relating to the calendar year-end holiday season impacting our results more predominately during our first and second fiscal quarters. Due to this change in our fiscal year-end, the effect of seasonality, particularly with respect to the effects of the year-end holiday season, on our business was less pronounced during the transition period ended June 30, 2018.
Moissanite
Over 120 years ago, Nobel Prize-winning chemist, Henri Moissan, Ph.D., first discovered the extremely rare mineral SiC in a meteorite crater in Arizona. Over a century after the discovery of SiC, and after years of experimentation, researchers from the Research Triangle Park in North Carolina developed and patented a thermal growing process for creating pure SiC crystals in a controlled laboratory environment. This long-sought-after breakthrough made possible the world’s first lab-created moissanite gemstone – posthumously named after its discoverer. With hardness rivaling any mineral on earth, and optical properties exceeding all mined and created gemstones, we believe moissanite is a brilliant jewel that is free from environmental and ethical issues, and capable of disrupting traditional definitions of fine jewelry.
Naturally-occurringNaturally occurring moissanite is generally very small in size, dark green or black in color, and not a commercially viable source of gemstone material. Therefore, in order to create high quality moissanite material in desirable colors and across a range of carat sizes that will appeal to a consumer audience, we expect only lab-grown SiC crystals to provide a sustainable source of moissanite for gemstones. In addition to carat size, important characteristics of a gemstone are beauty, durability, and rarity. The beauty of a colorless or near-colorless gemstone is characterized by its color, brilliance, and fire. The brilliance of a gemstone is measured by its refractive index, or the extent to which, when coupled with the facet design, the gemstone reflects light. The fire of a gemstone, or the breaking of light rays into spectral colors, is measured by its dispersion. Durability is determined by a gemstone’s hardness, or resistance to scratching and toughness, or resistance to chipping or cleaving. Rarity is the availability or perceived availability of a gemstone. Moissanite jewels have a unique combination of brilliance, fire, durability, and rarity.
The following table compares the physical properties of moissanite jewels with other fine gemstone materials, including lab grown diamonds:
| Description | | Refractive Index | | | Dispersion | | | Hardness (1) | | Toughness |
Charles & Colvard Created Moissanite® | | | 2.65-2.69 | | | | 0.104 | | | | 9.25 – 9.5 | | Excellent |
Diamond (including mined and lab grown diamonds) | | | 2.42 | | | | 0.044 | | | | 10 | | Good to Excellent (2) |
Ruby | | | 1.77 | | | | 0.018 | | | | 9 | | Excellent (3) |
Sapphire | | | 1.77 | | | | 0.018 | | | | 9 | | Excellent (3) |
Emerald | | | 1.58 | | | | 0.014 | | | | 7.50 | | Poor to Good |
(1) For purposes of this table, “hardness” is based on the Mohs Scale, which is a relative scale only. Quantitative comparisons of different gemstone materials cannot be made directly using the Mohs Scale. Moissanite jewels, while harder than all other known gemstones, are approximately one-half as hard as diamond.
(2) In cleavage direction, toughness is “good”.
(3) Except twinned stones
Sources: Gemological Institute of America, Gem Reference Guide for GIA Colored Stones, Gem Identification and Colored Stone Grading Courses 32-35, 65-82, 87-90 (1995); Cornelius S. Hurlburt, Jr. & Robert C. Kammerling, Gemology 320-324 (2d Ed. 1991); Kirk-Othmer, Encyclopedia of Chemical Technology 524-541 (5th Ed. 2004); Institution of Electrical Engineers, Properties of Silicon Carbide (Gary L. Harris, Ed., 1995); Robert Webster, Gems: Their Sources, Descriptions and Identification, 889-940 (5th Ed. 1994); W. von Muench, Silicon Carbide in Landolt-Börnstein - Numerical Data and Functional Relationships in Science and Technology, New Series, Group III, Vol. 17C, pp. 403-416 and 585-592 (M. Schultz and H. Weiss, Eds., 1984); Kurt Nassau, Shane F. McClure, Shane Ellen & James E. Shigley, Synthetic Moissanite: A New Diamond Substitute, Gems & Gemology, Winter 1997, 260-275; Kurt Nassau. Moissanite: A New Synthetic Gemstone Material, Journal of Gemology, 425-438 (1999); Mindat.org (a project of the Hudson Institute of Technology), “Moissanite” (https://www.mindat.org); and Wikipedia.org, “Moissanite” (https://en.wikipedia.org/wiki/Moissanite).
Moissanite’s beauty is objectively derived from its refractive index, which is higher than any other gemstone, including diamond. And its hardness is greater than all minerals, and all known gemstone materials with the exception of diamond. As a result, moissanite jewels, like diamond, can be cut with sharp, well-defined, and highly polished facets that accentuate their brilliance and fire. The cutting specifications (facet arrangement and proportions) for moissanite jewels are different than any other gemstone and designed to maximize the brilliance and fire of the raw material.
We evaluate the finished jewelsgems to exacting standards with automated video-imaging equipment using internal and independent third-party certified gemologists. Due to the rare natural occurrence of moissanite and both the proprietary and technical limitations in producing mass quantities of gem-grade moissanite, we believe that moissanite is among the rarest of jewels.
The following table compares the physical properties of moissanite jewels with other fine gemstone materials:
| Description | | Refractive Index | | | Dispersion | | | Hardness (1) | | Toughness |
Charles & Colvard Created Moissanite® | | | 2.65-2.69 | | | | 0.104 | | | | 9.25 – 9.5 | | Excellent |
| Diamond | | | 2.42 | | | | 0.044 | | | | 10 | | Good to Excellent (2) |
| Ruby | | | 1.77 | | | | 0.018 | | | | 9 | | Excellent (3) |
| Sapphire | | | 1.77 | | | | 0.018 | | | | 9 | | Excellent (3) |
| Emerald | | | 1.58 | | | | 0.014 | | | | 7.50 | | Poor to Good |
(1) For purposes of this table, “hardness” is based on the Mohs Scale, which is a relative scale only. Quantitative comparisons of different gemstone materials cannot be made directly using the Mohs Scale. Moissanite jewels, while harder than all other known gemstones, are approximately one-half as hard as diamond.
(2) In cleavage direction, toughness is “good”
(3) Except twinned stonesLab Grown Diamond
SourcesLab grown diamond materials have been synthesized since the early 1940s and eventually made their way into industrial applications during the next decade. : Gemological InstituteOriginally, this process was used mainly for producing diamond products used in industrial applications such as for diamond-tipped drill bits and commercial-grade abrasives as well as products used for unique specialized surgical equipment within the medical field. In 1955, scientists discovered a way to duplicate the conditions in a laboratory setting under which diamonds naturally develop. Inside a high-pressure cell, carbon atoms are subjected to intense heat and pressure, until the atoms grow and crystalize on seed crystals as a man-made diamond. More recently, an advanced technological method for creating diamonds, known as chemical vapor deposition, or CVD, mimics the method of America, Gem Reference Guidenatural diamond formations. CVD uses extreme pressure and a heated mixture of methane and hydrogen to produce gemstone quality lab grown diamonds that are used in the fine jewelry industry. Lab grown diamonds are cut and polished in the same manner as natural diamonds, producing identically optical, physical, and chemical properties as their mined diamond counterpart. The gemstone physical properties table set forth above denotes the range of physical attributes that are consistent for GIA Colored Stones, Gem Identificationboth mined and Colored Stone Grading Courses 32-35, 65-82, 87-90 (1995); Cornelius S. Hurlburt, Jr. & Robert C. Kammerling, Gemology 320-324 (2d Ed. 1991); Kirk-Othmer, Encyclopedia of Chemical Technology 524-541 (5th Ed. 2004); Institution Of Electrical Engineers, Properties of Silicon Carbide (Gary L. Harris, Ed., 1995); Robert Webster, Gems: Their Sources, Descriptions and Identification 889-940 (5th Ed. 1994); W. von Muench, “Silicon Carbide” in Landolt-Börnstein Numerical Data and Functional Relationships in Science and Technology, New Series, Group III, Vol. 17C, pp. 403-416 and 585-592 (M. Schultz and H. Weiss, Eds., 1984); Kurt Nassau, Shane F. McClure, Shane Elen & James E. Shigley, “Synthetic Moissanite: A New Diamond Substitute”, Gems & Gemology, Winter 1997, 260-275; Kurt Nassau. “Moissanite: A New Synthetic Gemstone Material”, Journal of Gemmology, 425-438 (1999); Mindat.org, “Moissanite” (https://www.mindat.org/min-2743.html); and Wikipedia, “Moissanite” (https://en.wikipedia.org/wiki/Moissanite).lab grown diamonds.
Many misconceptions exist surrounding lab grown diamonds. The most-asked question we receive regarding lab gown diamonds is whether or not lab grown diamonds are considered to be real diamonds. In response to this question, we unequivocally believe that lab grown diamonds are 100% real. We contend that the main difference between lab grown diamonds and those that are mined is simply the origin of the diamond itself. The critical characteristics of a diamond, those being its appearance, its chemical composition, and its physical properties are exactly the same in both a diamond that is mined versus one that is grown in a laboratory. A lab grown diamond can only be distinguished from natural diamonds using specialized equipment that can detect the minor differences in trace elements and crystal growth.
Products and Product Development
Moissanite Jewels
Historically, Charles & Colvard primarily sold legacy moissanite jewels including Forever ClassicTM™ and Forever Brilliant®. We continue to offer these legacy products in limited shapes and sizes, and only when available, through our Traditional segment as well as through our Online Channels segment through drop ship retail, and direct-to-consumer e-commerce marketplace outlets. In 2015, we announced availability of our premier product, the first colorless moissanite jewel, Forever OneTM™, which grades from colorless (D-E-F) to near-colorless (G-H-I) using the Gemological Institute of America’s, or GIA’s color grading scale. Our limited launch was met with great enthusiasm from channel partners and consumers. In response to this demand, we continue to expand our Forever OneTM™ product line with additional shapes and sizes. Today, we offer Forever OneTM™ in 27 cuts, and a multitude of sizes ranging from melee accent stones as small as .0020.002 carats to gemstones up to 6.13 carats, and our Exotics line of products that are as large as 15.55 carats diamond equivalent weight, or DEW.
In May 2018, we announced the availability of a new grade of gemstone, Moissanite by Charles & Colvard®. We believe that, with the exception of our own colorless moissanite jewel, Forever OneTM™, our newlatest gemstone is a cut above other moissanite on the market. Created from the same patented SiC material that offers unparalleled clarity, we believe that Moissanite by Charles & Colvard® is truly a revolutionary value. The distinction between Forever OneTM™ and Moissanite by Charles & Colvard® is made through our applied expertise throughout the design and manufacturing process summarized below and described in more detail in “Manufacturing and Quality Assurance”. We believe that due to the discerning approach we take to ensure the quality of Forever OneTM™, it remains far above any other offering available today. By closely evaluating clarity, color, and cut, we are able to determine which gemstones meet our exemplary standards for Forever OneTM™, and those that fit within one of the classifications for our multiple grade Moissanite by Charles & Colvard® gemstones.
Our manufacturing process starts with SiC material primarily manufactured by Cree through its patented process. This proprietary growing process creates a SiC material that is nearly free of micropipes – a type of inclusion sometimes found in lab-grown SiC material. However, based on the terms of the amended Supply Agreement with our strategic partner, we are permitted to purchase certain amounts of SiC materials from third parties under limited conditions. Either way, the SiC material comes to us as a boule, or a formed mass, that has the atomic structure of a single crystal. After beginning our manufacturing process, each boule is carefully inspected by our certified gemologists to ensure it meets our minimum standards for Charles & Colvard Created Moissanite® gemstones, including those for clarity and color grades. The products that meet appropriate minimum quality standards move forward on the journey to become our Charles & Colvard Created Moissanite® gemstones. From this point, as the product continues to move through our manufacturing process, it is subjected to further processing steps, such as cutting, faceting, and finishing. At the end of our manufacturing process, it’s the clarity and color designation, coupled with further inspection by our certified gemologists regarding the quality levels of the cutting, faceting, and finishing processes, that will ultimately determine if the product becomes one of our premier Forever OneTM™ gemstones or one our multiple grade Moissanite by Charles & Colvard® gemstones.
Moissanite Finished Jewelry
We began selling finished jewelry featuring moissanite in 2010. Our core designs included stud earrings, solitaire and three-stone rings, pendants, and bracelets. We are now selling an expanded selection of fashion-oriented, designer-inspired moissanite jewelry that we offer as an expansion to the core line of jewelry. The primary ingredientscomponents of our moissanite finished jewelry are loose moissanite jewels that we have on hand as part of our finished goods inventory, precious metal settings, and labor to mount the jewels into the settings.
Source of Moissanite Raw Material
Our moissanite jewels are made from gem-grade SiC crystals. Our primary supplier of SiC crystals is Cree with which we have certain exclusive supply rights for SiC crystals to be used for gemstone applications. In addition, based on the terms of the Supply Agreement with Cree, as amended, with Cree described below, we are permitted to purchase certain amounts of SiC materials from third parties under limited conditions. We source the metals used for our finished jewelry, including white, yellow, and rose gold, platinum, tantalum, and sterling silver, from a number of domestic and international manufacturers located in the U.S,U.S., China, India, Mexico, Hong Kong, Vietnam, or Portugal. In line with our goal of providing socially and ethically-sourcedethically sourced products, we require suppliers to adhere to our stringent supplier guidelines, as well as to certify that their gold isand tantalum are coming from conflict free sources and that all precious metals supplied to us are responsibly sourced.
Exclusive Supply Agreement with Cree
On December 12, 2014, we entered into an exclusive supply agreement with Cree, or the Supply Agreement, which superseded and replaced our prior agreement with Cree. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Cree, and Cree 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. However, effectiveEffective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement was also amended to (i)(i) provide us with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following expiration of the initial term; (ii)(ii) establish a process by which Cree 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; and (iii)(iii) 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 written 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 Cree 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.
We believe that our Supply Agreement with Cree, which holds the U.S. patent for micropipe-free silicon carbide material and the related method of manufacture, provides us a superior quality core material above all other moissanite and one that possesses an unrivaled level of gemstone clarity. We also believe that the terms and conditions contained within the amended Supply Agreement are overall more favorable when compared with those in the Supply Agreement prior to the amendment.amendments. Our total purchase commitment under the Supply Agreement, as amended, until June 20232025 is approximately $52.9$52.95 million, of which approximately $43.98 million$32.85 remains to be purchased as of June 30, 2019.2021.
For more information regarding the second amendment to our Supply Agreement, executed on August 26, 2020, see Note 10 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Lab Grown Diamonds
On September 14, 2020, we announced our expansion into the lab grown diamond product market with the launch of Caydia®, an exclusive brand of premium lab grown diamonds. Our Caydia® lab grown diamonds are hand selected by our GIA certified gemologists to meet Charles & Colvard’s standards and validated by independent third-party experts. Our Caydia® lab grown diamonds are available currently in E, F, and G color grades (based on the GIA’s color grading scale) with a minimum clarity in accordance with the GIA’s VS1 clarity classification along with excellent cut, polish, and symmetry. All of our Caydia® lab grown diamonds are set with responsibly sourced precious metals.
Lab Grown Diamond Finished Jewelry
We began offering finished jewelry featuring our Caydia® premium lab grown diamonds in September 2020. In addition to our core designs that include stud earrings, solitaire and multiple-gemstone rings, pendants, and bracelets, we are also selling a curated assortment of designer inspired luxury fashion finished jewelry featuring our Caydia® premium lab grown diamonds. The primary components of our Caydia® lab grown diamond finished jewelry are loose lab grown diamond jewels that we have either (i) purchased and have on hand from a core select group of lab grown diamond suppliers, manufacturers, and finishers or (ii) purchase directly from the same select group of lab grown diamond suppliers, manufacturers, and finishers for assembly with responsibly sourced precious metal settings that includes the cost of labor to mount the lab grown diamond jewels into the settings.
Sources of Lab Grown Diamond Raw Material
Our premium lab grown diamonds are made by third-party manufacturers from what we believe is the most technologically advanced method for laboratory created gemstone quality diamonds used in the fine jewelry industry. We purchase our lab grown diamonds from established domestic suppliers that comprises a supply chain, which we believe has proven to meet our rigid and quality certified standards and timelines to meet our inventory supply needs. We source the metals used for finished jewelry set with our Caydia® lab grown diamonds, including white, yellow, and rose gold, platinum, tantalum, and sterling silver, from a number of domestic and international manufacturers located in the U.S., China, India, Mexico, Hong Kong, Vietnam, or Portugal. In line with our goal of providing socially and ethically sourced products, we require suppliers to adhere to our stringent supplier guidelines, as well as to certify that their gold and tantalum are coming from conflict free sources and that all precious metals supplied to us are responsibly sourced.
Intellectual Property
We held a number of U.S. product and method patents for moissanite jewels that expired during 2015, under which we had broad, exclusive rights to manufacture, use, and sell moissanite jewels in the U.S. We held these same patents in 25 foreign jurisdictions, primarily across Asia and Europe, that expired in 2016, with one remaining in Mexico that expiresexpired in Fiscal 2021. In addition, we have certain trademarks and pending trademark applications that support our moissanite branding strategy. Additionally, we have certain pendingissued design patents that if approved we believe will differentiate our products in the gemstone and jewelry industry. Since the expiration of our patents, we have noted new providers of moissanite entering the market. We know how challenging it is to create high-quality moissanite and anticipate it will take emerging providers significant time and investment to bring meaningful and competitive products to market. As we experienced ourselves, achieving the capacity to consistently produce a high-quality moissanite product at mass scale requires a careful balance of SiC-specific faceting skills and a well-tuned global supply chain. Therefore, in the foreseeable future, we do not anticipate significant direct moissanite competition in our superior quality gemstone ranges with consistent production volumes.
Our success and our ability to compete successfully depends in part upon our proprietary technology. In addition to our remaining international patent,design patents, we rely on trade secret laws and employee, consultant, and customer confidentiality agreements to protect certain aspects of our technology. We currently are not subject to any claims that our products or processes infringe on the proprietary rights of third parties. At the present time, we are also dependent on Cree’s technology for the production of SiC crystals.
Manufacturing and Quality Assurance
Moissanite Jewels
The production of Charles & Colvard Created Moissanite® jewels is an elaborate process developed over a number of years of collaborative research and development, acquired and learned knowledge from scientists, and considerable investment expense.
Following are the key steps involved in the manufacturing processes of our moissanite jewels:
Growing gem-grade raw SiC crystals;
Manufacturing rough preforms;
Faceting and polishing jewels;
Inspecting, sorting, and grading; and
Growing Gem-Grade Raw SiC Crystals. SiC crystal growth suitable for gem-grade usage at commercial quantities is proprietary both in design and in operational methodology. Cree has grown the majority of our SiC crystals in accordance with the terms of the Supply Agreement. We routinely evaluate the yield and quality of saleable moissanite jewels from SiC crystals. The yield of saleable jewels from each crystal is one of the most significant factors affecting the volume and cost of moissanite jewels available for sale. Yield is dependent on the quality of the crystals, and variations in crystal quality can adversely affect our gross margin percentage.
Manufacturing Rough Preforms. We have made considerable investment in the design, development, and customization of a proprietary manufacturing process that includes equipment, software, and procedures to maximize raw material yield. The result is production of intermediary shapes, called “preforms,” that vary depending upon the size and shape of the desired finished jewel. WhileCurrently, we mayare not necessarily spend significantspending research and development funds during a specific operating period,in connection with these processes. However, when potential technology aligns with our production business model, we remain committedintend to explore and potentially invest in such research and development resources to improve raw material yield, including studying alternate preform shapes and cutting technologies, due to the dramatic effect such an improvement could have on our gross margin percentage.
Faceting and Polishing Jewels. Each preform is faceted and polished by our independent third-party gem-cutters to create what we believe to be our uniquely-faceteduniquely faceted Revolutionary Cut™ Cut™ gemstones based on master designs with multiple quality control measures built into the process. Gem-cutter training is a regimented program involving several months of progressive hands-on bench training. As we continue to expand the assortment of Forever One™, we will continue the process of certifying additional cutters to ensure sufficient scalability of our production capabilities to meet anticipated demand for this premium finished jewel.
Inspecting, Sorting, and Grading. Similar to other gemstones, each faceted moissanite jewel greater than 3.5 millimeters in size is individually graded against established master standards using our specially trained personnel. Additionally, as part of our overall quality assurance program, a representative sample from each batch of jewels is submitted to an image analyzer to ensure critical angles and other attributes designed to maximize moissanite’s optical properties are consistently maintained. This phase of manufacturing is relatively labor-intensive and requires skills not readily available in the general work force. In the future, we may elect to outsource certain portions of this stage of the manufacturing process to independent third parties that we will require to adhere to our rigorous quality control and monitoring standards.
Engraving. For moissanite gemstones that are four millimeters and larger in size, with certain exceptions Charles & Colvard laser inscribes an identifying code on the girdle of each Forever One™ and Moissanite by Charles & Colvard® gemstone that includes the Charles & Colvard Floret logo. This identifier matches a grading standard and is an important element in protecting the integrity of Charles & Colvard Created Moissanite® and ensuring the customer an authentic Charles & Colvard gemstone.
Moissanite Finished Jewelry
Our line of finished jewelry featuring moissanite is developed by a team of industry experts integrating our moissanite jewels into many forms of jewelry, generally made of precious metals, either designed or purchased by us utilizing a core group of suppliers, manufacturers, and finishers. In addition to our Limited Lifetime Warranty offered on our moissanite jewels, we provide a twelve-month Limited Warranty on all finished jewelry featuring our moissanite, and on jewelry designs that do not contain our moissanite gemstones, such as men’s wedding bands.
All procured finished jewelry components are sourced from our approved suppliers, and each finished jewelry item is jobbed and/or tracked by stock keeping unit, or SKU, utilizing our enterprise resource planning system. The components of moissanite finished jewelry comprised in each job are then manufactured into finished jewelry by assemblers either in the U.S. or internationally in China, India, Mexico, Hong Kong, Vietnam, or Portugal. We are continuously working with our existing manufacturing partners, as well as identifying new manufacturing partners, to expand our assortments and efficiencies.
All finished jewelry produced by Charles & Colvard undergoes a multi-point inspection process. A representative sampling of manufactured finished jewelry items undergoes stone and metals testing to ensure that the items for sale are of the quality that we strive to maintain. Also, in line with our goal of providing socially and ethically-sourcedethically sourced products, we require suppliers of our gold and tantalum to certify that the gold and tantalum is coming from conflict free sources and that all precious metals supplied to us are responsibly sourced. If required by government ordinance or requested by a customer, we facilitate the inspection of our finished jewelry by internationally recognized testing facilities to comply with legal requirements and to ensure consumer confidence.
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Lab Grown Diamonds
To ensure a premium lab grown diamond product standard, the quality assurance process for our purchased Caydia® gemstones, which are 0.5 Carat Total Weight, or CTW, and above, are individually hand selected by our GIA certified gemologists to meet our strict and uncompromising quality standards. The product quality and gemstone physical characteristics of each lab grown diamond we purchase are also validated by independent third-party gemology experts. Each lab grown diamond is accompanied by an official document that contains a unique prescribed and registered serial number that denotes such certification of qualification and authenticity.
Lab Grown Diamond Finished Jewelry
Our line of finished jewelry featuring our Caydia® lab grown diamonds is developed by a team of industry experts integrating our premium lab grown diamonds into many forms of jewelry, generally made of responsibly sourced precious metals, either designed or purchased by us utilizing a core group of suppliers, manufacturers, and finishers. We provide a twelve-month Limited Warranty on all finished jewelry featuring our Caydia® lab grown diamonds.
All procured finished jewelry components featuring our Caydia® lab grown diamonds are sourced from our approved suppliers, and each finished jewelry item is jobbed and/or tracked by stock keeping unit, or SKU, utilizing our enterprise resource planning system. The components of our Caydia® lab grown diamonds finished jewelry comprised in each job are then manufactured into finished jewelry by assemblers either in the U.S. or internationally in China, India, Mexico, Hong Kong, Vietnam, or Portugal. We are continuously working with our existing manufacturing partners, as well as identifying new manufacturing partners, to expand our assortments and efficiencies.
All finished jewelry featuring our Caydia® lab grown diamonds produced by Charles & Colvard undergoes a multi-point inspection process. A representative sampling of manufactured finished jewelry items undergoes stone and metals testing to ensure that the items for sale are of the quality that we strive to maintain. Also, in line with our goal of providing socially and ethically sourced products, we require suppliers of our gold and tantalum to certify that the gold and tantalum is coming from conflict free sources and that all precious metals supplied to us are responsibly sourced. If required by government ordinance or requested by a customer, we facilitate the inspection of our finished jewelry by internationally recognized testing facilities to comply with legal requirements and to ensure consumer confidence.
Each finished jewelry product we sell, which is set with our Caydia® gemstones, is inspected by our in-house GIA certified gemologists and quality assurance specialists prior to shipment to the end-consumer from our own fulfillment center in Research Triangle Park, North Carolina. The registered certificate of authenticity accompanies each Caydia® gemstone or finished jewelry set with Caydia® lab grown diamonds when shipped to the end consumer. All of our Caydia® lab grown diamonds are set with mostly recycled precious metals.
Working Capital Practices
Our primary source of working capital is cash on hand and cash generated by our operations. As global and U.S economic activity continues evolving in response to the ongoing COVID-19 pandemic, the risk of constraints on our cash and working capital, including experiencing potential liquidity challenges, remains in the forefront of our working capital management practices. Despite our cost-saving efforts, many business and operating expenses have remained flat or continued to rise. Cash flow management will remain crucial for our business in the months ahead and we intend to monitor fluctuations in our revenues that could impact our ongoing cash flow from operations. We expect to remain proactive in managing our inventory levels given the uncertainty in the worldwide supply chain, which may also place further demands on our level of working capital. Because we have a quarterly minimum purchase commitmentcommitments under the Supply Agreement, we may be required to purchase SiC materials in excess of our immediate needs from time to time, which may result in inventories that are higher than we might otherwise maintain.
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 approximately $13.99 million remains available after giving effect toall is available. However, we may offer and sell no more than one-third of our June 2019 public offering, includingfloat (which is the impactaggregate market value of the partial exercise of the underwriters’ over-allotment option, described below.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. conditions, which may be in turn, subject to, among other things, the potential disruption and volatility that may be caused by ongoing effects of the COVID-19 pandemic.
In June 2019, we completed an underwritten public offering of 6,250,000 shares of our common stock at a price of $1.60 per share, which, together with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July, resulted in aggregate net proceeds of approximately $9.99 million, net of the underwriting discount and fees and expenses.
Payment terms on trade receivables for our Traditional segment customers are generally between 30 and 90 days, though we may offer extended terms with specific customers and on significant orders from time to time. We extend credit to our customers based upon a number of factors, including an evaluation of the customer’s financial condition and credit history that is verified through trade association reference services, the customer’s payment history with us, the customer’s reputation in the trade, and/or an evaluation of the customer’s opportunity to introduce our moissanite jewels and lab grown diamonds or finished jewelry featuring both moissanite and lab grown diamonds to new or expanded markets.
Our returns policy for consumers on our charlesandcolvard.com websiteand moissaniteoutlet.com websites provides for the return of purchases for any reason generally within 60 days and 30 days, respectively, of shipment.the shipment date. Our returns policy for all other customers in our Online Channels segment (excluding those of charlesandcolvard.com) and those in our Traditional segment allows for the return of moissanite jewels, lab grown diamonds, and finished jewelry for credit generally within 30 days of shipment if returned for a valid reason. We have established an allowance for returns based on our historical return rate, which takes into account any contractual return privileges granted to our customers. Periodically, we ship loose jewel goodsgemstones and finished jewelry goods inventory to Traditional segment customers on consignment terms. Under these terms, the customer assumes the risk of loss and has an absolute right of return for a specified period that typically ranges from six months to one year.
Competition
As competitive moissanite and lab-created diamondlab grown diamonds expand and grow their global market presence, therewe believe that it is no more important time than now to confirmaffirm Charles & Colvard’s leadership position as a provider of the premier worldwide moissanite provider andgemstone as well as an exclusive brand of premium lab grown diamonds. Moving forward, we believe that we are well positioned to further establish our presence for both of our product lines in the worldwide emerging markets. We also believe our leadership position in these global markets is a product of more than 2025 years of moissanite innovation and as a purveyor of fine jewelry.
Accordingly, we believe our competitive advantage is bolstered by the following strengths:
| • | With our Forever OneTM™ gemstones, we believe that we have achieved a level of perfection that is rarely seen in any gemstone – featuring colorless grades with an innovative cut that we believe reveals optical properties unrivaled by any other jewel. This pinnacle of our legacy production process is the outcomeresult of continual improvement and a demonstration of our artisan craft.craftsmanship. Additionally, we believe that with our Moissanite by Charles & Colvard® gemstones we have brought forward a price-conscious alternative to competitive moissanite that we believe exceeds the quality of competitive moissanite – specifically in terms of clarity, as well as in cut and polish. The distinction between Forever OneTM™ and Moissanite by Charles & Colvard® is made through our applied expertise throughout the design and manufacturing processes and the discerning approach we believe we take to ensure the quality of Forever OneTM™ remains far above any other offering available today. By closely evaluating clarity, color, and cut, we are able to determine which gemstones meet our exemplary standards for Forever OneTM™ and those that should bear the Moissanite by Charles & Colvard® name. |
| • | With our success in developing and promoting Caydia®, our exclusive brand of lab grown diamonds, since September 2020 we believe that we have been able to demonstrate that we are able to successfully integrate and market these premium gems into fine jewelry finished products. |
With an exclusive SiC crystal Supply Agreement with Cree, which holds the U.S. patent for micropipe-free silicon carbide material and the related method of manufacture, we believe this core raw material empowers Charles & Colvard at a level that allows us to rise above all other moissanite products with an unrivaled level of gemstone clarity.
With our mature and innovative supply chain, while we have experienced instances of suppliers temporarily closing their operations, delaying order fulfillment needs or limiting their production as a result of the impact of the COVID-19 pandemic, we utilized alternative supply arrangements with partners whose businesses were able to successfully navigate the impact of the ongoing pandemic. Accordingly, we believe that we arehave remained able to seamlessly manage the complex manufacturing process of both our moissanite gemstones, meet the marketing demand and distribution needs of our lab grown diamond product line, and the varied finished jewelry options featuring both of these lab created gemstones we deliver to a global audience.
| • | With management’s vast experience in the worldwide fine jewelry industry, we likewise believe that we have been able to build a creative and dependable supply chain for our Caydia® product line. We believe this approach that was built on these many years of experience has proven to be successful as we continue building our brand and expanding this line of fine jewelry set with our exclusive brand of lab grown diamonds. |
With an established direct-to-consumer e-commerce presence and supporting digital marketing capacity,on our own mature transactional website, charlesandcolvard.com, coupled with the roll-out this fiscal year of our secondary transactional website, moissaniteoutlet.com, we believe we are able to leverage established consumer-driven online communication channels directly with our target audience.
With aan established global distribution network encompassing our own ability and that of our retail business partners, and notwithstanding the ongoing impact of the COVID-19 pandemic, we continue to believe that we have optimized this network for timely delivery of everythingour products from unique consumer orders to bulk distribution orders.
With our significant inventory and an established supply chain, we believe we are positioned to meet the just-in-time needs of our distribution partners. We believe having inventory quantities on the shelf is paramount to meeting the challenging delivery requirements of our customers.
With our above strengths outlined, it is also important to note that our future competitive success is reliant, in part, on the following:
| • | Our continued success in developing and promoting the Charles & Colvard brands, such as Forever OneTM™ and, Moissanite by Charles & Colvard®, and Caydia®, all of which are used in finished fine jewelry featuring moissanite and lab grown diamonds, resulting in increased 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 gemstone products, including competitive moissanite and the rapidly-emergingrapidly emerging lab-created diamond industry; |
The ongoing ability to operationally execute our digital marketing strategy for our Online Channels segment;
Our continued ability and the ability of manufacturers, designers, and retail jewelersjewelry partners to select jewelry settings that promote and encourage consumer acceptance of and demand for our moissanite jewels and finished jewelry;
The ability to understand our consumer market segment and effectively market to themsell a compelling value proposition to that market, which leads successfully to converted customers;
Our ability to continue our relationship with Cree 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 Charles & Colvard Created Moissanite®, and the 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 a high-quality standard of workmanship; and
Our continued ability and the ability of retail jewelers to effectively market and sell finished jewelry featuring moissanite jewels and lab grown diamonds to consumers.
Competitive Gemstones and Jewelry
Gemstone materials can be grouped into three types:
Those found in nature, generally through mining techniques;
Synthetic gemstone,gemstones, which hashave the same chemical composition and essentially the same physical and optical characteristics of natural gemstonegemstones but isare created or grown in a lab;laboratory; and
Simulants, which are similar in appearance to natural gemstonegemstones but do not have the same chemical composition, physical properties, or optical characteristics.
Moissanite is a rare, naturally-occurringnaturally occurring mineral. Our lab-created gemstones, Charles & Colvard Created Moissanite®, are considered a synthetic version of the naturally occurring moissanite mineral. Our exclusive brand of premium lab grown diamonds, Caydia®, are also considered a synthetic version of a natural diamond that is mined.
Our moissanite jewels and lab grown diamonds compete with fine gemstones such as ruby, sapphire, emerald, and tanzanite as well as with mined natural diamonds. We also face competition from synthetic diamonds, synthetic diamond films, and other sources of moissanite gemstones. Some suppliers of diamonds, including lab grown diamonds, and other fine gemstones, as well as the suppliers of other synthetic and lab-created gemstones, may have substantially greater financial, technical, manufacturing, and marketing resources and greater access to distribution channels than we do.
Competing with Mined Diamonds
The worldwide market for large, uncut, high-quality mined diamonds is significantly consolidated and controlled by the De Beers Group of Companies, or De Beers, (headquartered in South Africa), Alrosa (Russia), Rio Tinto (Australia), and BHP (Canada). These companies have a major impact on the worldwide supply and pricing of mined diamonds at both the wholesale and retail levels. While moissanite trades at a fraction of the cost of mined diamonds, diamond producers may undertake additional marketing or other activities designed to protect the mined diamond jewelry market against sales erosion from consumer acceptance of competing goods such as moissanite jewels.
We believe these indicators from the mined diamond trade show a change in consumer confidence in the diamond trade. In addition, in 2018 De Beers entered into the lab-created diamond trade – stating their intent to address market interest.
Competing with Lab-Created (Synthetic) Diamond
Lab-created diamond material has been synthesized since the early 1940s and made its way into industrial processes by the 1950s. Common applications such as diamond-tipped drill bits and abrasive processes led the way, followed by uses in solid-state electronics. In more recent years, lab-created diamonds have become accepted as a form of gemstone with companies such as Diamond Foundry, Pure Grown Diamonds and Lab Diamonds Direct gaining notoriety in the market.
In June 2018, De Beers – one of the world’s largest mined diamond sight holders – announced its initiative to launch a line of fashion jewelry with lab-created diamonds. We believe this step is a validation of the market opportunity for providing a socially and environmentally conscientious, quality alternative gemstone at a reasonable price compared to mined gemstones.
Consumer demand is driving the charge behind this recent adoption of lab-created gemstones. Today’s discerning consumer is seeking ethically-sourced options, better price points, and authenticity in the brands they choose to engage. We believe the recent rise in interest for lab-created diamond is creating a halo effect for the moissanite gemstone market. While we are experiencing growing traffic and interest in Charles & Colvard from the ongoing attention around lab-created gemstones, we may face future price point and consumer related demand pressures from the lab-created diamond industry. With current moissanite pricing averaging approximately 5% of mined diamond gemstones and approximately 10% of lab-created diamond, we believe that for the foreseeable future we will continue to be able to address an underserved segment of the market.
Competing with Other Moissanite Producers
Although we believe that our moissanite jewels have a leadership market position, we are beginning to face competition from other companies that develop competing SiC material. These products are emerging primarily from Far Eastern countries and are making their way into the U.S. market. Our ongoing research of the competitive landscape has identified competing moissanite, primarily in the “E-F” and below color range, according to the GIA’s grading scale. However, we have not yet identified competing moissanite that exhibits a consistent level of color, cut, clarity and polish that is competitive with the quality of our Forever OneTM™ gemstone.
We also have not identified competitive sources that have exhibited the ability to supply a consistent and high volume of quality moissanite substantial enough to address the considerable consumption needs of distributors and retailers that serve the jewelry trade. Achieving the capacity to consistently produce a high-quality moissanite product at mass scale requires a careful balance of SiC-specific faceting skills and a well-tuned global supply chain.
However, we are seeing a grade of moissanite material reaching the market that exhibits a lower color rating and/or lesser cut, clarity and polish standard compared to our Forever OneTM™ gemstone. This inferior product is coming to market at competitive price points, and we have subsequently been experiencing downward pricing pressures from price-sensitive purchasing channels. In May 2018, we entered thethis market with a value line of moissanite to compete directly with these lower-gradelower grade moissanite products. This new valueOur product line, known as Moissanite by Charles & Colvard®, is a competitively-pricedcompetitively priced line of gemstones that is fashioned from the same core material as our other created moissanite products. Finished gemstones that do not meet our meticulous grading standards for Forever OneTM™ – but do meet our high specifications for gemstones worthy of carrying the Charles & Colvard name – will now beare offered to the market at a value priced option. For the fiscal year ended June 30, 2019, 6%2021, approximately 15% of our revenue was generated from Moissanite by Charles & Colvard® gemstones and finished jewelry – we believe this percentage of revenue is validating the market for this value-priced product line.
Competing with Lab-Grown Diamonds
Lab-created diamond material has been synthesized since the early 1940s and made its way into industrial processes by the 1950s. Common applications such as diamond-tipped drill bits and abrasive processes led the way, followed by uses in solid-state electronics. In more recent years, lab grown diamonds have become accepted as a form of gemstone with companies such as Diamond Foundry, Pure Grown Diamonds and Lab Diamonds Direct gaining notoriety in the market.
Consumer demand is driving the charge behind this recent adoption of lab grown gemstones in the modern global luxury fashion jewelry space. Today’s discerning consumer is seeking ethically sourced options, better price points, and authenticity in the brands they choose to engage. We believe the recent rise in interest for the lab created diamond has created an increased interest in the moissanite gemstone market. With the launch of our Caydia® product line, an exclusive brand of premium lab grown diamonds, we believe that our entry into the lab grown diamond market could be a potential threat to - and increase competition for - our core moissanite products. While our moissanite gemstones and finished jewelry set with moissanite generally have different price points than those with lab grown diamonds, including our Caydia® product line, any cannibalization of moissanite product sales resulting from sales of our lab grown diamonds could have an adverse impact on sales of our moissanite jewels and finished jewelry set with moissanite.
Since our entry into the lab grown diamond space, we have experienced growing traffic and interest in Charles & Colvard from the ongoing attention around lab-created gemstones. We may face future price point and consumer related demand pressures from the lab grown diamond industry. However, with current moissanite pricing averaging between 5% and 10% of mined diamond gemstones and between 20% and 25% of lab grown diamonds, we believe that for the foreseeable future we will continue to be able to serve and thrive in this segment of the market.
Competing with Mined Diamonds
The worldwide market for large, uncut, high-quality mined diamonds is significantly consolidated and controlled by the De Beers Group of Companies, or De Beers (headquartered in South Africa), Alrosa Group (Russia), Rio Tinto Limited (Australia), and BHP Group Limited (Australia). These companies have a major impact on the worldwide supply and pricing of mined diamonds at both the wholesale and retail levels. While moissanite trades at a fraction of the cost of mined diamonds, diamond producers may undertake additional marketing or other activities designed to protect the mined diamond jewelry market against sales erosion from consumer acceptance of competing goods such as moissanite jewels.
Competing with Simulants
While moissanite is a synthetic gemstone (a lab-created version of the naturally-occurringnaturally occurring SiC mineral), we may also, to a lesser degree, face competition from simulant gemstones, including cubic zirconia and man-made crystals. Producers and sellers of these products may see the markets for these products being eroded by the market penetration of our moissanite jewels. We believe that the substantially lower price of these products is the primary basis upon which they will compete with our moissanite jewels; however, they are not considered fine gemstone or jewelry products.
Competing in the Finished Jewelry Space
The global fine jewelry market competition is fierce. Such well-known jewelry designers and manufacturers as James Allen®, Brilliant Earth, LLC, and Blue Nile Inc., among others, have a variety of jewelry collections featuring diamond and other precious and semi-precious gemstones, and enjoy strong brand recognition and a loyal consumer following. These companies also have greater financial resources than we do to develop and market their products.
We intend to expand our market share and compete with these well-known brands primarily on the basis of the combination of quality, design, and value, as moissanite is the highest quality, affordable alternative available to more expensive gemstones such as diamond. We believe that focusing on the clear advantages in moissanite’s retail price points, especially in the one-carat and larger sizes, will provide a key point of differentiation and value proposition to the end consumer who may not have had the opportunity to previously purchase fine jewelry due to limitations in discretionary spending income.
In addition, we believe that the Charles & Colvard Created Moissanite® suite, including moissanite jewels such as Forever OneTM™ and Moissanite by Charles & Colvard®, along with moissanite finished jewelry that we are developing pursuant to our marketing programs, mayas well as the line of finished jewelry featuring our Caydia® lab grown diamonds all combine to create what we believe is a long-term competitive advantage for our products as we buildcontinue building brand recognition. We endeavor to partner with recognized designers and jewelry companies, in addition to developing our own proprietary brands of finished jewelry. While our finished jewelry business is still developing, our goal is to build multiple strong brands sought after by the end consumer. We propose to focus our marketing efforts on emphasizing our attractive designs, coupled with moissanite’s exceptional brilliance, fire, durability, and rarity, to establish moissanite as a primary consumer choice in fine jewelry.
Our design, manufacture and marketing of finished jewelry featuring moissanite for sale at wholesale pricing to distributors and retailers and at retail to end consumers through our charlesandcolvard.com and other Online Channels outlets may result in some of our current wholesale customers perceiving us as a competitor, despite our efforts to use primarily non-conflicting sales channels. As we continue to develop our finished jewelry business, we intend to increase distribution through new and existing channels similarly to how many other companies have executed cross-channel marketing and distribution strategies. Due to the size of the finished jewelry market, we believe that such sales channels can co-exist, with the overall end result being increased consumer and brand awareness of moissanite products and a corresponding increased demand for not only our products, but those of our distributor and manufacturer customers as well.
19Competing with Lab Grown Diamond Retailers
Government Regulation
We are subject to governmental regulations in the manufacture and sale of moissanite jewels and finished jewelry. In particular, in July 2018 the Federal Trade Commission, or FTC, issued updated guidelines governing the description of lab-grown diamonds and other gemstones that require such gemstones to be clearly identified as to the gemstone’s lab-grown origin in any promotional or marketing materials. In addition, the precious metal in our finished jewelry may be subject to requirements, which vary by country and by state, such as hallmarking and alloy content. While we have a policy to ensure compliance with applicable regulations, if our actions are found to be in violation of FTC or other governmental regulations, we may be required to suspend marketing of our products and could incur significant expenses in developing new marketing strategies and materials that would not violate governmental regulations.
EmployeesHuman Resources Capital
As of August 29, 2019,27, 2021, we had a total of 6351 employees, all of whom were full-time and none of whom were part-time. None of our employees are represented by a labor union. We believe that our employee relations are good.
Directors and Executive Officers of Charles & Colvard, Ltd.
The members of our current Board of Directors are the following:
Neal I. Goldman
Chairman of the Board of Directors of Charles & Colvard, Ltd.; President of Goldman Capital Management, Inc., an investment advisory firm.
Anne M. Butler
Chief Executive Officer of Butler Advisors,advisors, a consulting firm specializing in strategic and operational advising to private equity, venture capital, and institutional investors on direct selling acquisitionsacquisition and management.
Benedetta Casamento
Retail Consultant specializing in finance, business operations, and financial planning and analysis.
Jaqui Lividini
Chief Executive Officer and Founding Partner of Lividini & Co., a brand strategy company that specializes in brand development and marketplace positioning, engagement marketing, and retail strategy.
Suzanne MiglucciDon O’Connell
President and Chief Executive Officer of Charles & Colvard, Ltd.
Ollin B. Sykes
President of Sykes & Company,Company. P.A., a regional accounting firm specializing in accounting, tax, and financial advisory services.
Our current executive officers are the following:
Suzanne MiglucciDon O’Connell
President and Chief Executive Officer
Clint J. Pete
Chief Financial Officer
Don O’Connell
Chief Operating Officer and Senior Vice President, Supply Chain
Available Information
Our corporate information is accessible through our investor relations website at https://www.charlesandcolvard.comir.charlesandcolvard.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available, free of charge, access on our website to all reports we file with, or furnish to, the SEC, including our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. A copy of this Annual Report on Form 10-K and our other reports are available without charge upon written request to Investor Relations, Charles & Colvard, Ltd., 170 Southport Drive, Morrisville, North Carolina 27560.
We operate in a dynamic and rapidly changing business environment that involves substantial risk and uncertainty, and these risks may change over time. The following discussion addresses some of the risks and uncertainties that could cause, or contribute to causing, actual results to differ materially from expectations. In evaluating our business, you should pay particular attention to the descriptions of risks and uncertainties described below. If any of these risks actually occur, our business, financial condition, or results of operations could be materially and adversely affected.
Risks Related to our Operations
The COVID-19 pandemic and related global economic impacts have adversely affected our business and are expected to continue to adversely affect our business, financial condition, and results of operations. The global outbreak of COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the U.S. Government in March 2020 and has negatively affected the U.S. and global economy. In response to this pandemic, federal, state, county and local governments and public health organizations and authorities around the world have implemented a variety of measures intended to control the spread of the virus including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing, and hygiene requirements. While some of these measures have been lifted or eased in certain jurisdictions, other jurisdictions have seen increases in new COVID-19 cases, resulting in restrictions being reinstated or new restrictions being imposed. There continues to be considerable uncertainty regarding such measures and potential future measures. These measures have adversely affected workforces, customers, economies, and global supply chains, and resulted in significant travel and transport restrictions. It has also disrupted the normal operations of many businesses, including ours.
In response to the COVID-19 pandemic, we implemented measures aimed at limiting its spread for the health and safety of our employees, customers, and the communities in which we live and work as well as in accordance with orders and decrees of governmental agencies. These measures included closures of physical offices, employee furloughs, reductions in force, increased social distancing mandates, remote working and prohibiting non-essential travel. Many of these actions remain in effect to varying degrees although we may implement new or revise existing requirements as circumstances require. The actions and reactions to voluntary and involuntary requirements have been highly disruptive to our business and may continue to be disruptive. As physical offices are allowed to reopen, the rules and regulations for reopening will likely increase in complexity, making compliance more difficult. Furthermore, if employees perceive the protocols and requirements we implement to create a safe and effective work environment to be inadequate, overly burdensome or no longer necessary, employees may choose to leave, productivity may decline or we may experience employee absenteeism, unrest, slowdowns, stoppages or other demands, we may fail to timely meet customer demand or fulfill orders, the costs to maintain or implement protective measures or deliver our products may increase, and we may be subject to increased litigation, including occupational safety and condition claims.
Additionally, a segment of our employees continues to work remotely as a result of the pandemic. Remote working arrangements could increase operational risks, including risks associated with information technology and systems, including service interruptions, misappropriation of data, or breaches of security, any of which could have a material adverse effect on our business. Working outside of the typical work environment may also introduce additional complexity or inefficiency into our normal processes for key areas like the preparation of financial statements or marketing and sales, which could negatively impact our business.
The COVID-19 pandemic has also significantly increased economic uncertainty and has led to continued disruption and volatility in the global capital markets, which could increase the cost of capital and adversely impact access to capital. While unlikely to be drawn upon given our current liquidity position, to maintain this position we have access to our new $5.00 million cash secured credit facility with JPMorgan Chase Bank, N.A., which we entered into in July 2021, or we could incur other indebtedness through the issuance of debt securities. An increase in our outstanding indebtedness will result in additional interest expense. We may also seek to conserve cash by delaying capital expenditures, which could negatively impact our operations.
The pandemic has also interfered with general commercial activity related to our supply chain, including our raw material and components sources. We experienced instances of suppliers temporarily closing their operations, delaying order fulfillment, or limiting their production, impacting our supply chain and ability to produce finished goods and deliver them to our customers. In our Online Channels segment, our primary transactional website, charlesandcolvard.com, has remained open and shipped products to our consumers throughout the pandemic, but in the early months of the shutdown at the beginning of the pandemic during our fiscal quarter ended June 30, 2020, was restricted to available stock, the limited production capacity of then-functioning suppliers, and shipping restrictions. Since that period of time, with the change in worldwide consumer shopping habits during the pandemic and throughout our fiscal year ended June 30, 2021, charlesandcolvard.com has demonstrated strong sales performance, which we believe is consistent with the growth in global e-commerce sales. While we expect consumer shopping patterns to continue to change, there is no guarantee that these global online buying habits will continue at the same level or at the same rate of year-over-year growth. In our Traditional segment, our brick-and-mortar customers began closing their stores to foot traffic in March 2020 and the re-opening of these stores has been measured and has resulted in a weakening of the retail sector throughout much of our fiscal year ended June 30, 2021. We have also experienced instances of our distributor network reducing or closing their operations during certain phases of the pandemic, impacting our ability to maintain significant levels of sales through our wholesale sales customers. While we have seen somewhat of a strengthening in these sectors during the fiscal year ended June 30, 2021, there is no assurance this growth will continue in future financial reporting periods. In addition, jewelry and gemstone trade shows, jewelry industry events, and finished jewelry product demonstrations have begun to be re-scheduled in time for the critical production season leading up to the calendar year-end 2021 holiday season. However, with recent increases in new COVID-19 cases in many jurisdictions and regions around the world, this pattern could result in business and travel restrictions being reinstated or new restrictions being imposed. There is no guarantee that this pattern of a return to industry-related events will continue and there is considerable uncertainty regarding such measures and the potential adverse impact that such future measures could have on these events and on the retail jewelry industry as a whole. As a result, our selling activities and our ability to convert those activities into sales have been, and we expect may continue to be, adversely impacted by the pandemic. While we have seen business strengthen in both our Online Channels segment and Traditional segment during the fiscal year ended June 30, 2021, our business, financial condition, and results of operations are expected to continue to be adversely affected by the COVID-19 pandemic until business resumes – and the U.S. and global economies return – to pre-pandemic levels.
The extent to which the COVID-19 pandemic impacts us will depend on numerous evolving factors and future developments that are uncertain and that we are not able to predict at this time. These factors include: the severity, duration and scope of the pandemic and the governmental, business, individual and other actions taken in response thereto; the effect on our suppliers and distributors, and disruptions to the global supply chain; the impact on economic activity; the extent and duration of the impact on Traditional segment partner confidence and order placements; the effect on consumer demand and purchasing behavior as pandemic-related restrictions are curtailed or lifted, remote working declines and discretionary spending patterns shift and our ability to timely and effectively respond to any resulting decreases or increases in demand; the effect of any closures or other changes in operations of our and our suppliers’ and distributors’ facilities; the health of and the effect on our employees and our ability to meet staffing needs in our manufacturing and distribution facility and other critical functions, particularly if employees become ill, are quarantined as a result of exposure or are reluctant to show up for work; our ability to sell our products worldwide and provide customer support, including as a result of travel restrictions, work from home requirements and arrangements and other restrictions or changes in behavior or preferences for interactions; data privacy and cybersecurity risks from new or expanded use of remote working; the impact of remote working arrangements on our financial reporting systems and internal control over financial reporting; restrictions or disruptions to transportation, including reduced availability of ground, sea or air transport; the ability of our distributors, retailers, third party customers and consumers to pay for our products; the effect of the fair value measurement of certain assets or liabilities; the effect on our ability to access capital on favorable terms and continue to meet our liquidity needs; and the diversion of management as they focus on the short- and long-term ramifications of the pandemic. Even after the COVID-19 pandemic has subsided, we may continue to experience adverse impacts to our business as a result of any economic recession that has occurred or may continue for the foreseeable future. The COVID-19 pandemic could also exacerbate or trigger other risks discussed in this Annual Report on Form 10-K, any of which could have a material and adverse effect on our business, results of operations, and financial condition. Additionally, any comparisons of our financial results for the financial reporting periods of our fiscal year ended June 30, 2021 (or future financial reporting periods) to previous financial reporting periods may not be a useful means by which to evaluate the health of our business and our results of operations because of the pandemic’s broad and significant but non-uniform impact to our business.
We continue to monitor the pandemic, have actively implemented updated policies and procedures to address the current business and economic environment, and may adjust our current policies and procedures as more information and guidance become available to address the ongoing and evolving situation. 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/or cash flows in the fiscal year ending June 30, 2022.
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. 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,ethically sourced, affordable, luxurious alternative to other gemstones, such as a mined diamond, and our ability to develop brands and execute strategic initiatives, in particular, 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 moissanite.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. Additionally, as other competitors enter the market, 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 continued success in developingability to develop and promotingpromote the Charles & Colvard brands, such as Forever OneTM™ and, Moissanite by Charles & Colvard®, and Caydia®, all of which are used in finished jewelry featuring moissanite resultingand lab grown diamonds, which may in increasedpart drive interest and demand for moissanite 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-createdrapidly emerging lab grown diamond industry; |
TheOur 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;
TheOur 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 Cree 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™, Charles & Colvard Created Moissanite®, and theCaydia® 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 to effectively market and sell finished jewelry featuring moissanite and lab grown diamonds to consumers.
The execution of our business plans could significantly impact our liquidity. 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 OneTM and Moissanite by Charles & Colvard® jewels, requires significant investment of our resources, which may reduce our cash position. Should we fail to execute on our business plans, we could see delays in the return of cash from our investments, resulting in a liquidity shortfall. Under the $5.00 million asset-based revolving credit facility, or the White Oak Credit Facility, that we obtained from White Oak on July 13, 2018, failure to meet one or more of the following covenants could restrict our ability to draw on the White Oak Credit Facility: (i) failure to provide White Oak with certain financial information; (ii) failure to make required payments to third parties; and (iii) failure to comply with the other covenants and defaults contained in the White Oak Credit Facility, including a financial covenant to maintain at least $500,000 in excess availability (as defined under the White Oak Credit 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 (approximately $13.99 million after giving effect to our June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option). If we are not able to draw on the White Oak Credit Facility, or if we are unable to access the capital markets when we need to or issue equity on terms that are acceptable to us or at all, our cash and cash equivalents and other working capital may be insufficient to meet our working capital and capital expenditure needs. The White Oak Credit Facility matures on July 13, 2021, and there is no guarantee of extension or renewal.
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. As sales of our loose moissanite jewels increase, including our Forever OneTM and Moissanite by Charles & Colvard® gemstones, availability of certain shapes and sizes may be at risk. In addition, finished jewelry has a large variety of styles of which we maintain on-hand stock for such core designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets; and made-to-order under strict deadlines for certain wholesale and direct-to-consumer e-commerce outlets. We must adequately maintain relationships, forecast demand, and operate within the lead times of third parties that facet jewels and manufacture finished jewelry settings to ensure adequate on-hand quantities and/or the shipment of customer orders in a timely manner as we transition certain customers from Forever Brilliant® and Forever ClassicTM to Forever OneTM or Moissanite by Charles & Colvard®. In addition, we are currently dependent upon certain vendors for most of the faceting of our loose jewels. If any or all of these vendors were to cancel their arrangements with us, we could experience a disruption in our operations and incur additional costs to procure faceting services from a replacement vendor. The inability to fulfill orders on a timely basis and within promised customer deadlines could result in a cancellation of the orders and loss of customer goodwill that could materially and adversely affect our business, results of operations, and financial condition.
We face intense competition in the worldwide jewelry industry. The jewelry industry is highly competitive and we compete with numerous other jewelry products. In addition, we face competition from mined diamonds, lab-created (synthetic) diamonds, other moissanite products, and simulants. A substantial number of companies supply products to the jewelry industry, many of whom we believe have greater financial resources than we do. Competitors could develop new or improved technologies, including those for lab-grown diamonds, that may render the price point for moissanite noncompetitive, which could have an adverse effect on our business, results of operations, and financial condition.
We have previously relied on our patent rights and other intellectual property rights to maintain our competitive position. Our current U.S. product and method patents for moissanite jewels expired in 2015 and most of our patents in foreign jurisdictions expired in 2016 with only one in Mexico remaining (which expires in 2021). However, we have certain trademarks and pending trademark applications that support our moissanite branding strategy. Additionally, we have certain pending design patents that we believe, if approved, will differentiate our products in the gemstone and jewelry industry. Notwithstanding the foregoing, since the expiration of our patents we have noted new providers of moissanite and competitive products entering the market. However, as we experienced ourselves, achieving the capacity to consistently produce a high-quality moissanite product at mass scale requires a careful balance of SiC-specific faceting skills and a well-tuned global supply chain. In addition, today’s consumers demand transparency from and high visibility into the brands they choose to align with and purchase from. As our pending patent rights and other pending intellectual property rights are approved, we will continue to rely on these patents and our carefully-executed brand awareness and digital marketing campaigns to build our consumer relationships and maintain our competitive position going forward. If, however, we are unable to successfully build strong brands for our moissanite jewels and finished jewelry featuring moissanite or competition grows faster than expected, we may not have commercially meaningful protection for our products or a commercial advantage against our competitors or their competitive products or processes, which may have a material adverse effect on our business, results of operations, and financial condition.
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.We are subject to a concentration of credit risk amongst our major customers (some of whom are distributors), and a default by any of these customers on their amounts owed to us could have a material adverse effect on our financial position. Future sales and our ability to collect accounts receivable depend, in part, on the financial strength of our customers and our distributors’ willingness and ability to successfully market our products. We estimate an allowance for accounts for which collectability is at risk and this allowance adversely impacts profitability. In the event customers experience greater than anticipated financial difficulties, insolvency, or difficulty marketing products, we expect profitability to be further adversely impacted by our failure to collect accounts receivable in excess of the amount due, net of the estimated allowance. In these circumstances, we may demand the return of product sold to such customers, resulting in an increase in inventory and a reduction in accounts receivable. While general economic conditions have improved in recent periods, uncertainty in the current economic environment, constrained access to capital, the impact of inflation on our currency, or general market contractions may heighten our exposure to customer default and generate lower than expected distributor sales.
We are currently dependent on a limited number of distributor and retail partners in our Traditional segment for the sale of our products. A significant portion of the moissanite jewels and finished jewelry featuring moissanite that we sell are distributed through a limited number of distributors and retail partners in our Traditional segment, and therefore, we are dependent upon these companies for distribution of our products. During the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the calendar year ended December 31, 2017, our three largest customers collectively accounted for approximately 30%, 33% and 38%, respectively, of our net sales. As we continue to build our finished jewelry business, we anticipate in the near term that a significant portion of the moissanite jewels and finished jewelry featuring moissanite that we sell through our Traditional segment will continue to be to a limited number of distributors and retailers.
We depend on a single supplier for substantially all of our 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.We are party to an exclusive supply agreement with Cree, which we depend on for the provision of substantially all of the SiC material we use to produce moissanite jewels. Under the terms and conditions of the Supply Agreement, we agreed to purchase from Cree, and Cree agreed to supply, all of our required SiC material, subject to terms and conditions that allow us to purchase certain amounts of SiC materials from third parties under limited conditions. The Supply Agreement is set to expire in 2023 and we have the option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following expiration of the initial term. If our supply of high-quality SiC crystals is interrupted, then we may not be able to meet demand for moissanite jewels and our business may be materially and adversely affected. Cree has certain proprietary rights relating to its process for growing large single crystals of SiC and its process for growing colorless and near-colorless SiC crystals. There is no guaranty that we would be able to obtain similar quality SiC crystals from another provider. There can be no assurance that Cree will be able to continue to produce and supply us with SiC crystals of sufficient quality, sizes, and volumes that we desire or that we will be able to continue to negotiate future purchase commitments at acceptable prices that enable us to manage our inventories and raw material costs effectively
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, could be adversely impacted by disruptions in global financial markets, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increased unemployment rates, and uncertainty about economic stability including the increased risk of global trade tensions. We are unable to predict the likely duration and severity of the effects of these disruptions in the financial markets and the adverse global economic conditions, and if economic conditions deteriorate, our business and results of operations could be materially and adversely affected. The consequences of such adverse effects could 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 and/or suppliers.
Luxury products, such as fine jewelry, are discretionary purchases for consumers. Recessionary economic cycles, higher interest rates, higher fuel and energy costs, inflation, levels of unemployment, conditions in the residential real estate and mortgage markets, access to credit, 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.
We face intense competition in the worldwide jewelry industry. The jewelry industry is highly competitive and we compete with numerous other jewelry products. In addition, we face competition from mined diamonds, lab-created (synthetic) diamonds, other lab grown diamonds, other moissanite products, and simulants. A substantial number of companies supply products to the jewelry industry, many of whom we believe have greater financial resources than we do. Competitors could develop new or improved technologies, including those for lab grown diamonds, that may render the price point for our moissanite and our lab grown diamonds noncompetitive, which could have an adverse effect on our business, results of operations, and financial condition.
With the launch of our Caydia® product line, we believe that our entry into the lab grown diamond market could be a potential threat to - and increase competition for - our core moissanite products. While our moissanite gemstones and finished jewelry set with moissanite generally have different price points than those of our Caydia® product line, any cannibalization of moissanite product sales resulting from sales of our lab-created diamonds could have an adverse impact on sales of our moissanite jewels and finished jewelry set with moissanite.
We have previously relied on our patent rights and other intellectual property rights to maintain our competitive position. Our U.S. product and method patents for moissanite jewels expired in 2015 and most of our patents in foreign jurisdictions expired in 2016 with only one in Mexico that expired in 2021. Since the expiration of our product and method patents we have noted new providers of moissanite and competitive products entering the market. As our pending patent rights and other pending intellectual property rights are approved, we will continue to rely on these patents and our carefully executed brand awareness and digital marketing campaigns to build our consumer relationships and maintain our competitive position going forward. If, however, we are unable to successfully build strong brands for our moissanite jewels, lab grown diamonds, and finished jewelry featuring moissanite and lab grown diamonds or competition grows faster than expected, we may not have commercially meaningful protection for our products or a commercial advantage against our competitors or their competitive products or processes, which may have a material adverse effect on our business, results of operations, and financial condition.
A failure of our information technology, or IT, infrastructure or a failure to protect confidential information of our customers and our network against security breaches could adversely impact our business and operations. We rely upon the capacity, reliability, and security of our IT infrastructure and our ability to expand and continually update this infrastructure in response to the changing needs of our business related to the deployment, integration, and management of new technology. For example, we regularly implement new IT systems and update payment gateways that support our Online Channels segment. As we implement and integrate new systems, as well as retire and de-integrate existing systems, the IT operating environment following such changes may not perform as expected. We also face the challenge of supporting our older systems and implementing necessary upgrades. If we experience a problem with the functioning of an important IT system or a security breach of our IT systems, the resulting disruptions could have an adverse effect on our business.
In addition, we and certain of our third-party vendors receive and store personal information associated with our sales operations and other aspects of our business. In connection with our e-commerce business, we rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including credit card numbers. Our disclosure controls and procedures address cybersecurity and include elements intended to ensure that there is an analysis of potential disclosure obligations arising from security breaches. We also maintain compliance programs to address the potential applicability of restrictions against trading while in possession of material, nonpublic information generally and in connection with a cybersecurity breach. The breakdown in existing controls and procedures around our cybersecurity environment may prevent us from detecting, reporting or responding to cyber incidents in a timely manner and could have a material adverse effect on our financial position and value of our Company’s stock. Despite our implementation of security measures, our IT systems and e-commerce business are vulnerable to damages from computer viruses, natural disasters, unauthorized access, cyber-attack, and other similar disruptions. An increasing number of websites and Internet companies have reported breaches of their security. Any such compromise of our security could damage our reputation, business, and brand and expose us to a risk of loss or litigation and possible liability, which could substantially harm our business and results of operations. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations, damage our computers or those of our customers, or otherwise damage our reputation and business. These issues are likely to become more difficult as we expand the number of countries in which our e-commerce website operates. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.
For example, in 2016, the European Union, or E.U., Parliament approved the new E.U. data protection legal framework known as the General Data Protection Regulation, or GDPR. The GDPR, which became effective in May 2018, replaced previously existing regulations and thereby extended the scope of E.U. data protection law to all non-E.U. companies processing data of E.U. residents. The GDPR contains numerous requirements and changes from prior E.U. law, including more robust obligations on data processors, greater rights for data subjects, and heavier documentation requirements for data protection compliance programs. The GDPR also imposes strict rules on the transfer of personal data out of the E.U., including to the U.S., and recent legal developments in Europe have created complexity and uncertainty regarding such transfers of personal data from the E.U. to the U.S. For example, in July 2020, the Court of Justice of the European Union, or the CJEU, invalidated the E.U.-U.S. Privacy Shield framework, or Privacy Shield, one of the mechanisms used to legitimize the transfer of personal data from the E.U. to the U.S. The CJEU decision also drew into question the long-term viability of an alternative means of data transfer, the standard contractual clauses, for transfers of personal data from the E.U. to the U.S. While we were not self-certified under the Privacy Shield, this CJEU decision may lead to increased scrutiny on data transfers from the E.U. to the U.S. generally and increase our costs of compliance with data privacy legislation. The costs of compliance with, and other burdens and any penalties imposed by, such international and domestic laws, regulations and policies could have a material adverse impact on our results of operations.
We are subject to certain risks due to our international operations, distribution channels and vendors. We have continued to expand our direct international sales operations, with international net sales accounting for approximately 13%5% of total consolidated net sales during fiscal 2019.Fiscal 2021. We also currently have numerous international wholesale distributors and retail sales channels covering portions of Canada, the UK,U.K., Western Europe, Australia and New Zealand, Southeast Asia, the Middle East, and the Greater China Region. In addition, we use certain companies based outside the U.S. to facet our moissanite jewels and to manufacture finished jewelry. We plan to continue to increase marketing and sales efforts and anticipate expanding our direct international sales in addition to continuing to serve international distributors. Any international expansion plans we choose to undertake will increase the complexity of our business, require attention from management and other personnel and cause additional strain on our operations, financial resources and our internal financial control and reporting functions. Further, our expansion efforts may be unsuccessful as we have limited experience selling our products in certain international markets and in conforming to the local cultures, standards or policies necessary to successfully compete in those markets. In addition, we may have to compete with retailers that have more experience with local markets. Our ability to expand and succeed internationally may also be limited by the demand for our products, the ability to successfully transact in foreign currencies, the ability of our brand to resonate with consumers globally and the adoption of online or Internet commerce in these markets. Different privacy, censorship and liability standards and regulations, and different intellectual property laws in foreign countries may also prohibit expansion into such markets or cause our business and results of operations to suffer. Through our planned international expansion and our continued reliance on development of foreign markets and use of foreign vendors, we are subject to the risks of conducting business outside of the U.S.
These risks include the following:
the adverse effects on U.S.-based companies operating in foreign markets that might result from war; terrorism; changes in diplomatic, trade, or business relationships (including labor disputes); or other political, social, religious, or economic instability;
an outbreak of a contagious disease, such as COVID-19, which may cause us or our distributors, vendors, and/or customers to temporarily suspend our or their respective operations in the affected city or country;
the continuing adverse economic effects of any global financial crisis;
unexpected changes in, or impositions of, legislative or regulatory requirements;
delays resulting from difficulty in obtaining export licenses;
international regulatory requirements, tariffs and other trade barriers and restrictions, including the consequences of U.S. led tariff actions;
the burdens of complying with a variety of foreign laws and regulations, including foreign taxation and varying consumer and data protection laws, and other factors beyond our control, and the risks of non-compliance;
longer payment cycles and greater difficulty in collecting accounts receivable;
our reliance on third-party carriers for product shipments to our customers;
risk of theft of our products during shipment;
limited payment, shipping and insurance options for us and our customers;
difficulties in obtaining export, import or other business licensing requirements;
customs and import processes, costs or restrictions;
the potential difficulty of enforcing agreements with foreign customers and suppliers; and
the complications related to collecting accounts receivable through a foreign country’s legal or banking system.
In particular, there is currently significant uncertainty about the future relationship between the U.S. and various other countries, with respect to trade policies, treaties, government regulations, and tariffs. For example, the recent imposition of tariffs and/or increase in tariffs on various products by the U.S. and other countries, including China and Canada, have introduced greater uncertainty with respect to trade policies and government regulations affecting trade between the U.S. and other countries, and new and/or increased tariffs have subjected, and may in the future subject, us to additional costs and expenditure of resources. Major developments in trade relations, including the imposition of new or increased tariffs by the U.S. and/or other countries, and any emerging nationalist trends in specific countries could alter the trade environment and consumer purchasing behavior which, in turn, could have a material effect on our financial condition and results of operations. While the U.S. and China signed a “phase one” trade deal in 2020, to reduce planned increases to tariffs, concerns over the stability of bilateral trade relations continue to exist, and in some cases, have heightened in 2021. In addition, the ongoing negotiations surrounding the UK’sU.K.’s exit from the European Union in January 2020, known as Brexit, and the ongoing negotiations of the future trading relationship between the U.K. and the European Union have yet to provide clarity on whatbe completely finalized. Accordingly, the ultimate outcome will beand long-term impacts for the UKU.K. or Europe. ChangesEurope remain uncertain. Ongoing changes and uncertainties related to Brexit couldcontinue to subject us to heightened risks in that region, including disruptions to trade and free movement of goods, services and people to and from the UK,U.K., disruptions to the workforce of our business partners, increased foreign exchange volatility with respect to the British pound and additional legal, political and economic uncertainty. If these actions impacting our international distribution and sales channels result in increased costs for us or our international partners, such changes could result in higher costs to us, adversely affecting our operations, particularly as we expand our international presence.
Additionally, while substantially all of our foreign transactions are denominated in U.S. dollars, foreign currency fluctuations could impact demand for our products or the ability of our foreign suppliers to continue to perform. Further, some of our foreign distributors operate relatively small businesses and may not have the financial stability to assure their continuing presence in their markets. There can be no assurance that the foregoing factors will not adversely affect our operations in the future or require us to modify our anticipated business practices.
We rely on assumptions, estimatesOur business and data to calculate certainour results of operations could be materially adversely affected as a result of our key metricsinability to fulfill orders on a timely basis. As sales of our loose moissanite and real or perceived inaccuracies in such metricslab grown diamond gems increase, including our Forever One™, Moissanite by Charles & Colvard®, and Caydia® gemstones, availability of certain shapes and sizes may harm our reputation and negatively affect our business. We believe that certain metrics are key to our business, including but not limited to average order value, or AOV, average advertising spend per customer, and repeat customers. As both the industry inbe at risk. In addition, finished jewelry has a large variety of styles of which we maintain on-hand stock for such core designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets; and made-to-order under strict deadlines for certain wholesale and direct-to-consumer e-commerce outlets. We must adequately maintain relationships, forecast material and product demand, and operate within the lead times of third parties that facet jewels and manufacture finished jewelry settings to ensure adequate on-hand quantities and meet shipment requirements for customer orders in a timely manner. In addition, we are currently dependent upon certain vendors for most of the faceting of our business continue to evolve, so too might the metrics by which we evaluate our business. While the calculationloose gems. If any or all of these metrics is basedvendors were to cancel their arrangements with us, we could experience a disruption in our operations and incur additional costs to procure faceting services from a replacement vendor. The inability to fulfill orders on what we believe to be reasonable estimates, our internal tools are not independently verified by a third partytimely basis and may have a number of limitations and, furthermore, our methodologies for tracking these metrics may change over time. Given the difficulty in tracking consumers online, calculations of our unique visitors may not accurately reflect the number of people actually visiting our platforms. We continue to improve upon our tools and methodologies to capture data and believe that our current metrics are accurate; however, the improvement of our tools and methodologies could cause inconsistency between current data and previously reported data, which could confuse investors or lead to questions about the integrity of our data. In addition, if the internal tools we use to track these metrics under-count or over-count performance or contain algorithm or other technical errors, the data we report may not be accurate. Accordingly, you should not place undue reliance on these metrics.
Our failure to maintain compliance with Nasdaq’s continued listing requirementswithin promised customer deadlines could result in a cancellation of the delistingorders and loss 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 two separate occasions in the past five years, we have received a notification letter from Nasdaq indicatingcustomer goodwill that we were not in compliance with listing requirements because the minimum bid price of our common stock closed below $1.00 per share for 30 consecutive business days. However, Nasdaq subsequently notified us in both instances that we had regained compliance with the minimum bid price requirement. If we fail to satisfy Nasdaq’s listing requirements in the future, we expect to take actions to regain compliance, but we can provide no assurance that any such action would prevent our common stock from dropping below the Nasdaq minimum bid price requirement or prevent future non-compliance with Nasdaq’s listing requirements. If our common stock is delisted from Nasdaq, the delisting could substantially decrease trading in our common stockmaterially and adversely affect our business, results of operations, and financial condition. In addition, the market liquidity ofCOVID-19 pandemic has caused, and may continue to cause, us or our common stock; adversely affectdistributors, vendors, and/or customers to temporarily suspend our or their respective operations and have an adverse impact on our ability to obtain financingfulfill orders on acceptable terms, if at all;a timely basis.
We are currently dependent on a limited number of distributor and may resultretail partners in our Traditional segment for the sale of our products. A significant portion of the moissanite jewels and finished jewelry featuring moissanite that we sell are distributed through a limited number of distributors and retail partners in our Traditional segment, and therefore, we are dependent upon these companies for distribution of our products. Our three largest customers collectively accounted for approximately 31% and 33% of our net sales during the fiscal years ended June 30, 2021 and 2020, respectively. As we continue to build our finished jewelry business, we anticipate in the potential lossnear term that a significant portion of confidence by investors, suppliers, customers,the moissanite jewels and employeesfinished jewelry featuring moissanite that we sell through our Traditional segment will continue to be to a limited number of distributors 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.retailers.
We may experience quality control challenges from time to time that can result in lost revenue and harm to our brands and reputation. Part of our strategy for success is to align Charles & Colvard with reputable, high-quality, and sophisticated strategic partners. The achievement of this goal depends in large part on our ability to provide customers with high-quality moissanite and finished jewelry featuring moissanite. Although we take measures to ensure that we sell only the best quality products, we may face quality control challenges, which could impact our competitive advantage. There can be no assurance we will be able to detect and resolve all quality control issues prior to shipment of products to our distributors, manufacturers, retailers, and end consumers. Failure to do so could result in lost revenue, lost customers, significant warranty and other expenses, and harm to our reputation.
Seasonality of our business may adversely affect our net sales and operating income. Sales in the retail jewelry industry are typically seasonal due to increased consumer purchases during the calendar year-end holiday season. Because historically we have primarily sold our loose moissanite jewels and finished jewelry featuring moissanite at wholesale pricing to distributors, manufacturers, and retailers, our sales to support the holiday season have largely taken place during the third and beginning of the fourth calendar quarters, depending on the sales channel and the level of advance planning and production our customers undertook. As sales of our finished jewelry featuring moissanite to retailers and directly to consumers increase, both in dollars and as a percentage of total sales, our results for the three months in the calendar quarter ending December 31 of each year may depend upon the general level of retail sales during the holiday season as well as general economic conditions and other factors beyond our control. In anticipation of increased sales activities during the three months in the calendar quarter ending December 31 of each year, we may incur significant additional expenses and increases in our finished jewelry inventory levels to support expected sales in the second half of the calendar year.
In recent years, excluding one-time sales events, we have experienced a higher degree of seasonality in the three months ending December 31 than we have experienced in prior years primarily as a result of the calendar year-end holiday season sales to end consumers through our Online Channels segment and as a result of increased sales through our brick-and-mortar retailers within our Traditional segment. Our quarterly results of operations may continue to fluctuate as a result of a number of factors, including seasonal cycles, the timing of new product introductions, the timing of orders by our customers, and the mix of product sales demand, and these factors may significantly affect our results of operations in a given quarter.
Our operations could be disrupted by natural disasters. We conduct substantially all of our activities, including executive management, manufacturing, packaging, and distribution activities, at one North Carolina location. Although we have taken precautions to safeguard our facility, including obtaining business interruption insurance, any future natural disaster, such as a hurricane, flood or fire, could significantly disrupt our operations and delay or prevent product shipment during the time required to repair, rebuild or replace our facility, which could be lengthy and result in significant expenses. Furthermore, the insurance coverage we maintain may not be adequate to cover our losses in any particular case or continue to be available at commercially reasonable rates and terms. In addition, the vendors that perform some of the faceting of our loose moissanite jewels are located in regions that are susceptible to tsunamis, flooding, and other natural disasters that may cause a disruption in our vendors’ operations for sustained periods and the loss or damage of our work-in-process inventories located at such vendors’ facilities. Damage or destruction that interrupts our ability to deliver our products could impair our relationships with our customers. Prolonged disruption of our services as a result of a natural disaster may result in product delivery delays, order cancellations, and loss of substantial revenue, which could materially and adversely affect our business, results of operations, and financial condition.
Sales of moissanite and lab grown diamond jewelry could be dependent upon the pricing of precious metals, which is beyond our control. Any increases in the market price of precious metals (primarily gold) could affect the pricing and sales of jewelry incorporating moissanite jewels.jewels and lab grown diamonds. The majority of price increases in precious metals are passed on to the end consumer in the form of higher prices for finished jewelry. These higher prices could have a negative impact on the sell-through of moissanite and lab grown diamond jewelry at the retail level. From 20062007 through 2019,2021, the price of gold has increased significantly, resulting in higher retail price points for gold jewelry. Accordingly, higher gold prices could have an adverse impact on both sales of moissanite and lab grown diamond finished jewelry and the jewelry industry as a whole.
Our current customers may potentially perceive us as a competitor in the finished jewelry business. As described above, we are currently dependent on a limited number of customers, including distributors and retailers, for the sale of our products in the Traditional segment. Our design, manufacture, and marketing of finished jewelry featuring moissanite and lab grown diamonds for sale to distributors and retailers may result in some of these current customers perceiving us as a competitor, despite our efforts to use primarily non-conflicting sales channels. In response, these customers may choose to reduce their orders for our products. This reduction in orders could occur faster than our sales growth in this business, which could materially and adversely affect our business, results of operations, and financial condition.
We depend on a single supplier for substantially all of our 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.We are party to an exclusive supply agreement with Cree, which we depend on for the provision of substantially all of the SiC material we use to produce moissanite jewels. Under the terms and conditions of the Supply Agreement, we agreed to purchase from Cree, and Cree agreed to supply, all of our required SiC material, subject to terms and conditions that allow us to purchase certain amounts of SiC materials from third parties under limited conditions. The Supply Agreement is set to expire in 2025, but may be further extended upon mutual agreement of the parties to the Supply Agreement. If our supply of high-quality SiC crystals is interrupted, then we may not be able to meet demand for moissanite jewels and our business may be materially and adversely affected. Cree has certain proprietary rights relating to its process for growing large single crystals of SiC and its process for growing colorless and near-colorless SiC crystals. There is no guaranty that we would be able to obtain similar quality SiC crystals from another provider. There can be no assurance that Cree will be able to continue to produce and supply us with SiC crystals of sufficient quality, sizes, and volumes that we desire or that we will be able to continue to negotiate future purchase commitments at acceptable prices that enable us to manage our inventories and raw material costs effectively.
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. As e-commerce emerges as one of our primary selling channels, our business model becomes more reliant on third-party platforms to achieve success. Should our products, product listings, or business not meet the requirements of certain third-party transactional channels such as marketplaces, comparison shopping engines, or social commerce sites, it may affect our ability to meet our revenue targets. Additionally, Amazon,Amazon.com, Inc., eBay Jet,Inc., Walmart.com, Gemvara, a Berkshire Hathaway Inc. Company, or other desirable e-commerce platforms may decide to make significant changes to their respective business models, policies, systems, or plans, and those changes could impair or inhibit our ability to sell our products through those channels. Further, a significant change in consumer online behavior or the introduction of new or disruptive technology could adversely affect overall e-commerce trends and diminish the value of investments we have made in select online channels. Any of these results could cause a significant reduction in our revenue and have a material adverse effect on our results of operations.
A failure of our information technology, or IT, infrastructure or a failure to protect confidential information of our customers and our network against security breaches could adversely impact our business and operations. We rely upon the capacity, reliability, and security of our IT infrastructure and our ability to expand and continually update this infrastructure in response to the changing needs of our business related to the deployment, integration, and management of new technology. For example, we regularly implement new IT systems and update payment gateways that support our Online Channels segment. As we implement and integrate new systems, as well as retire and de-integrate existing systems, the IT operating environment following such changes may not perform as expected. We also face the challenge of supporting our older systems and implementing necessary upgrades. If we experience a problem with the functioning of an important IT system or a security breach of our IT systems, the resulting disruptions could have an adverse effect on our business.
In addition, we and certain of our third-party vendors receive and store personal information associated with our sales operations and other aspects of our business. In connection with our e-commerce business, we rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including credit card numbers. Our disclosure controls and procedures address cybersecurity and include elements intended to ensure that there is an analysis of potential disclosure obligations arising from security breaches. We also maintain compliance programs to address the potential applicability of restrictions against trading while in possession of material, nonpublic information generally and in connection with a cybersecurity breach. The breakdown in existing controls and procedures around our cybersecurity environment may prevent us from detecting, reporting or responding to cyber incidents in a timely manner and could have a material adverse effect on our financial position and value of our Company’s stock. Despite our implementation of security measures, our IT systems and e-commerce business are vulnerable to damages from computer viruses, natural disasters, unauthorized access, cyber-attack, and other similar disruptions. An increasing number of websites and Internet companies have reported breaches of their security. Any such compromise of our security could damage our reputation, business, and brand and expose us to a risk of loss or litigation and possible liability, which could substantially harm our business and results of operations. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations, damage our computers or those of our customers, or otherwise damage our reputation and business. These issues are likely to become more difficult as we expand the number of countries in which our e-commerce website operates. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.
For example, in 2016, the European Union, or EU, Parliament approved the new EU data protection legal framework known as the General Data Protection Regulation, or GDPR. The GDPR, which became effective in May 2018, replaced previously existing regulations and thereby extended the scope of EU data protection law to all non-EU companies processing data of EU residents. The GDPR contains numerous requirements and changes from prior EU law, including more robust obligations on data processors, greater rights for data subjects, and heavier documentation requirements for data protection compliance programs. The costs of compliance with, and other burdens and any penalties imposed by, such international and domestic laws, regulations and policies could have a material adverse impact on our results of operations.
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. We rely primarily on patent, copyright, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights, all of which provide only limited protection. We held U.S. product and method patents for moissanite jewels, which expired in 2015, under which we believed that we had broad, exclusive rights to manufacture, use, and sell moissanite jewels in the U.S. We had these same patents in 25 foreign jurisdictions primarily across Asia and Europe that expired in 2016 and one that will expire in Mexico in 2021. However, our patent expirations have enabled competitors and other businesses to duplicate and market a similar product and enter the marketplace. Without patent protection, we must rely primarily on our branding strategy and the Supply Agreement under which Cree supplies SiC crystals exclusively to us, as well as confidentiality procedures, to protect our proprietary rights, which may or may not be sufficient. In addition, at the present time, we are primarily dependent on Cree’s technology for the production of SiC crystals. There can be no assurance that any patents issued to or licensed by or to us will provide any significant commercial protection, that we will have sufficient resources to protect our respective patents and proprietary rights, that any additional patents will be issued in the future, or that any existing or future patents will be upheld by a court should we seek to enforce our rights against an infringer. At this point, we cannot reasonably estimate the impact these patent expirations will have on our future results of operations.
The existence of valid patents does not prevent other companies from independently developing competing technologies. Existing producers of SiC crystals or others may refine existing processes for growing SiC crystals or develop new technologies for growing large single crystals of SiC or colorless SiC crystals in a manner that does not infringe any patents issued to or licensed by or to us. Accordingly, existing and potential competitors have been able to develop products that are competitive with or superior to certain of our products, and such competition could have a material adverse effect on our business, results of operations, and financial condition.
In addition, we have certain trademarks and pending trademark applications that support our moissanite branding strategy. The success of our growth strategy may depend on our continued ability to use our existing brand names in order to increase consumer awareness and further develop strong brands around our moissanite jewels and finished jewelry collections. We cannot assure that any future trademark or other registrations will be issued for pending or future applications or that we will be able to obtain licenses or other contractual rights to use brand names that may infringe the proprietary rights of third parties. We also cannot assure that any registered or unregistered trademarks or other intellectual property or contractual rights will be enforceable or provide adequate protection of our proprietary rights. Our inability to secure proprietary protection with respect to our brands could have a material adverse effect on our business, results of operations, and financial condition.
We also cannot be certain that our products and brand names do not or will not infringe valid patents, trademarks, and other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business. Litigation to determine the validity of any third party’s claims could result in significant expense and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor. In the event of an adverse result of any such litigation, we could be required to expend significant resources to develop non-infringing technology or to obtain licenses for, and pay royalties on the use of, the technology subject to the litigation. We have no assurance that we would be successful in such development or that any such license would be available on commercially reasonable terms.
Negative or inaccurate information on social media could adversely affect our brand and reputation. We are actively using various forms of digital and social media outreach to accomplish greater awareness of our brand and the value proposition we offer. These social media platforms and other forms of Internet-based communications allow access not only by us, but by any individual, to a broad audience of consumers and other interested persons. Consumers value readily available information concerning goods that they have or plan to purchase; however, they may act on such information without further investigation or authentication. Many social media platforms, including those relating to recruiting and placement activities, immediately publish the content of their participants’ posts, often without filters or checks on accuracy of the content posted. While we actively monitor social media sites, we may be unable to quickly and effectively respond to or correct inaccurate and/or unfavorable information posted on social media platforms. Any such information may harm our reputation or brand, which could in turn materially and adversely affect our business, results of operations, and financial condition.
If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer. From time to time we evaluate strategic opportunities available to us for product, technology, or business acquisitions or dispositions. If we choose to make acquisitions or dispositions, we face certain risks, such as failure of an acquired business to meet our performance expectations, failure to recognize cost savings from a disposition, diversion of management attention, retention of management and existing customers of our current and any acquired business, and difficulty in integrating or separating a business’s operations, personnel, and financial and operating systems. We may not be able to successfully address these risks or any other problems that arise from future acquisitions or dispositions. Any failure to successfully evaluate strategic opportunities and address risks or other problems that arise related to any acquisition or disposition could adversely affect our business, results of operations, and financial condition.
Governmental regulation and oversight might adversely impact our operations. We are subject to governmental regulations in the manufacture and sale of moissanite jewels and finished jewelry. In particular, in July 2018 the FTC issued updated guidelines governing the description of lab-grown diamonds and other gemstones that require such gemstones to be clearly identified as to the gemstone’s lab-grown origin in any promotional or marketing materials. In addition, the precious metal in our finished jewelry may be subject to requirements, which vary by country and by state, such as hallmarking and alloy content. We may be under close scrutiny both by governmental agencies and by competitors in the gemstone industry, any of which may challenge our promotion and marketing of our moissanite jewels and finished jewelry products. While we have a policy to ensure compliance with applicable regulations, if our production or marketing of moissanite jewels and/or finished jewelry is challenged by governmental agencies or competitors, or if regulations are issued that restrict our ability to market our products, our business, results of operations, and financial condition could be materially adversely affected.
Risks Related to our Financial Position
The execution of our business plans could significantly impact our liquidity. 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 on 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, 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, which matures on July 31, 2022. There is no guarantee of extension or renewal in connection with the terms and conditions of the JPMorgan Chase Credit Facility.
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.We are subject to a concentration of credit risk amongst our major customers (some of whom are distributors), and a default by any of these customers on their amounts owed to us could have a material adverse effect on our financial position. Future sales and our ability to collect accounts receivable depend, in part, on the financial strength of our customers and our distributors’ willingness and ability to successfully market our products. We estimate an allowance for accounts for which collectability is at risk and this allowance adversely impacts profitability. In the event customers experience greater than anticipated financial difficulties, insolvency, or difficulty marketing products, we expect profitability to be further adversely impacted by our failure to collect accounts receivable in excess of the amount due, net of the estimated allowance. In these circumstances, we may demand the return of product sold to such customers, resulting in an increase in inventory and a reduction in accounts receivable. Uncertainty in the current economic environment, as a result of the COVID-19 pandemic, constrained access to capital, the impact of inflation on our currency, and general market contractions has heightened, and may continue to heighten, our exposure to customer default and generate lower than expected distributor sales.
Negative or inaccurate information on social media could adversely affect our brand and reputation. We are actively using various forms of digital and social media outreach to accomplish greater awareness of our brand and the value proposition we offer. These social media platforms and other forms of Internet-based communications allow access not only by us, but by any individual, to a broad audience of consumers and other interested persons. Consumers value readily available information concerning goods that they have or plan to purchase; however, they may act on such information without further investigation or authentication. Many social media platforms, including those relating to recruiting and placement activities, immediately publish the content of their participants’ posts, often without filters or checks on accuracy of the content posted. While we actively monitor social media sites, we may be unable to quickly and effectively respond to or correct inaccurate and/or unfavorable information posted on social media platforms. Any such information may harm our reputation or brand, which could in turn materially and adversely affect our business, results of operations, and financial condition.
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. We believe that certain metrics are key to our business, including but not limited to average order value, or AOV, and revenue growth for charlesandcolvard.com, our primary transactional website. As both the industry in which we operate and our business continue to evolve, so too might the metrics by which we evaluate our business. While the calculation of these metrics is based on what we believe to be reasonable estimates, our internal tools are not independently verified by a third party and may have a number of limitations and, furthermore, our methodologies for tracking these metrics may change over time. We continue to improve upon our tools and methodologies to capture data and believe that our current metrics are accurate; however, the improvement of our tools and methodologies could cause inconsistency between current data and previously reported data, which could confuse investors or lead to questions about the integrity of our data. In addition, if the internal tools we use to track these metrics under-count or over-count performance or contain algorithm or other technical errors, the data we report may not be accurate. Accordingly, you should not place undue reliance on these metrics.
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. We rely primarily on patent, copyright, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights, all of which provide only limited protection. We held U.S. product and method patents for moissanite jewels, which expired in 2015, under which we believed that we had broad, exclusive rights to manufacture, use, and sell moissanite jewels in the U.S. We had these same patents in 25 foreign jurisdictions primarily across Asia and Europe that expired in 2016 and one in Mexico that expired in 2021. However, our product and method patent expirations have enabled competitors and other businesses to duplicate and market a similar product and enter the marketplace. Without patent protection, we must rely primarily on our branding strategy and the Supply Agreement under which Cree supplies SiC crystals exclusively to us, as well as confidentiality procedures, to protect our proprietary rights, which may or may not be sufficient. In addition, at the present time, we are primarily dependent on Cree’s technology for the production of SiC crystals. There can be no assurance that any patents issued to or licensed by or to us will provide any significant commercial protection, that we will have sufficient resources to protect our respective patents and proprietary rights, that any additional patents will be issued in the future, or that any existing or future patents will be upheld by a court should we seek to enforce our rights against an infringer.
The existence of valid patents does not prevent other companies from independently developing competing technologies. Existing producers of SiC crystals or others may refine existing processes for growing SiC crystals or develop new technologies for growing large single crystals of SiC or colorless SiC crystals in a manner that does not infringe any patents issued to or licensed by or to us. Accordingly, existing and potential competitors have been able to develop products that are competitive with or superior to certain of our products, and such competition could have a material adverse effect on our business, results of operations, and financial condition.
In addition, we have certain trademarks and pending trademark applications that support our moissanite and lab grown diamond branding strategy. The success of our growth strategy may depend on our continued ability to use our existing brand names in order to increase consumer awareness and further develop strong brands around our moissanite jewels and finished jewelry collections. We cannot assure that any future trademark or other registrations will be issued for pending or future applications or that we will be able to obtain licenses or other contractual rights to use brand names that may infringe the proprietary rights of third parties. We also cannot assure that any registered or unregistered trademarks or other intellectual property or contractual rights will be enforceable or provide adequate protection of our proprietary rights. Our inability to secure proprietary protection with respect to our brands could have a material adverse effect on our business, results of operations, and financial condition.
We also cannot be certain that our products and brand names do not or will not infringe valid patents, trademarks, and other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business. Litigation to determine the validity of any third party’s claims could result in significant expense and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor. In the event of an adverse result of any such litigation, we could be required to expend significant resources to develop non-infringing technology or to obtain licenses for, and pay royalties on the use of, the technology subject to the litigation. We have no assurance that we would be successful in such development or that any such license would be available on commercially reasonable terms.
If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer. From time to time, we evaluate strategic opportunities available to us for product, technology, or business acquisitions or dispositions. If we choose to make acquisitions or dispositions, we face certain risks, such as failure of an acquired business to meet our performance expectations, failure to recognize cost savings from a disposition, diversion of management attention, retention of management and existing customers of our current and any acquired business, and difficulty in integrating or separating a business’s operations, personnel, and financial and operating systems. We may not be able to successfully address these risks or any other problems that arise from future acquisitions or dispositions. Any failure to successfully evaluate strategic opportunities and address risks or other problems that arise related to any acquisition or disposition could adversely affect our business, results of operations, and financial condition.
Our PPP Loan eligibility and forgiveness remains subject to review for compliance with applicable SBA requirements. On June 18, 2020, we received the proceeds from a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. Our loan in the principal amount of $965,000, or the PPP Loan, was disbursed by Newtek Small Business Finance, LLC, or the Lender, a nationally licensed lender under the SBA, pursuant to the Promissory Note issued by us on June 15, 2020. Pursuant to Section 1106 of the CARES Act, on June 14, 2021, we applied for forgiveness of our PPP Loan. On June 23, 2021, we were granted forgiveness by the SBA for the full principal amount of the PPP Loan.
In accordance with applicable eligibility requirements to receive the PPP Loan and for compliance with the forgiveness requirements of Section 7(a)(36) and Section 7A of the Small Business Act, we must retain all records relating to our PPP Loan for a period of six years from the date the loan was forgiven. During this period, our PPP Loan eligibility and loan forgiveness application are subject to review and audit by the SBA. While we made our certification for loan eligibility in good faith after analyzing, among other things, our financial situation and access to alternative forms of capital, and believe that we satisfied all eligibility criteria for the PPP Loan and that our receipt of the PPP Loan was consistent with the broad objectives of the Paycheck Protection Program of the CARES Act, the certification described above did not contain any objective criteria and is subject to interpretation. If, despite our good faith belief that we satisfied all eligibility requirements for the PPP Loan, we are found to have been ineligible to receive the PPP Loan or in violation of any of the laws or regulations that apply to us in connection with the PPP Loan, including the False Claims Act, we may be subject to penalties, including significant civil, criminal, and administrative penalties and could be required to repay the PPP Loan. Now that we have applied for and have been granted forgiveness of our PPP Loan by the SBA, we were also required to make certain certifications in connection with that application for forgiveness, which are subject to audit and review by governmental entities and could subject us to significant penalties and liabilities if found to be inaccurate. A review or audit by the SBA or other government entity or claims under the False Claims Act could consume significant financial and management resources. Any of these events could harm our business, results of operations and financial condition.
Risks Related to Ownership of our Common Stock
Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our company. A number of provisions of our articles of incorporation and bylaws impact matters of corporate governance and the rights of shareholders. Certain of these provisions have an anti-takeover effect and may delay or prevent takeover attempts not first approved by our Board of Directors (including takeovers that certain shareholders may deem to be in their best interests). These provisions also could delay or frustrate the removal of incumbent directors or the assumption of control by shareholders. We believe that these provisions are appropriate to protect our interests and the interests of all of our shareholders.
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 three separate occasions in the past five years, including on one occasion in Fiscal 2021, we have received notification letters from Nasdaq indicating that we were not in compliance with listing requirements because the minimum bid price of our common stock closed below $1.00 per share for 30 consecutive business days. However, Nasdaq subsequently notified us that in all instances we had regained compliance with the minimum bid price requirement. If we fail to satisfy Nasdaq’s listing requirements in the future, we expect to take actions to regain compliance, but we can provide no assurance that any such action would prevent our common stock from dropping below the Nasdaq minimum bid price requirement or prevent future non-compliance with Nasdaq’s listing requirements. If our common stock is delisted from Nasdaq, 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, and 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 1B. | Unresolved Staff Comments |
Not applicable.
We currently lease approximately 36,350 square feet of office, storage, and light manufacturing space in the Research Triangle Park, area of North Carolina, from an unaffiliated third-party that is used by both of our current operating and reportable business segments.
The majority of all U.S. personnel, including our executive offices, sales offices, and administrative personnel, as well as our production and productiondistribution facilities are housed in theour current leased space.
There are no material pending legal proceedings to which we are a party or to which any of our property is subject.
Not applicable.
PART II
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market for Registrant’s Common Equity
Our common stock is traded on the Nasdaq Capital Market under the symbol “CTHR.” As of August 29, 2019,27, 2021, there were 229231 shareholders of record of our common stock.
We did not pay any dividends on our common stock during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 2018, or the calendar year ended December 31, 2017.2021 and 2020. We will regularly review and consider the best policies and practices for our company, including the dividend policy. The payment of future dividends will be dependent on the facts and circumstances at the time of that review.
Not applicable.
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussionManagement’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, is intended to provide a better understanding of our 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 Item 1A, “Risk Factors” and our consolidated financial statements and the notes thereto included in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. Historical results and percentage relationships among any amounts in the consolidated financial statements are not necessarily indicative of trends in operating results for future periods.
Change in Fiscal YearBusiness Overview
In January 2018, our Board of Directors approved a change in our fiscal year from a fiscal year beginning on January 1 and ending on December 31 of each year to a fiscal year beginning on July 1 of each year and ending on June 30 of the following calendar year. The change to the fiscal year reporting cycle began July 1, 2018. As a result of the change, we reported our financial results for the transition period ended June 30, 2018 on our Transition Report on Form 10-KT filed with the SEC on September 7, 2018, and we are reporting our results for the first full fiscal year ended June 30, 2019 in this Annual Report on Form 10-K.
In this Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, when financial results for the fiscal year ended June 30, 2019 are compared to financial results for the prior year period, the results compare the twelve-month period ended June 30, 2019 to the unaudited results for the twelve-month period ended June 30, 2018. When financial results for the transition period ended June 30, 2018 are compared to financial results for the prior year period, the results compare the six-month period ended June 30, 2018 to the unaudited results for the six-month period ended June 30, 2017. In the opinion of management, while we adopted new revenue recognition guidance, as required, on January 1, 2018, the unaudited results for the twelve months ended June 30, 2018 and the six months ended June 30, 2017 are comparative for purposes of this analysis since there was no change in the timing or measurement of revenues. Additionally, management believes these unaudited results for the periods presented reflect all adjustments necessary to present the financial position and results of operations as of and for both periods in accordance with the accounting principles generally accepted in the United States of America, or U.S. GAAP. A detailed discussion of our financial results for the calendar year ended December 31, 2017 is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, in our Transition Report on Form 10-KT filed with the SEC on September 7, 2018.
The following table shows the months included within the various comparison periods in our MD&A:
Fiscal Year-End 2019 Results Compared With Prior Year Period 2018 Results |
2019
(twelve-month, audited)
| | 2018
(twelve-month, unaudited)
|
July 2018 – June 2019 | | July 2017 – June 2018 |
Transition Period Ended June 30, 2018 Results Compared With
Prior Year Period 2017 Results
|
Transition Period Ended June 30, 2018
(six-month, audited)
| | Prior Year Period 2017
(six-month, unaudited)
|
January 2018 – June 2018 | | January 2017 – June 2017 |
OverviewOur Mission
At Charles & Colvard, we believe luxury can be both beautiful and conscientious. With innovative technology and sustainable practices,Ltd., our goalmission is to lead a revolution inredefine the definition of real within the jewelry industry – delivering a brilliant product at extraordinary value balanced with environmental and social responsibility.for consumers everywhere. We believe fine jewelry can be accessible, beautiful, and conscientious.
About Charles & Colvard
Charles & Colvard, Ltd., a North Carolina corporation founded in 1995 manufactures, markets(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 distributesdistribute 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 gemstonejewels and premium lab grown diamonds for sale in the worldwide jewelry market. Our unique differentiator, moissanite – The World’s Most Brilliant Gem® – is core to our ambition to create a movement around beautiful, environmentally and socially responsible fine jewelry and fashion jewelry.market. Charles & Colvard is the originatororiginal source of lab-createdcreated 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 we are leading the way in delivering the premium moissanite brand through technological advances in gemstone manufacturing, cutting, polishing and setting. By coupling what we believe to be unprecedented gemstones with responsibly-sourced precious metals, we are deliveringaddition of lab grown diamonds is a uniquely-positioned product linenatural progression for the conscientious consumer.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 comprisesencompasses our digital properties components, comprised of our charlesandcolvard.com website,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. For moreWe report segment information aboutbased 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 segments,and reportable segments.
We operate in an e-commerce environment characterized by both complexity in global markets and ongoing economic uncertainties in the U.S. and internationally. Our strategy is to build a globally revered and accessible brand of gemstones and finished fine jewelry products set with moissanite and lab grown diamonds. We believe that our goods appeal to a wide consumer audience and leverage our advantage of being the original and leading worldwide source of moissanite and purveyor of premium lab grown diamonds. We believe a direct relationship with consumers is an important component to this strategy, which entails delivering tailored educational content, engaging in interactive dialogue with our audience, and positioning our brand to meet the demands of today’s discerning consumer. A significant component of our strategy in this environment is to focus on our core products, improving the quality and predictability of the delivery of our products and services, and placing those products quickly into the hands of our U.S. and international customers at affordable prices. Moreover, recognizing today that our customers and vendors are resource constrained, we are endeavoring to develop and extend our portfolio of products in a disciplined manner with a focus on domestic markets close to our core capabilities, as well as growing our global marketplace sales. We continue to focus on affordability initiatives. We also expect to continue innovating and investing in lab created gemstone technologies to fulfill evolving product requirements for our customers and investing in our people so that we have the technical and production skills necessary to succeed without limiting our ability to build sound financial returns to our investors.
We believe our expanding application of an omni-channel sales strategy across the fine jewelry trade and to the end consumer with accessible gemstones and value branded finished jewelry featuring Charles & Colvard Created Moissanite® and Caydia® lab grown diamonds positions our products at the many touchpoints where consumers are when they are making their buying decisions – thereby continuing to create greater exposure for our brand and increasing consumer demand.
COVID-19
In March 2020, the novel strain of coronavirus, known as COVID-19, was declared a pandemic by the World Health Organization and declared a national emergency by the U.S. Government, and has continued to negatively affect the U.S. and global economies. In response to the pandemic, federal, state, county and local governments, and public health organizations and authorities around the world have implemented a variety of measures intended to control the spread of the virus including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing, and hygiene requirements. While some of these measures have been lifted or eased in certain jurisdictions, other jurisdictions have seen increases in new COVID-19 cases, resulting in restrictions being reinstated or new restrictions being imposed. There continues to be considerable uncertainty regarding such measures and potential future measures.
We have continued taking measures to protect the health and safety of our employees, including updating our return-to-work policies, as necessary, working with our customers and suppliers to minimize disruptions, and supporting our community in addressing the challenges posed by this ongoing global pandemic. During Fiscal 2021, we experienced impacts in our business related to COVID-19, primarily in continued increased coronavirus-related costs, interruptions in supplier deliveries, impacts of travel and delivery restrictions, site access and quarantine restrictions, and the impacts of remote work and adjusted work schedules.
The COVID-19 pandemic continues to present business challenges and we expect these to continue into Fiscal 2022. We have executed plans to reintroduce employees to the workplace as vaccine rates increase and COVID-19 cases decrease. Although, in light of the recent increase in infections due to evolving viral variants, we have not yet returned to pre-pandemic workforce levels in our workplace, and we are experiencing stabilization of employee attendance in our operations and distribution facilities and throughout our supply chain. A segment of our corporate staff continues working a blend of remote and in-person work schedules and we are taking measures to facilitate the provision of vaccines to our employees in line with state and local guidelines. We also continue working with our customers and suppliers to minimize disruptions, including at times accelerating payments to key suppliers that are due by their terms in future periods. We expect to continue accelerating payments to our suppliers in some cases into Fiscal 2022.
Although the COVID-19 pandemic did not have a significant adverse impact on our financial results in Fiscal 2021, the ultimate impact of COVID-19 on our operations and financial performance in future periods, including our ability to execute our strategic initiatives in the expected timeframes, remains uncertain and will depend on future pandemic related developments, including the duration of the pandemic, any potential subsequent waves of COVID-19 and its variant viral infections, the effectiveness, distribution and acceptance of COVID-19 vaccines, and related government actions to prevent and manage disease spread, all of which are uncertain and cannot be predicted. We cannot at this time predict the full impact of the COVID-19 pandemic, but we anticipate that the COVID-19 pandemic is likely to continue to impact our business, financial condition, results of operations and/or cash flows in the fiscal year ending June 30, 2022.
At the onset of the pandemic, we successfully applied for and received the proceeds from a PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. Our PPP Loan in the principal amount of $965,000 was disbursed by our Lender pursuant to a Promissory Note issued by us on June 15, 2020. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of the gain in connection with the extinguishment of the underlying debt, including the forgiveness of accrued and unpaid interest in the amount of approximately $9,000, was recognized in the fiscal year ended June 30, 2021.
We took advantage of available COVID-19 related payroll tax credits for certain wages and paid leave provided by us during the pandemic. A portion of these eligible tax credits are determined by qualified emergency paid sick and expanded family and medical leave wages pursuant to the Families First Coronavirus Response Act, or FFCRA, which had positive impact on our cash from operations in Fiscal 2021. In addition, the Consolidated Appropriations Act, 2021, provides that employers who received a PPP loan may also qualify for the Employee Retention Credit (the “ERC”). Previously, pursuant to the 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 qualify for certain employer-related tax benefits pursuant to the ERC and expect to amend our applicable federal payroll tax returns for such benefit. Further, as permitted by the NC COVID-19 Relief Act, we expect to receive an incremental tax credit towards our contributions to the North Carolina Unemployment Insurance Fund. Accordingly, we will recognize any payroll tax credits related to these federal and state legislative actions in the period such benefits are received.
Currently, we are conducting business with certain modifications. In accordance with recent Centers for Disease Control and Prevention, or CDC, and the North Carolina Department of Health and Human Services, or the NCDHHS, guidelines related to maximizing protection from the spread and infection of the Delta variant of COVID-19, we are requiring all employees, contractors, and visitors to wear masks and practice physical distancing while onsite, regardless of vaccination status. We believe that our employees and contractors continue to play a critical role in our COVID-19 prevention and mitigation efforts for the Company as well as for our community at large.
Recent modifications to our COVID-19 return-to-work policy include but are not limited to the following: all employees, contractors, and visitors are encouraged to clean and sanitize all work surfaces, including personal office or cubicle areas; office common areas will be cleaned nightly, and floors and carpets will be cleaned as necessary; and currently, we are not mandating that employees, contractors, and visitors receive the COVID-19 vaccine or that non-fully vaccinated individuals provide evidence of negative COVID-19 test results in order to enter our facilities.
At this time, and until further notice, the following precautionary steps and procedures within our policy remain in place. Prior to entry to our facilities, all employees, contractors, and visitors (regardless of vaccination status) are required to comply with the following: complete a COVID-19 symptom screening questionnaire; properly wear a mask; take a thermal body temperature scan; and practice social distancing at all times within the facility, including designated common areas. We are supplying all employees, contractors, and visitors with face masks and latex gloves for their personal use, and we have established a designated quarantine room to isolate any employee, contractor, or visitor who may be experiencing COVID-19-like symptoms while in our facilities. Given our office’s square footage, we intend to continue to observe recommended governmental guidelines related to occupancy and capacity restrictions.
Regardless of vaccination status, any employees, contractors, or visitors presenting with symptoms of COVID-19 or who have tested positive for the COVID-19 virus may only return to our facilities once ten days have passed since symptoms of COVID-19 first appeared, at least 24 hours have passed with no fever (without the use of fever-reducing medications), and any other COVID-19 symptoms (i.e., loss of taste or smell) continue improving. Employees, contractors, or visitors who may have been exposed to COVID-19, but remain asymptomatic, are able to return to work after receiving a negative COVID-19 test result three-to-five days following a known exposure or 14 days since the last contact with an individual who was presumed to have or had COVID-19.
Our current return-to-work policy is tentative and subject to change based on federal, state, or local governmental guidance as well as the evolution of the pandemic itself. Going forward, we plan to continue monitoring the development and progression of COVID-19 and its variant infections in our state and local geographical area. If we believe such policy changes are warranted, we intend to consider and plan to take appropriate actions at that time.
As global and U.S economic activity continues evolving in response to the ongoing COVID-19 pandemic, the risk of constraints on our cash and working capital, including experiencing potential liquidity challenges, remains in the forefront of our working capital management practices. Despite our cost-saving efforts, many business and operating expenses have remained flat or continued to rise. Cash flow management will remain crucial for our business in the months ahead and we intend to monitor fluctuations in our revenues that could impact our ongoing cash flow from operations We continue to focus on being more nimble in managing our inventory levels given the uncertainty in the supply chain, which may also place further demands on working capital.
Our outlook remains subject to the various risks and uncertainties in connection with the pandemic and is based on assumptions that management believes in good faith are reasonable, but which may be materially different from actual results. Currently, we believe there are multiple factors that could cause actual results to differ materially from the forward-looking statements in this Form 10-K, including our strategic goals for Fiscal 2022 set forth in Our Strategic Outlook, included in Part I, Item 1, “Business”, of this Annual Report on Form 10-K. These factors include, but are not limited to: our ability to face the challenges posed by the COVID-19 pandemic and implementation of any such related response plans; fluctuations in COVID-19 cases in the U.S. and the extent that geography of outbreak primarily matches the regions in which we and our principal business partners operate; the resiliency and potential adverse impacts on our various consumer end-use markets; the potential negative impact of the COVID-19 pandemic on our ability to continue producing and supplying finished goods and related services at normal levels or at all; the duration, impact and severity of the impact of the COVID-19 pandemic on our operations, including the markets in which we do business, our suppliers, customers or other business partners as well as our employees; the economic impact of government responses to the pandemic; the performance of the U.S. economy, including the impact on the economy of the COVID-19 pandemic and governmental orders restricting activities imposed to prevent further outbreak of viral infections; and the resulting economic events beyond our control.
We believe that our management has taken – and continues to take – swift and appropriate action designed to hedge against the overall impact that the pandemic may have on our business, to prepare for a potential recessionary environment, and to efficiently manage the business while maintaining adequate liquidity and maximum operating flexibility. We remain focused on three critical areas of wellbeing, including safeguarding the health and safety of our employees, streamlining operations while ensuring support of our brand and customers, and maintaining our financial strength and stability as we move forward into Fiscal 2022.
Highlights of the Fiscal Year Ended June 30, 2021
During the fiscal year ended June 30, 2021, we delivered on several key initiatives, which we believe leaves us well poised for future growth as we move forward into the fiscal year ending June 30, 2022. These accomplishments in fiscal year ended June 30, 2021, include the following:
Expansion of Digital Presence. During Fiscal 2021, we remained focused on our digital marketing advertising strategy that includes a high-conversion consumer targeting plan coupled with lower marketing funnel activities. We believe that the success we’ve seen targeting consumers with whom we have already engaged – and who have expressed interest in our products – continues to be a more effective use of our digital advertising spend and provides a more immediate return on our marketing investment. We believe this strategy is critical to our top line growth as we move forward into Fiscal 2022. In addition, during Fiscal 2021, we expanded our presence on available social media channels such as TikTok, and rolled out new social media programming shows on Facebook Live and Instagram Live. In March 2021, we launched moissaniteoutlet.com, which is a product disposition channel that we believe complements our global positioning and dominance in the moissanite gemstone market. Our website, moissaniteoutlet.com, is an e-commerce shopping destination that caters to the opportunistic and bargain-seeking consumer base for our moissanite products;
Enhanced Customer Experience. This fiscal year we expanded our virtual consultation services that we introduced last year, by adding additional expert jewelry consultants to our team that provides us with broader availability to make it easier for consumers to schedule personal consultive services. This is a personal shopping concierge service where we offer a customized virtual experience designed to simplify the ring buying process for our customers. This customer support service offers deeper personalization and a more immersive shopping experience for our consumers. We also launched our Macy’s in-store program in Fiscal 2021 to reach and service more customers who are seeking to see, touch, and feel our products when shopping. As consumers are returning to in-store shopping, we believe this is a critical component of our omnichannel marketing strategy, which places our products where the customer is actually shopping. Lastly, in September we upgraded the online shopping experience on charlesandcolvard.com, our primary transactional website. These online modifications provide new and improved functionality as well as a new look and feel to our website. We believe that offering these ongoing enhanced customer experiences, particularly those featuring virtual personal shopping opportunities, are important for the growth of our brand. We also believe that these options remain relevant and important to our customers when social distancing practices are – and will likely remain – in place throughout the U.S. and much of the world;
| • | Product Development. In Fiscal 2021, we expanded our patented Signature Collection of Forever One™ moissanite jewelry assortment to include emerald, elongated cushion, and radiant cut gemstones. Previously, these gems and unique cuts were not available in our Signature Collection line of products. In September 2020 we launched Caydia®, an exclusive brand of premium lab grown diamonds and jewelry. We believe our premium lab grown diamonds provide us access to serve a broader and completely new segment of the gemstone audience and customer base that is predisposed to shopping for a real diamond. Throughout Fiscal 2021, we continued to expand our Caydia® lab grown diamond jewelry assortment with new styles as well as additional gemstone cuts. Currently, our exclusive brand of Caydia® lab grown diamonds are available in round, oval, cushion, emerald, and princess cuts; and |
Disciplined Growth. We capitalized on the change in the global consumer behavior and buying habits that developed during the past year as shoppers turned to online shopping and e-commerce purchasing opportunities as the world evolved and learned to live with the restrictions imposed by the COVID-19 pandemic. We achieved stability and improved technical access to our shopping platforms, which resulted in a strong shopping foundation that supports our omnichannel marketing strategy. We also developed and initiated a new strategic relationship and business partnership with JPMorgan Chase Bank, N.A., that includes a new $5.00 million cash collateralized line of credit facility that may be used for general corporate and working capital purposes. We believe this new commercial banking and financial relationship provides a foundation for us to solidify our strategic and financial objectives and is a basis for us to expand our financial capabilities going forward.
As we move forward into Fiscal 2022, our strategic focus remains centered on the health and growth of our brand on a global scale. We will continue to execute on our key strategies with an ongoing commitment to measured spending and generating sustainable earnings improvement.
Further, as we continue managing through these challenging and unprecedented times, we plan to remain highly focused on prudently developing the reach of our brand – both domestically and internationally – through select digital marketing initiatives that align with consumer engagement and demand. We continue to believe that our long-term mission will ultimately be accomplished through our ability to remain fluid and shift brand awareness strategies that are sensitive and responsive to these ever-changing times.
Our MD&A generally discusses Fiscal 2021 and Fiscal 2020 items and year-to-year comparisons between Fiscal 2021 and Fiscal 2020. Discussions of Fiscal 2020 items and year-to-year comparisons between Fiscal 2020 and the fiscal year ended June 30, 2019, or Fiscal 2019, that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results or Operations” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2020 filed with the SEC on September 4, 2020.
The following table sets forth certain consolidated statements of operations data for the fiscal years ended June 30, 2021 and 2020:
| | | Year Ended June 30, | |
| | | 2021 | | | 2020 | |
| Net sales | | $ | 39,235,839 | | | $ | 29,189,020 | |
| Costs and expenses: | | | | | | | | |
| Cost of goods sold | | | 20,809,690 | | | | 21,200,207 | |
| Sales and marketing | | | 8,476,716 | | | | 9,443,244 | |
| General and administrative | | | 4,441,441 | | | | 4,861,297 | |
| Total costs and expenses | | | 33,727,847 | | | | 35,504,748 | |
| Income (Loss) from operations | | | 5,507,992 | | | | (6,315,728 | ) |
| Other income (expense): | | | | | | | | |
| Gain on extinguishment of debt | | | 974,328 | | | | - | |
| Interest income | | | 5,581 | | | | 158,091 | |
| Interest expense | | | (8,953 | )
| | | (884 | ) |
| Loss on foreign currency exchange | | | (603 | )
| | | (1,829 | ) |
| Total other income (expense), net | | | 970,353 | | | | 155,378 | |
| Income (Loss) before income taxes | | | 6,478,345 | | | | (6,160,350 | ) |
| Income tax benefit (expense) | | | 6,332,421 | | | | (1,733 | ) |
| Net income (loss) | | $ | 12,810,766 | | | $ | (6,162,083 | ) |
Consolidated Net Sales
Consolidated net sales for the fiscal years ended June 30, 2021 and 2020 comprise the following:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 24,401,546 | | | $ | 16,777,628 | | | $ | 7,623,918 | | | | 45 | % |
| Loose jewels | | | 14,834,293 | | | | 12,411,392 | | | | 2,422,901 | | | | 20 | % |
| Total consolidated net sales | | $ | 39,235,839 | | | $ | 29,189,020 | | | $ | 10,046,819 | | | | 34 | % |
Consolidated net sales were $39.24 million for the fiscal year ended June 30, 2021 compared to $29.19 million for the fiscal year ended June 30, 2020, an increase of $10.05 million, or 34%. In addition to the adverse impact that the COVID-19 pandemic had on consolidated net sales for the fiscal year ended June 30, 2020, the increase in consolidated net sales for the fiscal year ended June 30, 2021 compared with consolidated net sales for the prior fiscal year was also principally due to robust calendar year-end holiday sales during our fiscal quarter ended December 31, 2020, coupled with strong February Valentine’s Day sales and March St. Patrick’s Day sales during our fiscal quarter ended March 31, 2021. These higher sales for Fiscal 2021 were also related to increased consumer awareness and ongoing strong demand for our moissanite jewels, lab grown diamonds, and finished jewelry featuring both moissanite and lab grown diamonds. These increases resulted in higher finished jewelry product net sales during the fiscal year ended June 30, 2021 in both our Online Channels segment and Traditional segment. One of the most profound changes in consumer buying habits over the past fiscal year was the shift to digital channels shopping from the more traditional brick-and-mortar platforms. We believe the COVID-19 pandemic accelerated this shift toward e-commerce, as consumers worldwide became more reliant on the digital channel while in isolation. Accordingly, we saw strong increases in our Online Channels segment net sales in the fiscal year ended June 30, 2021. As consumer confidence strengthened during the second half of Fiscal 2021, net sales in our Traditional segment increased over this period driven by stronger loose jewel sales in our distributor network. However, these increased loose jewel net sales in our Traditional segment were offset in part due to lower international sales during the fiscal year ended June 30, 2021.
Sales of finished jewelry represented 62% and 57% of total consolidated net sales for the fiscal years ended June 30, 2021 and 2020, respectively. For the fiscal year ended June 30, 2021, finished jewelry sales were $24.40 million compared to $16.78 million for the fiscal year ended June 30, 2020, an increase of $7.62 million, or 45%. This increase in finished jewelry sales was due primarily to higher finished jewelry sales of Moissanite by Charles & Colvard® and our Signature Collection line of products in our Online Channels segment as well as in our Traditional segment. Net sales of our Moissanite by Charles & Colvard®and our Signature Collection finished jewelry and loose jewels represented 15% and 9%, respectively, of total net sales for the fiscal year ended June 30, 2021, compared to that of 11% and 7%, respectively, for the prior fiscal year.
Sales of loose jewels represented 38% and 43% of total consolidated net sales for the fiscal years ended June 30, 2021 and 2020, respectively. For the fiscal year ended June 30, 2021, loose jewel sales were $14.83 million compared to $12.41 million for the fiscal year ended June 30, 2020, an increase of $2.42 million, or 20%. The increase for the fiscal year ended June 30, 2021 was primarily a result of higher sales of loose jewels through our domestic distributors. However, these increased loose jewel sales were offset somewhat by lower sales of loose jewels through the international distribution network in our Traditional segment.
U.S. net sales accounted for approximately 95% and 92% of total consolidated net sales during the fiscal years ended June 30, 2021 and 2020, respectively. U.S. net sales increased during the fiscal year ended June 30, 2021 principally as a result of increased sales to U.S. customers in both our Online Channels segment and Traditional segment.
Our largest U.S. customer during the fiscal years ended June 30, 2021 and 2020 accounted for 13% of total consolidated net sales during each of the respective periods then ended. Likewise, our second largest U.S. customer during the fiscal years ended June 30, 2021 and 2020 accounted for 12% of total consolidated net sales during each of the respective periods. It should be noted that our largest and second largest customers in Fiscal 2021 were our second largest and largest customers, respectively, in Fiscal 2020. We expect that we will remain dependent on our ability, and that of our largest customers, to maintain and enhance retail and wholesale programs. A change in or loss of any of these customers or retailer relationships could have a material adverse effect on our results of operations.
International net sales accounted for approximately 5% and 8% of total consolidated net sales during the fiscal years ended June 30, 2021 and 2020, respectively. International net sales decreased to $2.01 million, or 15%, during the fiscal year ended June 30, 2021 compared to $2.37 million in the fiscal year ended June 30, 2020. International sales decreased during the fiscal year ended June 30, 2021, compared to the prior fiscal year primarily as a result of lower demand in our international distributor market, which was partially offset by growth in our direct-to-consumer presence internationally reflecting solid direct-to-consumer sales from our Online Channels segment in international markets. In light of the effects of ongoing global economic conditions and as the world continues to recover from the COVID-19 pandemic, we continue to evaluate these and other potential distributors in international markets to determine the best long-term partners. As a result, and in light of the ongoing worldwide pandemic and international trade challenges, we expect our sales in these markets to continue to fluctuate significantly each reporting period.
We did not have an international customer account for 10% or more of total consolidated sales during the fiscal years ended June 30, 2021 and 2020. A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal years ended June 30, 2021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Finished jewelry | | $ | 11,272,012 | | | $ | 7,469,790 | | | $ | 3,802,222 | | | | 51 | % |
| Loose jewels | | | 6,857,755 | | | | 6,062,186 | | | | 795,569 | | | | 13 | % |
| Total product line cost of goods sold | | | 18,129,767 | | | | 13,531,976 | | | | 4,597,791 | | | | 34 | % |
| Non-product line cost of goods sold | | | 2,679,923 | | | | 7,668,231 | | | | (4,988,308 | ) | | | (65 | )% |
| Total cost of goods sold | | $ | 20,809,690 | | | $ | 21,200,207 | | | $ | (390,517 | ) | | | (2 | )% |
Total cost of goods sold was $20.81 million for the fiscal year ended June 30, 2021 compared to $21.20 million for the fiscal year ended June 30, 2020, a net decrease of approximately $391,000, or 2%. 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 fiscal year ended June 30, 2021 as compared to the fiscal year ended June 30, 2020 was driven primarily by the prior year write-off during the quarter ended March 31, 2020, of approximately $5.26 million representing the carrying value of our legacy loose jewel inventory and finished goods inventory set with these legacy gemstones. This decrease in cost of goods sold for the fiscal year ended June 30, 2021, was offset in part by higher cost of goods sold principally driven by increased sales of finished jewelry, which reflect higher material and labor costs, in both our Online Channels segment and Traditional segment as a result of strong product demand during the year.
The net decrease in non-product line cost of goods sold for the fiscal year ended June 30, 2021 comprises a $5.71 million lower change in inventory valuation adjustments principally related to the prior fiscal year’s write-off of the carrying cost of the Company’s legacy material inventory of $5.26 million during the quarter ended March 31, 2020, as well as other inventory valuation adjustments related to changes in obsolescence reserves in the fiscal year ended June 30, 2021, compared to those in the prior fiscal year. This decrease in non-product line cost of goods sold was offset in part by a $503,000 increase in freight out principally from increased shipments resulting from substantial Online Channels segment sales growth during the fiscal year ended June 30, 2021; a $147,000 increase in non-capitalized manufacturing and production control expenses in the current year principally due to the timing when work-in-process goods are received into inventory and applicable overhead costs are allocated; and an approximate $76,000 change in other inventory adjustments primarily relating to adverse changes in production standard cost variances compared to those during the fiscal year ended June 30, 2020.
For further discussion of non-product line cost of goods sold, see Note 3 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.10-K.
We believe our expanding application of an omni-channel sales strategy across the jewelry tradeSales and to the end consumer with gemstones and branded finished jewelry featuring Charles & Colvard moissanite positions our goods at the many touchpoints where consumers are when they are making their buying decisions – thereby creating greater exposure for our brand and increasing consumer demand.Marketing
Highlights ofSales and marketing expenses for the Fiscal Year Endedfiscal years ended June 30, 20192021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| Sales and marketing | | $ | 8,476,716 | | | $ | 9,443,244 | | | $ | (966,528 | ) | | | (10 | )% |
During
Sales and marketing expenses were $8.48 million for the fiscal year ended June 30, 2019, we delivered on several key initiatives, which we believe further solidified2021 compared to $9.44 million for the Charles & Colvard brand. We also believe that we are well poised for future growth as we move forward into the fiscal year ending June 30, 2020.
These accomplishments in fiscal year ended June 30, 2019, include2020, a decrease of approximately $967,000, or 10%.
The decrease in sales and marketing expenses for the following:fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 was primarily due to a $1.31 million decrease in compensation-related expenses; a $164,000 decrease in professional services fees principally comprising non-recurring consulting services for cybersecurity and merchandising imaging incurred in the prior year; a $26,000 decrease in travel expenses as a result of COVID-19 cost-control measures; and a $1,000 net decrease in miscellaneous other general sales and marketing expenses. These decreases were partially offset by a $282,000 increase in advertising and digital marketing expenses; an $84,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; an $83,000 increase in general office-related expenses, which are principally related to higher credit card transaction fees from increased online sales levels; a $69,000 increase in depreciation and amortization expense relating to capitalized costs associated with information technology-related upgrades; and a $17,000 increase in employment-related recruiting fees.
Compensation expenses for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 decreased primarily as a result of a $1.25 million decrease in salaries, commissions, and related employee benefits in the aggregate as a result of our June 2020 management reorganization and workforce reduction; a $76,000 decrease in employee-related severance costs recognized in the prior year which also was a result of our June 2020 management reorganization and workforce reduction; and a $68,000 decrease in employee stock-based compensation expense associated with the modification of terms for certain participant stock options in Fiscal 2020 that resulted in the recognition of higher stock compensation expense in the prior fiscal year. These decreases were partially offset by an $84,000 increase in bonus expense reflecting improved operating results in the current year that impacts this performance-based compensation-related benefit.
The increase in digital marketing expenses for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 was primarily due to a $766,000 increase in Internet marketing costs and a $20,000 increase in print media expenses. Both increases reflect changes in our overall social media and print marketing strategies during Fiscal 2021 compared with those in Fiscal 2020. These increases were partially offset by a $386,000 decrease in outside agency fees, also as a consequence of modifications in our marketing strategy and reliance on internal resources during the current year; a $111,000 decrease in cooperative advertising; and a $7,000 decrease in promotion-related expenses.
General and Administrative
General and administrative expenses for the fiscal years ended June 30, 2021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| General and administrative | | $ | 4,441,441 | | | $ | 4,861,297 | | | $ | (419,856 | ) | | | (9 | )% |
General and administrative expenses were $4.44 million for the fiscal year ended June 30, 2021 compared to $4.86 million for the fiscal year ended June 30, 2020, a decrease of approximately $420,000, or 9%.
The decrease in general and administrative expenses for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 was primarily due to a $428,000 decrease in professional services; a $206,000 decrease in compensation-related expenses; a $7,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; and a $1,000 net decrease in miscellaneous other general and administrative expenses. These decreases were partially offset by a $58,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed in January 2021; a $50,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; a $38,000 increase in housing allowances and travel-related expenditures; a $30,000 increase in insurance expenses principally related to higher renewal premiums; a $20,000 increase in bank charges as a result of transaction fees associated with increased online transactions; a $14,000 increase in Board member retainer fees due to the temporary reduction in fees paid to our Board of Directors in connection with cost control measures implemented during the COVID-19 pandemic in the prior year; a $9,000 increase in depreciation and amortization expense; and a $3,000 increase in business taxes and licenses.
Professional services fees decreased for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 primarily due to a $283,000 decrease in legal fees resulting from non-recurring non-capitalized fees incurred in connection with our underwritten public offering and corporate governance matters in the prior year; a $101,000 decrease in consulting and other professional services primarily in connection with accounting department support in the prior year; and a $66,000 decrease in investor relations fees. These decreases were partially offset by a $22,000 increase in fees associated with audit and tax services in the current year.
Compensation expenses decreased for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 primarily due to a $282,000 decrease in severance expenses recognized in the prior year related to our June 2020 management reorganization and workforce reduction; a $184,000 decrease in salaries and related employee benefits in the aggregate which also was a result of our Common StockJune 2020 management reorganization and workforce reduction; and a $54,000 decrease in employee stock-based compensation expense associated with the modification of terms for certain participant stock options in Fiscal 2020 that resulted in the recognition of higher stock compensation expense in the prior fiscal year. These decreases were offset in part by a $314,000 increase in bonus expense reflecting improved operating results in Fiscal 2021 that impacts this performance-based compensation-related benefit.
Gain on Extinguishment of Debt
Gain on extinguishment of debt for the fiscal years ended June 30, 2021 and 2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
Gain on extinguishment of debt | | $ | 974,328 | | | $ | - | | | $ | 974,328 | | | | 100 | % |
On June 18, 2020, we received the proceeds from our Paycheck Protection Program Loan, or the PPP Loan, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, as administered by the U.S. Small Business Administration, or SBA. The PPP Loan in the principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, or the Lender, pursuant to a promissory note, or the Promissory Note, dated June 15, 2020. – During the period of time that the principal under the Promissory Note was outstanding, we accounted for the Promissory Note as debt within the accompanying consolidated financial statements. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of interest expense to-date in the amount of approximately $9,000 that the Company recognized during the period the principal of the PPP Loan was outstanding was also forgiven by the SBA. Accordingly, the full amount of the gain in connection with the extinguishment of this debt, including the benefit from the forgiveness of the inception to-date interest expense, was recognized in the fiscal year ended June 30, 2021.
Interest Income
Interest income for the fiscal years ended June 30, 2021 and 2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Interest income | | $ | 5,581 | | | $ | 158,091 | | | $ | (152,510 | ) | | | (96 | )% |
In June 2019, we completed an underwritten public offering of 6,250,000 shares of our common stock, at a price of $1.60 per share, which together with the partial exercise of the underwriters’ over-allotmentoverallotment option for an additional 630,500 shares in July 2019, resulted in aggregate net proceeds of approximately $9.99 million. The net proceeds from this offering, along with excess operating cash, are deposited into and maintained in an interest-bearing account with a federally insured commercial bank. Accordingly, during the fiscal years ended June 30, 2021 and 2020, we earned interest from cash on deposit in this interest-bearing account. The decrease in earned interest reflects adverse changes in interest rate fluctuations during Fiscal 2021 compared with Fiscal 2020.
Interest Expense
Interest expense for the fiscal years ended June 30, 2021 and 2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Interest expense | | $ | 8,953 | | | $ | 884 | | | $ | 8,069 | | | | 913 | % |
In accordance with the terms of the Promissory Note, during the period of time the principal of the PPP Loan was outstanding through June 23, 2021, we accrued interest at a fixed rate of 1% per annum. Our accrual for interest expense associated with the PPP Loan began June 18, 2020, the date we received the proceeds for the PPP Loan from our Lender. Likewise, we accrued interest on the PPP Loan during the fiscal year ended June 30, 2021, through June 23, 2021, the date our PPP Loan was forgiven by the SBA.
Loss on Foreign Currency Exchange
Loss on foreign currency exchange related to foreign sales transacted in functional currencies other than the U.S. dollar for the fiscal years ended June 30, 2021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | 603 | | | $ | 1,829 | | | $ | (1,226 | ) | | | (67 | )% |
During the fiscal years ended June 30, 2021 and 2020, we had international sales transactions denominated in currencies other than the U.S dollar that resulted in foreign currency exchange net losses. The decrease in these losses reflects the lower level of international sales denominated in foreign currencies as well as foreign currency exchange rate fluctuations during fiscal year ended June 30, 2021 compared with those of the prior fiscal year.
Provision for Income Taxes
We recognized a net income tax benefit of approximately $6.33 million and a net income tax expense of approximately $2,000 for the fiscal years ended June 30, 2021 and 2020, respectively. Our income tax provisions in these periods contain estimated taxes, penalties, and interest associated with uncertain tax positions.
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. Beginning in 2014, we determined that negative evidence outweighed the positive and established a full valuation allowance against our deferred tax assets and we maintained such full valuation allowance through the period ended June 30, 2020. However, as of June 30, 2021, cumulative positive taxable income over the last three tax years had been generated in the U.S., as compared to the negative evidence of cumulative losses in previous years. We also determined that our expectations of future taxable income in upcoming tax years, including estimated growth rates applied to future expected taxable income that includes significant management estimates and assumptions, would be sufficient to result in full utilization of our federal net operating loss carryforwards and certain of the deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence exists as of June 30, 2021, to conclude that it is more likely than not deferred tax assets of approximately $6.35 million are realizable, and we reduced our valuation allowance accordingly. The reduction of the valuation allowances against these deferred tax assets was the main driver of the income tax benefit during the fiscal year ended June 30, 2021 of approximately $6.33 million. A valuation allowance remains against certain deferred tax assets primarily relating to state net operating loss carryforwards from our e-commerce subsidiary due to the timing uncertainty of when it will generate positive taxable income to utilize the associated deferred tax assets. In addition, a valuation allowance also remains against certain deferred tax assets relating to operating loss carryforwards relating to our dormant subsidiary located in Hong Kong.
Our statutory tax rate as of the fiscal year ended June 30, 2021 is 22.24% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.24%, net of the federal benefit.
Certain Operating Metrics
We believe that certain metrics are key to our business, including but not limited to monitoring our average order value, or AOV. We use the AOV computation in part to make strategic digital marketing related decisions and to monitor the performance and return on investment of our marketing activities. Our AOV is based on financial results and customer-related data for charlesandcolvard.com, LLC, our wholly owned subsidiary and through which we operate our primary transactional website. Our calculation for AOV is sensitive to several factors, including sales volume and product mix. Therefore, we believe that this metric may vary widely going forward as we respond to ever changing consumer demand and provide the products – that may have widely variable price points – which our audiences are seeking.
For the fiscal year ended June 30, 2021, our AOV, based on charlesandcolvard.com revenue, net of returns, divided by the total number of customer orders, is estimated to be approximately $1,000.
An additional metric that we use to manage charlesandcolvard.com operations and to make strategic digital marketing decisions for our transactional website is period-over-period revenue growth. Accordingly, we believe this level of growth reinforces our current year’s digital marketing program and affirms our decision to increase our investment in consumer-driven marketing efforts in charlesandcolvard.com during Fiscal 2021. While we believe this metric is sensitive to many factors and may vary in future periods, we expect to continue to monitor and base our marketing-related investments in part on charlesandcolvard.com revenue growth going forward.
For the fiscal year ended June 30, 2021, we experienced a 45% year-over-year growth in charlesandcolvard.com revenue compared to revenue for the fiscal year ended June 30, 2020.
Liquidity and Capital Resources
The full impact of the COVID-19 pandemic on the global and domestic economy remains uncertain and the world continues adapting to the ongoing pandemic and evolving viral variants and its adverse effects on global economics and worldwide business operations. The impact of the COVID-19 pandemic continues to place unprecedented pressures on global and U.S. businesses including our own. Depending on future developments, including the success of the global vaccine efforts to control the spread of the underlying virus and evolving variants, the pandemic could materially adversely impact our capital resources and liquidity in the future. We remain increasingly focused on the COVID-19 pandemic and are continually evaluating its potential effect on our business and liquidity and capital resources.
Capital Structure and Long-Term Debt
On June 18, 2020, we received the proceeds from the PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of $965,000 was disbursed by the Lender pursuant to a promissory note, or the Promissory Note, issued by us on June 15, 2020. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of the gain in connection with the extinguishment of this debt, including the forgiveness of accrued and unpaid interest of approximately $9,000, was recognized in the fiscal year ended June 30, 2021.
The CARES Act provided that existing AMT credit carryforwards were eligible for acceleration and refundable AMT credits were to be completely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, we elected to have our then existing AMT tax completely refunded and filed a refund claim for the remaining portion of our AMT tax credit. Accordingly, the remaining balance of our AMT credit refund in the amount of approximately $270,000 was completely refunded during the fiscal year ended June 30, 2021.
We took advantage of available COVID-19 related payroll tax credits for certain wages and paid leave provided by us during the pandemic. A portion of these eligible tax credits are determined by qualified emergency paid sick and expanded family and medical leave wages pursuant to FFCRA. In addition, the Consolidated Appropriations Act, 2021, provides that employers who received a PPP loan may also qualify for the Employee Retention Credit (the “ERC”). Previously, pursuant to the 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 qualify for certain employer-related tax benefits pursuant to the ERC and expect to amend our applicable federal payroll tax returns for such benefit. Further, as permitted by the NC COVID-19 Relief Act, we expect to receive an incremental tax credit towards our contributions to the North Carolina Unemployment Insurance Fund. Accordingly, we will recognize any payroll tax credits related to these federal and state legislative actions in the period such benefits are received.
For further discussion of the effects of the CARES Act, the Consolidated Appropriations Act, 2021, and the NC COVID-19 Relief Act on our provision for income taxes and deferred tax assets, see Note 13 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
As a component of our liquidity and capital structure, we have an effective shelf registration statement on Form S-3 on file with the SEC that allows us to periodically offer and sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total of $25.00 million, of which all is available. However, we may offer and sell no more than one-third of our public float (which is the aggregate market value of our outstanding common stock held by non-affiliates) in any 12-month period. Our ability to issue equity securities under the shelf registration statement is subject to market conditions, which may be in turn, subject to, among other things, the potential disruption and volatility that may be caused by ongoing effects of the COVID-19 pandemic. Any capital raise is not assured and may not be at terms that would be acceptable to us.
Financing Activities
In June 2019, we completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the public of $1.60 per share, pursuant to our effective shelf registration statement on Form S-3. Net proceeds from the offering were approximately $9.06 million, net of the underwriting discount and fees and expenses, whichexpenses. Pursuant to the terms of the underwriting agreement entered into in connection with this offering, the underwriters were granted a 30-day option to buy up to an additional 937,500 shares of our common stock to cover over-allotments. Pursuant to the partial exercise of the underwriters’ over-allotment option, in July 2019, we intendissued an additional 630,500 shares of our common stock at a price of $1.60 per share for net proceeds of approximately $932,000, net of the underwriting discount and fees and expenses of approximately $77,000. After giving effect to use the partial exercise of the over-allotment option, we sold an aggregate of 6,880,500 shares of our common stock at a price of $1.60 per share with total gross proceeds of approximately $11.01 million, before deducting the underwriting discount and fees and expenses of approximately $1.02 million. Early during Fiscal 2020, we began using the aggregate net proceeds of approximately $9.99 million from the offering for marketing and for general corporate and working capital purposes. Accordingly, with these funds we plan In response to expand our brand’s reach primarily throughthe COVID-19 pandemic and its impact on consumer confidence and spending, management drastically reduced related advertising and digital marketing efforts. We believe that investmentsexpenditures in top-of-funnelmid-March 2020. However, we continue to monitor and adjust our advertising and digital marketing activities, such as social media advertising, influencer marketing programs, and international campaigns, will increase the overall awareness of Charles & Colvard. We also intendprofessional services expenditure levels to expand our opted-in targetcorrespond to market and drive top line growth. We believe that withchanges. As a result, we increased these funds being secured in the June and July timeframe, this opportunity provides us the ability to positively impact the 2019 calendar year-end holiday season and ultimately accelerate our growth potential.
Achieved Four Consecutive Quarters of Net Income – With four consecutive quarters of profitabilityexpenditures during the fiscal year ended June 2019,30, 2021, and may continue seeing an increase in these expenditure levels during Fiscal 2022 and beyond.
As discussed above, on June 18, 2020, we believe our financial performance for this fiscal year was strong. We believe that we have right-sized our operations, balanced our resources, and understandreceived the puts and takes of running a healthy business. We believe that this performance positions us with a strong foundation on which to apply and achieve the maximum benefitproceeds from the net proceedsPPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of $965,000 was disbursed by the Lender pursuant to a Promissory Note issued by us on June 15, 2020. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our recent public offering.
Established Our Position as a Direct-to-Consumer Brand – Our legacy is thatPPP Loan forgiveness was approved and processed by the SBA for the full principal of a moissanite gemstone manufacturer. This traditional business was our focus until October 2016, when we re-launched the business modelPPP Loan in the amount of $965,000. The full amount of the gain in connection with the intent to establish a direct-to-consumer, or DTC, presence. We finished our fiscal year-end 2019 with more than halfextinguishment of our business derived from our Online Channels segment, which serves our DTC customer. More than halfthis debt, including the forgiveness of our Online Channels segment’s business is generated from our own transactional website, charlesandcolvard.com, where we can offer an exceptionalaccrued and direct customer experience while controlling our brand and commanding high product margins. Delivering on our direct-to-consumer vision and our Online Channels segment eclipsing our Traditional segment in less than three years is oneunpaid interest of our most significant recent accomplishments.
Forged New Inroads into International Markets – One of our key growth opportunities is in international markets. In fiscal 2019, we leaned into this opportunity with the launch of several marketplaces including but not limited to Amazon sites in Australia, Germany, Italy, France, Spain, and Japan. We believe that the use of marketplaces as a low-cost market research opportunity provides less expensive exposure into new markets. While leveraging the significant subscribers of these established online retail outlets, we have the opportunity to test products and price points to identify whether we have a customer in a given region and which products that customer has a propensity to buy. This allows us to then curate the right selection of products for a region and only then will we begin to invest significant digital marketing resources in order to grow a regional presence. Concurrently, we continued to support CBT efforts to drive international customers to our U.S.-based website with enhanced international shopping features. And lastly, we leveraged regional distributors to act as our ‘boots on the ground’ for certain regions, such as China, that require a significant local presence and investment of resources. With international sales increasing to $4.26 million, or 106%,approximately $9,000, was recognized in the fiscal year ended June 30, 2019 from $2.07 million in the twelve months ended June 30, 2018 (unaudited), we feel confident in our agile international growth model and plan to continue these efforts into fiscal 2020.
| • | Expanded Our Product Selection to Meet Market Demand – In May 2018 we introduced Moissanite by Charles & Colvard®, which is a value line of gemstones that offers cost-conscious consumers a competitively-priced option for moissanite jewels. Throughout fiscal 2019, we expanded the footprint of this new product line, closing the year with 6% of all sales attributable to this line of gemstones. In September of 2018 we announced our Signature Collection, a patent-pending line of exclusive jewelry featuring our unique floret logo. By the end of fiscal 2019, our Signature Collection represented 7% of our charlesandcolvard.com sales. We believe this is an indication of the significant recognition and adoption of our brand by consumers. In April 2019, we were named the Official Jewelry Sponsor of the North Carolina Courage, a professional women’s soccer team based in Raleigh, North Carolina, and a member of the National Women’s Soccer League, or NWSL. In fiscal 2019, we provided the entire North Carolina Courage sports and management teams with championship rings commemorating their NWSL 2018 National Championship. In coordination with this soccer team, we released a line of soccer-themed jewelry specifically targeted at the emerging Gen-Z consumer. Throughout fiscal 2019, we continually iterated our jewelry options while introducing new gemstone cuts, such as our Duet Rose, and additional styles of rose cut gems. We believe that we actively solicit customer feedback and respond timely to market demand with the introduction of current product trends.
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Operating Activities and Cash Flows
Grew Our Presence with Key Retail Partners – Since 2017, we have broadenedWe require cash to fund our relationship with Helzberg Diamonds stores with the additionoperating expenses and working capital requirements, including outlays for capital expenditures. As of incremental product stylesJune 30, 2021, our principal sources of liquidity were cash, cash equivalents, and expanded case line presence in nearly all doors. In October 2018, we announced the establishmentrestricted cash totaling $21.45 million, trade accounts receivable of a new relationship with Macy’s, with whom we have built a significant$1.66 million, and growing online presence. Notably, duenet current inventory of $11.45 million, as compared to the maturitycash, cash equivalents, and restricted cash totaling $14.62 million, trade accounts receivable of certain retail relationships, we have recently migrated select brick-and mortar partners$671,000, and net current inventory of $7.44 million as of June 30, 2020. We also had access during Fiscal 2021 to a blended asset and consignment model account structure, which affords us more favorable customer payment terms that result in more favorable cash flow. We will continue to evolve our retail channel strategy as we optimize our methods and partnership arrangements.
Executed New Credit Facility with White Oak Commercial Finance, LLC – During June and July of 2018, we negotiated and entered into a $5.00 million asset-based revolving credit facility with White Oak, Commercial Finance, LLC, or the White Oak Credit Facility, which replaced our previous asset-based revolvingwe terminated in accordance with its terms as of July 9, 2021. As described more fully herein, effective July 7, 2021, we obtained from JPMorgan Chase Bank, N.A., or JPMorgan Chase, a $5.00 million cash collateralized line of credit facility, or the JPMorgan Chase Credit Facility. Also as described more fully herein, we had long-term debt in the form of a PPP Loan in the amount of $965,000, of which $193,000 was classified as current as of June 30, 2020. Effective June 23, 2021, the Company’s PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000 as well as forgiveness of accrued and unpaid interest of approximately $9,000.
During the fiscal year ended June 30, 2021, our working capital increased by approximately $12.72 million to $30.14 million from $17.42 million at June 30, 2020. As described more fully below, the increase in working capital at June 30, 2021 is primarily attributable to an increase in our cash, cash equivalents, and restricted cash, principally resulting from cash provided by our operations, 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 receivable, a decrease in our accounts payable, an increase in connection with the issuance of a short-term note receivable, a decrease in the current portion of our long-term debt, resulting from the forgiveness of our PPP Loan, and a decrease in our short-term operating lease liabilities. These factors were offset partially by an increase in our accrued expenses and other liabilities and a decrease in our prepaid expenses and other assets.
During the fiscal year ended June 30, 2020, our working capital decreased by approximately $5.75 million to $17.42 million from $23.17 million at June 30, 2019. As described more fully below, the decrease in working capital at June 30, 2020 is primarily attributable to a decrease in our allocation of inventory from long-term to short-term, a decrease in accounts receivable, an increase in short-term operating lease liabilities resulting from the adoption of the new lease accounting standard as of July 1, 2019, an increase in accrued expenses and other liabilities, an increase in accounts payable, and an increase in the current maturity of our long-term debt. These factors were offset partially by an increase in our cash, cash equivalents, and restricted cash resulting from cash provided by operating and financing activities and an increase in prepaid expenses and other assets.
During the fiscal year ended June 30, 2021, approximately $6.47 million of cash was provided by our operations. The primary drivers of our cash flows from operations were the favorable effect of net income in the amount of $12.81 million; an increase in accrued expenses and other liabilities of $3.71 million; a decrease in inventory of $1.31 million; and an increase in accrued income taxes in the amount of $2,000. These factors were offset partially by an increase in prepaid expenses and other assets of $3.14 million; an increase in accounts receivable of $955,000; and a decrease in accounts payable of $974,000. In addition, the net effect of non-cash items included in net income totaling $6.29 million, driven by the benefit recognized for deferred income taxes in the amount of approximately $6.35 million in connection with the release of our valuation allowance and the gain on extinguishment of debt resulting from the forgiveness of our PPP Loan, including forgiveness of accrued and unpaid interest, in the amount of approximately $974,000, also unfavorably impacted net cash provided by operating activities during the fiscal year ended June 30, 2021.
During the fiscal year ended June 30, 2020, approximately $249,000 of cash was provided by our operations. The primary drivers underlying the cash provided by our operating activities were a decrease in accounts receivable of $1.32 million; a decrease in prepaid expenses and other assets of $490,000; an increase in accounts payable of $469,000; and an increase in accrued expenses and other liabilities of $109,000. In addition, non-cash items totaling $6.78 million also had a favorable impact on our cash flow from operations during the fiscal year ended June 30, 2020. These factors were offset partially by the unfavorable effect of our net loss in the amount of $6.16 million and an increase in inventory of approximately $2.76 million resulting from lower quantities of inventory items sold as a result of lower period sales stemming from the impact of the COVID-19 pandemic.
During the fiscal year ended June 30, 2021, accounts receivable increased principally due to the increased level of sales during the three months ended June 30, 2021, as compared with the sales during the period leading up to June 30, 2020. As a result of the COVID-19 pandemic, from time to time we offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers during Fiscal 2021 and the second half of Fiscal 2020. 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.
During the fiscal year ended June 30, 2021, prepaid expenses and other assets decreased principally as a result of the timing of payments, primarily for insurance-related premium expenses, in advance of goods or services received. During the fiscal year ended June 30, 2021, accrued expenses and other liabilities increased principally as a result of the increase in our operating lease liability associated with the new lease amendment for our corporate headquarters facilities that was executed in January 2021. During the fiscal year ended June 30, 2021, accounts payable decreased primarily as a result of the timing of payments for costs associated with inventory-related purchases and professional services incurred. As a result of the pandemic, we have from time-to-time paid certain vendor business partners in advance of their payment terms to secure and achieve supply chain needs.
During the fiscal year ended June 30, 2020, prepaid expenses and other assets increased principally as a result of the timing of payments, principally for insurance-related expenses, in advance of goods or services received. During the fiscal year ended June 30, 2020, accounts payable increased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors’ payment terms. Likewise, accrued expenses and other liabilities increased principally due to the severance accrual in connection with our June 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to payments received prior to shipment of good from customers.
We manufactured approximately $7.63 million and $10.64 million in loose jewels and $12.72 million and $7.82 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 fiscal years ended June 30, 2021 and 2020, 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 increased significantly over the past decade, resulting in higher retail price points for gold jewelry. Because the market price of gold and other precious metals is beyond our control, the upward price trends could continue and have a negative impact on our operating cash flow as we manufacture finished jewelry.
Historically, our raw material inventories of SiC crystals had been purchased under exclusive supply agreements with a commercial bank.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 June 30, 2021 and 2020, $17.72 million and $23.19 million, respectively, 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 $1.78 million and new raw material that we purchase pursuant to the Supply Agreement.
A more detailed description of our inventories is included in Note 6 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
We made income tax payments of approximately $15,000 and $2,000 during the fiscal years ended June 30, 2021 and 2020, respectively. As of June 30, 2021, all of our remaining federal income tax credits had expired or been utilized, and therefore, are not available to be carried forward to offset future income taxes. As of June 30, 2021 and 2020, we had federal tax net operating loss carryforwards of approximately $19.00 million and $23.72 million, respectively, expiring between 2034 and 2037, or that have no expiration, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $19.87 million and $20.12 million, respectively, expiring between 2023 and 2035; and various other state tax net operating loss carryforwards expiring between 2023 and 2040, which can be used to offset against future state taxable income.
Contractual Commitment
On December 12, 2014, we entered into the Supply Agreement with Cree. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of our required SiC materials in quarterly installments that must equal or exceed a set minimum order quantity. The White Oakinitial term of the Supply Agreement was scheduled to expire on June 24, 2018, unless extended by the parties. Effective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement, as amended, also provides for the exclusive production of our premium moissanite product, Forever One™ and provided us with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following the expiration of the initial term. In addition, the amendment to the Supply Agreement established a process by which Cree 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 Cree 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 $32.85 million remains to be purchased as of June 30, 2021.
For more information regarding the second amendment to our Supply Agreement, executed on August 26, 2020, see Note 10 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
During the fiscal years ended June 30, 2021 and 2020, we purchased approximately $3.78 million and $7.47 million, respectively, of SiC crystals from Cree. Going forward, we expect to use existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, together with future cash expected to be provided by operating activities to finance our purchase commitment under the Supply Agreement, as amended.
Line of Credit
Effective July 7, 2021, we obtained from JPMorgan Chase our $5.00 million cash collateralized JPMorgan Chase Credit Facility. The JPMorgan Chase Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions and maturescertain additional indebtedness for borrowed money, installment obligations, and obligations under capital and operating leases. The JPMorgan Chase Credit Facility is secured by a cash deposit in the amount of $5.05 million held by JPMorgan Chase as collateral for the line of credit facility.
Each advance accrues interest at a rate equal to JPMorgan Chase’s monthly London Interbank Offered Rate, or LIBOR, multiplied by a statutory reserve rate for eurocurrency funding to which JPMorgan Chase is subject with respect to the adjusted LIBOR rate as established by the U.S. Federal Reserve Board, plus a margin of 1.25% per annum. Interest is calculated monthly on an actual/360 day basis and payable monthly in arrears. Principal outstanding during an event of default, at JPMorgan Chase’s option, accrues interest at a rate of 3% per annum in excess of the above rate. Any advance may be prepaid in whole or in part at any time. See Note 2, under the caption of Recently Issued Accounting Pronouncements, to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K for more detailed information relating to concerns about structural risks of interbank offered rates, or IBORs, and, particularly, the risk of cessation of the LIBOR.
The JPMorgan Chase Credit Facility is evidenced by a credit agreement between us and JPMorgan Chase, or the JPMorgan Chase Credit Agreement, dated as of July 12, 2021, 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, 2022, 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, and changes in control.
In connection with the JPMorgan Chase Credit Facility, 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. We also agreed to maintain our primary banking depository and disbursement relationship with JPMorgan Chase.
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.
On July 12, 2021, upon its execution, we did not request any advances pursuant to the terms of the JPMorgan Chase Credit Facility.
Prior to obtaining the JPMorgan Chase Credit Facility, we and our wholly owned subsidiary, charlesandcolvard.com, LLC, collectively referred to as the Borrowers, had a $5.00 million asset-based revolving credit facility, or the White Oak Credit Facility, from White Oak Commercial Finance, LLC, or White Oak, which we terminated in accordance with its terms as of July 9, 2021. The effective date of the White Oak Credit Facility was July 13, 2018, and it was scheduled to mature on July 13, 2021.
The White Oak Credit Facility was available for general corporate and working capital purposes, including permitted acquisitions and was guaranteed by the Borrowers. Under the terms of the White Oak Credit Facility, the Borrowers were required to maintain at least $500,000 in excess availability at all times. The White Oak Credit Facility contained no other financial covenants.
Advances under the White Oak Credit Facility could have been either revolving or non-revolving. During the first year of the term of the White Oak Credit Facility, any revolving advances would have accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and any non-revolving advances would have accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins would have been reduced upon the Company’s achievement of a specified fixed charge coverage ratio during the period of any outstanding advances. However, any advances were in all cases subject to a minimum interest rate of 5.50% and interest would have been calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default, which again did not occur during the term of the White Oak Credit Facility, would have accrued interest at a rate 2% in excess of the rate that would have been otherwise applicable. The annual borrowing fees associated
We had not borrowed against the White Oak Credit Facility as of July 9, 2021, the date upon which we terminated the White Oak Credit Facility in accordance with its terms.
More detailed descriptions of both our newJPMorgan Chase Credit Facility and former White Oak Credit Facility are lower than thoseincluded in connection withNote 11 to our previous credit facility,consolidated financial statements in Item 8, “Financial Statements and moreover, we believe the borrowing terms and financial covenants underlying the new White Oak Credit Facility are less restrictive than those under our previous credit arrangement. Accordingly, we believe the new White Oak Credit Facility will empower us to be more nimble when executing our strategic plansSupplementary Data”, of this Annual Report on .
As we continue to execute our strategy to build47
Liquidity and reinvest resources in our business, significant expenses and investment of cash will continue to be required ahead of the revenue streams we expect in the future. While this strategy resulted in some unprofitable reporting periods during 2017 and the transition period ended June 30, 2018, we had four consecutive quarters of net income during the fiscal year ended June 30, 2019. Accordingly, we will continue to analyze each investment decision with the ongoing intent to grow our business while maintaining our goal of achieving positive financial results and cash flows. Capital Trends
We believe that we will continue to generate or haveour existing cash and cash equivalents and access to sufficientother working capital resources, including but not limited to the issuance of equity securities, and future cash expected to fund operations as we executebe provided by operating activities combined will be sufficient to meet our plans to expandworking capital and growcapital expenditure needs over the business.next twelve months.
The execution as well as its impact on our rate of sales growth; the expansion of our strategy to continue growing our company,sales and marketing activities; the timing and extent of raw materials and labor purchases in connection with the ultimate goal of increasing consumer awareness and clearly communicating the value proposition of moissanite, is challenging and not without risk. As such, there can be no assurance that future results for each reporting period will exceed past results in sales, operating cash flow, and net income due to the challenging business environment in which we operate and our investment in various initiativesloose jewel production to support our growth strategies. In addition, salesmoissanite jewels and lab grown diamond business and precious metals and labor purchases in the retailconnection with jewelry industry are typically seasonal dueproduction to increased consumer purchasing patterns during the calendar year-end holiday season. We can also see the effect of seasonality due tosupport our finished jewelry business; the timing of orders we receive to support new or expanded distributioncapital expenditures; and the levelrisk factors described in more detail in “Risk Factors” in Part I, Item 1A of current inventory positions held by our customers. Whilethis Annual Report on Form 10-K. Currently, we have the effect of seasonalityJPMorgan Chase Credit Facility through its expiration on our business, particularly with respect to the impact of the year-end holiday season, was less pronounced during the transition period ended June 30, 2018,July 31, 2022, which we expect to continue seeingbelieve would mitigate these types of seasonal trends impact financial results in future fiscal year-end reporting periods. However, as we execute our growth strategy, we remain committedrisks to our current prioritiescash and liquidity position. Also, we may make investments in, or acquisitions of, generating positive cash flow and strengthening our financial position while both monetizing our existing inventory and manufacturing products that meet sales demand. We believe the results of these efforts will propel our revenue growth and profitability, and further enhance shareholder value in coming years – however, we continuecomplementary businesses, which could also require us to fully recognize the business and economic challenges that we face.seek additional equity or debt financing.
Critical Accounting PoliciesCertain Operating Metrics
We believe that certain metrics are key to our business, including but not limited to monitoring our average order value, or AOV. We use the AOV computation in part to make strategic digital marketing related decisions and Estimatesto monitor the performance and return on investment of our marketing activities. Our AOV is based on financial results and customer-related data for charlesandcolvard.com, LLC, our wholly owned subsidiary and through which we operate our primary transactional website. Our calculation for AOV is sensitive to several factors, including sales volume and product mix. Therefore, we believe that this metric may vary widely going forward as we respond to ever changing consumer demand and provide the products – that may have widely variable price points – which our audiences are seeking.
For the fiscal year ended June 30, 2021, our AOV, based on charlesandcolvard.com revenue, net of returns, divided by the total number of customer orders, is estimated to be approximately $1,000.
An additional metric that we use to manage charlesandcolvard.com operations and to make strategic digital marketing decisions for our transactional website is period-over-period revenue growth. Accordingly, we believe this level of growth reinforces our current year’s digital marketing program and affirms our decision to increase our investment in consumer-driven marketing efforts in charlesandcolvard.com during Fiscal 2021. While we believe this metric is sensitive to many factors and may vary in future periods, we expect to continue to monitor and base our marketing-related investments in part on charlesandcolvard.com revenue growth going forward.
For the fiscal year ended June 30, 2021, we experienced a 45% year-over-year growth in charlesandcolvard.com revenue compared to revenue for the fiscal year ended June 30, 2020.
Liquidity and Capital Resources
The full impact of the COVID-19 pandemic on the global and domestic economy remains uncertain and the world continues adapting to the ongoing pandemic and evolving viral variants and its adverse effects on global economics and worldwide business operations. The impact of the COVID-19 pandemic continues to place unprecedented pressures on global and U.S. businesses including our own. Depending on future developments, including the success of the global vaccine efforts to control the spread of the underlying virus and evolving variants, the pandemic could materially adversely impact our capital resources and liquidity in the future. We remain increasingly focused on the COVID-19 pandemic and are continually evaluating its potential effect on our business and liquidity and capital resources.
Capital Structure and Long-Term Debt
On June 18, 2020, we received the proceeds from the PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of $965,000 was disbursed by the Lender pursuant to a promissory note, or the Promissory Note, issued by us on June 15, 2020. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of the gain in connection with the extinguishment of this debt, including the forgiveness of accrued and unpaid interest of approximately $9,000, was recognized in the fiscal year ended June 30, 2021.
The CARES Act provided that existing AMT credit carryforwards were eligible for acceleration and analysisrefundable AMT credits were to be completely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, we elected to have our then existing AMT tax completely refunded and filed a refund claim for the remaining portion of our financial conditionAMT tax credit. Accordingly, the remaining balance of our AMT credit refund in the amount of approximately $270,000 was completely refunded during the fiscal year ended June 30, 2021.
We took advantage of available COVID-19 related payroll tax credits for certain wages and results of operations are based upon our consolidated financial statements, which we prepared in accordance with U.S. GAAP. The preparationpaid leave provided by us during the pandemic. A portion of these consolidated financial statements requires useligible tax credits are determined by qualified emergency paid sick and expanded family and medical leave wages pursuant to make estimates and judgmentsFFCRA. In addition, the Consolidated Appropriations Act, 2021, provides that affectemployers who received a PPP loan may also qualify for 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 importantEmployee Retention Credit (the “ERC”). Previously, pursuant to the financial statement presentationCARES Act, taxpayers that received a PPP loan were not eligible for the ERC and that require the most difficult, subjective, or complex judgments. this change is retroactive to March 27, 2020. We base our estimates on historical experience and on various other factorsbelieve that we believequalify for certain employer-related tax benefits pursuant to be reasonable under the circumstances,ERC and expect to amend our applicable federal payroll tax returns for such benefit. Further, as permitted by the resultsNC COVID-19 Relief Act, we expect to receive an incremental tax credit towards our contributions to the North Carolina Unemployment Insurance Fund. Accordingly, we will recognize any payroll tax credits related to these federal and state legislative actions in the period such benefits are received.
For further discussion of which form the basiseffects of the CARES Act, the Consolidated Appropriations Act, 2021, and the NC COVID-19 Relief Act on our provision for making judgments about the carrying value of assetsincome taxes and liabilities that are not readily apparent from other sources. Under different assumptions and/or conditions, actual results of operations may materially differ. The most significant estimates impacting our consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions, 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.
Valuation and Classification of Inventories - Inventories are stated at the lower of cost or net realizable value on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs. Any inventory on hand at the measurement date in excess of our current requirements based on historical and anticipated levels of sales is classified as long-term on our Consolidated Balance Sheets. Our classification of our inventory as either short- or long-term inventory requires us to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized in cost of goods sold over the next 12 months.
Our work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. Our moissanite jewel manufacturing process involves the production of intermediary shapes, called “preforms,” that vary depending upon the size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of June 30, 2019, June 30, 2018 and December 31, 2017, work-in-process inventories issued to active production jobs approximated $1.23 million, $2.45 million, and $2.99 million, respectively.
Each accounting period, we evaluate the valuation and classification of inventories including the need for potential adjustments to inventory-related reserves, which also include significant estimates by management, on a period-by-period basis. Seesee Note 213 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data,”Data”, of this Annual Report on Form 10-K10-K.
As a component of our liquidity and capital structure, we have an effective shelf registration statement on Form S-3 on file with the SEC that allows us to periodically offer and sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total of $25.00 million, of which all is available. However, we may offer and sell no more than one-third of our public float (which is the aggregate market value of our outstanding common stock held by non-affiliates) in any 12-month period. Our ability to issue equity securities under the shelf registration statement is subject to market conditions, which may be in turn, subject to, among other things, the potential disruption and volatility that may be caused by ongoing effects of the COVID-19 pandemic. Any capital raise is not assured and may not be at terms that would be acceptable to us.
Financing Activities
In June 2019, we completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the public of $1.60 per share, pursuant to our effective shelf registration statement on Form S-3. Net proceeds from the offering were approximately $9.06 million, net of the underwriting discount and fees and expenses. Pursuant to the terms of the underwriting agreement entered into in connection with this offering, the underwriters were granted a 30-day option to buy up to an additional 937,500 shares of our common stock to cover over-allotments. Pursuant to the partial exercise of the underwriters’ over-allotment option, in July 2019, we issued an additional 630,500 shares of our common stock at a price of $1.60 per share for net proceeds of approximately $932,000, net of the underwriting discount and fees and expenses of approximately $77,000. After giving effect to the partial exercise of the over-allotment option, we sold an aggregate of 6,880,500 shares of our common stock at a price of $1.60 per share with total gross proceeds of approximately $11.01 million, before deducting the underwriting discount and fees and expenses of approximately $1.02 million. Early during Fiscal 2020, we began using the aggregate net proceeds of approximately $9.99 million from the offering for marketing and for general corporate and working capital purposes. In response to the COVID-19 pandemic and its impact on consumer confidence and spending, management drastically reduced related advertising and digital marketing expenditures in mid-March 2020. However, we continue to monitor and adjust our advertising and digital marketing and professional services expenditure levels to correspond to market changes. As a result, we increased these expenditures during the fiscal year ended June 30, 2021, and may continue seeing an increase in these expenditure levels during Fiscal 2022 and beyondInventories.
As discussed above, on June 18, 2020, we received the proceeds from the PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of $965,000 was disbursed by the Lender pursuant to a Promissory Note issued by us on June 15, 2020. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of the gain in connection with the extinguishment of this debt, including the forgiveness of accrued and unpaid interest of approximately $9,000, was recognized in the fiscal year ended June 30, 2021.
Operating Activities and Cash Flows
We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of June 30, 2021, our principal sources of liquidity were cash, cash equivalents, and restricted cash totaling $21.45 million, trade accounts receivable of $1.66 million, and net current inventory of $11.45 million, as compared to cash, cash equivalents, and restricted cash totaling $14.62 million, trade accounts receivable of $671,000, and net current inventory of $7.44 million as of June 30, 2020. We also had access during Fiscal 2021 to a $5.00 million asset-based revolving credit facility with White Oak, or the White Oak Credit Facility, which we terminated in accordance with its terms as of July 9, 2021. As described more fully herein, effective July 7, 2021, we obtained from JPMorgan Chase Bank, N.A., or JPMorgan Chase, a $5.00 million cash collateralized line of credit facility, or the JPMorgan Chase Credit Facility. Also as described more fully herein, we had long-term debt in the form of a PPP Loan in the amount of $965,000, of which $193,000 was classified as current as of June 30, 2020. Effective June 23, 2021, the Company’s PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000 as well as forgiveness of accrued and unpaid interest of approximately $9,000.
During the fiscal year ended June 30, 2021, our working capital increased by approximately $12.72 million to $30.14 million from $17.42 million at June 30, 2020. As described more fully below, the increase in working capital at June 30, 2021 is primarily attributable to an increase in our cash, cash equivalents, and restricted cash, principally resulting from cash provided by our operations, 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 receivable, a decrease in our accounts payable, an increase in connection with the issuance of a short-term note receivable, a decrease in the current portion of our long-term debt, resulting from the forgiveness of our PPP Loan, and a decrease in our short-term operating lease liabilities. These factors were offset partially by an increase in our accrued expenses and other liabilities and a decrease in our prepaid expenses and other assets.
During the fiscal year ended June 30, 2020, our working capital decreased by approximately $5.75 million to $17.42 million from $23.17 million at June 30, 2019. As described more fully below, the decrease in working capital at June 30, 2020 is primarily attributable to a decrease in our allocation of inventory from long-term to short-term, a decrease in accounts receivable, an increase in short-term operating lease liabilities resulting from the adoption of the new lease accounting standard as of July 1, 2019, an increase in accrued expenses and other liabilities, an increase in accounts payable, and an increase in the current maturity of our long-term debt. These factors were offset partially by an increase in our cash, cash equivalents, and restricted cash resulting from cash provided by operating and financing activities and an increase in prepaid expenses and other assets.
During the fiscal year ended June 30, 2021, approximately $6.47 million of cash was provided by our operations. The primary drivers of our cash flows from operations were the favorable effect of net income in the amount of $12.81 million; an increase in accrued expenses and other liabilities of $3.71 million; a decrease in inventory of $1.31 million; and an increase in accrued income taxes in the amount of $2,000. These factors were offset partially by an increase in prepaid expenses and other assets of $3.14 million; an increase in accounts receivable of $955,000; and a decrease in accounts payable of $974,000. In addition, the net effect of non-cash items included in net income totaling $6.29 million, driven by the benefit recognized for deferred income taxes in the amount of approximately $6.35 million in connection with the release of our valuation allowance and the gain on extinguishment of debt resulting from the forgiveness of our PPP Loan, including forgiveness of accrued and unpaid interest, captionin the amount of approximately $974,000, also unfavorably impacted net cash provided by operating activities during the fiscal year ended June 30, 2021.
During the fiscal year ended June 30, 2020, approximately $249,000 of cash was provided by our operations. The primary drivers underlying the cash provided by our operating activities were a decrease in accounts receivable of $1.32 million; a decrease in prepaid expenses and other assets of $490,000; an increase in accounts payable of $469,000; and an increase in accrued expenses and other liabilities of $109,000. In addition, non-cash items totaling $6.78 million also had a favorable impact on our cash flow from operations during the fiscal year ended June 30, 2020. These factors were offset partially by the unfavorable effect of our net loss in the amount of $6.16 million and an increase in inventory of approximately $2.76 million resulting from lower quantities of inventory items sold as a result of lower period sales stemming from the impact of the COVID-19 pandemic.
During the fiscal year ended June 30, 2021, accounts receivable increased principally due to the increased level of sales during the three months ended June 30, 2021, as compared with the sales during the period leading up to June 30, 2020. As a result of the COVID-19 pandemic, from time to time we offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers during Fiscal 2021 and the second half of Fiscal 2020. 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.
During the fiscal year ended June 30, 2021, prepaid expenses and other assets decreased principally as a furtherresult of the timing of payments, primarily for insurance-related premium expenses, in advance of goods or services received. During the fiscal year ended June 30, 2021, accrued expenses and other liabilities increased principally as a result of the increase in our operating lease liability associated with the new lease amendment for our corporate headquarters facilities that was executed in January 2021. During the fiscal year ended June 30, 2021, accounts payable decreased primarily as a result of the timing of payments for costs associated with inventory-related purchases and professional services incurred. As a result of the pandemic, we have from time-to-time paid certain vendor business partners in advance of their payment terms to secure and achieve supply chain needs.
During the fiscal year ended June 30, 2020, prepaid expenses and other assets increased principally as a result of the timing of payments, principally for insurance-related expenses, in advance of goods or services received. During the fiscal year ended June 30, 2020, accounts payable increased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors’ payment terms. Likewise, accrued expenses and other liabilities increased principally due to the severance accrual in connection with our June 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to payments received prior to shipment of good from customers.
We manufactured approximately $7.63 million and $10.64 million in loose jewels and $12.72 million and $7.82 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 fiscal years ended June 30, 2021 and 2020, 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 increased significantly over the past decade, resulting in higher retail price points for gold jewelry. Because the market price of gold and other precious metals is beyond our control, the upward price trends could continue and have a negative impact on our operating cash flow as we manufacture finished jewelry.
Historically, our raw material inventories of SiC crystals had been purchased under exclusive supply agreements with a limited number of suppliers. Because the supply agreements restricted the sale of these crystals exclusively to us, the suppliers negotiated minimum purchase commitments with us that, when combined with reduced sales levels during prior periods in which the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As of June 30, 2021 and 2020, $17.72 million and $23.19 million, respectively, 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 $1.78 million and new raw material that we purchase pursuant to the Supply Agreement.
A more detailed description of our inventories accounting policyis included in Note 6 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
We made income tax payments of approximately $15,000 and $2,000 during the fiscal years ended June 30, 2021 and 2020, respectively. As of June 30, 2021, all of our remaining federal income tax credits had expired or been utilized, and therefore, are not available to be carried forward to offset future income taxes. As of June 30, 2021 and 2020, we had federal tax net operating loss carryforwards of approximately $19.00 million and $23.72 million, respectively, expiring between 2034 and 2037, or that have no expiration, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $19.87 million and $20.12 million, respectively, expiring between 2023 and 2035; and various other state tax net operating loss carryforwards expiring between 2023 and 2040, which can be used to offset against future state taxable income.
Contractual Commitment
On December 12, 2014, we entered into the Supply Agreement with Cree. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of our required SiC materials in quarterly installments that must equal or exceed a set minimum order quantity. The initial term of the Supply Agreement was scheduled to expire on June 24, 2018, unless extended by the parties. Effective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement, as amended, also provides for the exclusive production of our premium moissanite product, Forever One™ and provided us with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following the expiration of the initial term. In addition, the amendment to the Supply Agreement established a process by which Cree 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 Cree 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 $32.85 million remains to be purchased as of June 30, 2021.
For more information regarding the second amendment to our Supply Agreement, executed on August 26, 2020, see Note 510 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
During the fiscal years ended June 30, 2021 and 2020, we purchased approximately $3.78 million and $7.47 million, respectively, of SiC crystals from Cree. Going forward, we expect to use existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, together with future cash expected to be provided by operating activities to finance our purchase commitment under the Supply Agreement, as amended.
Line of Credit
Effective July 7, 2021, we obtained from JPMorgan Chase our $5.00 million cash collateralized JPMorgan Chase Credit Facility. The JPMorgan Chase Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions and certain additional indebtedness for borrowed money, installment obligations, and obligations under capital and operating leases. The JPMorgan Chase Credit Facility is secured by a cash deposit in the amount of $5.05 million held by JPMorgan Chase as collateral for the line of credit facility.
Each advance accrues interest at a rate equal to JPMorgan Chase’s monthly London Interbank Offered Rate, or LIBOR, multiplied by a statutory reserve rate for eurocurrency funding to which JPMorgan Chase is subject with respect to the adjusted LIBOR rate as established by the U.S. Federal Reserve Board, plus a margin of 1.25% per annum. Interest is calculated monthly on an actual/360 day basis and payable monthly in arrears. Principal outstanding during an event of default, at JPMorgan Chase’s option, accrues interest at a rate of 3% per annum in excess of the above rate. Any advance may be prepaid in whole or in part at any time. See Note 2, under the caption of Recently Issued Accounting Pronouncements, to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K for more detailed information relating to our accounting for inventory-related reserves.concerns about structural risks of interbank offered rates, or IBORs, and, particularly, the risk of cessation of the LIBOR.
Accounts Receivable Reserves - Estimates are usedThe JPMorgan Chase Credit Facility is evidenced by a credit agreement between us and JPMorgan Chase, or the JPMorgan Chase Credit Agreement, dated as of July 12, 2021, and customary ancillary documents, in the principal amount not to determineexceed $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, 2022, the amount of two reserves against trade accounts receivable. $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 first reserve is an allowance for sales returns. At the time revenue is recognized, we estimate future returns using a historical return rate that is reviewed quarterly with consideration of any contractual return privileges granted to customers,JPMorgan Chase Credit Agreement and we reduce salesancillary documents contain customary covenants, representations, fees, debt, contingent obligations, liens, loans, leases, investments, mergers, acquisitions, divestitures, subsidiaries, affiliate transactions, and trade accounts receivable by this estimated amount. The allowance for sales returns was $746,000, $648,000 and $537,000 at June 30, 2019, June 30, 2018 and December 31, 2017, respectively.
The second reserve is an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. This allowance reduces trade accounts receivable to an amount expected to be collected. Based on historical percentages of uncollectible accounts by aging category, changes in payment history, and facts and circumstances regarding specific accounts that become known to management when evaluating the adequacy of the allowance for doubtful accounts, we determine a percentage based on the age of the receivable that we deem uncollectible. The allowance is then calculated by applying the appropriate percentage to each of our accounts receivable aging categories, with consideration given to individual customer account activity subsequent to the current period, including cash receipts, in determining the appropriate allowance for doubtful accounts in the current period. Any increases or decreases to this allowance are charged or credited, respectively, as a bad debt expense to general and administrative expenses. We generally use an internal collection effort, which may include our sales personnel as we deem appropriate. After all internal collection efforts have been exhausted, we generally write off the account receivable.control.
Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstances of the specific account. During our reviews for the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the year ended December 31, 2017, we determined no additional reserves were necessary for specific accounts. Based on these criteria, management determined that allowances for doubtful accounts receivable of $249,000, $233,000 and $254,000 at June 30, 2019, June 30, 2018 and December 31, 2017, respectively, were required.
Deferred Tax Assets -As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. Beginning in 2014, management determined that negative evidence outweighed the positive and established a full valuation allowance against our deferred tax assets. We maintained a full valuation allowance as of June 30, 2019, June 30, 2018 and December 31, 2017.
Our deferred tax assets in Hong Kong were fully reserved with a valuation allowance of $996,000 as of June 30, 2019, June 30, 2018 and December 31, 2017 and had been fully reserved in all prior periods due to the uncertainty of future taxable income in this jurisdiction to utilize the deferred tax assets. Charles & Colvard (HK) Ltd., our Hong Kong subsidiary, which was re-activated in December 2017, but had no operating activity during the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the year ended December 31, 2017, previously ceased operations during 2008 and became a dormant entity during 2009. If we use any portion of our deferred tax assets in future periods, the valuation allowance would need to be reversed and may impact our future operating results.
As a result of the Tax Cuts and Jobs Act, or Tax Act, enacted in December 2017, we wrote down our net deferred tax assets as of December 31, 2017 by approximately $519,000 driven principally by the lowering of the U.S. corporate income tax rate from 35% to that of 21% effective January 1, 2018. Likewise, in December 2017, we recorded a corresponding net adjustment to our valuation allowance related to the re-measurement of certain net deferred tax assets using the lower U.S. corporate income tax rate.
In connection with filing our 2017 U.S. corporate income tax return in June 2018,the JPMorgan Chase Credit Facility, we completed our analysis of the income tax effects of the Tax Act and the effect on our existing corporate alternative minimum tax, or AMT, deferred tax asset, including the nature, validity, and recoverability of our AMT-related deferred tax credit carryforwards. Upon completing this analysis, we determined that we were able to recognize the underlying tax benefit relating to the realization of the recoverable portion of its AMT-related deferred tax credit carryforwards, net of an expected sequestration reduction,incurred a non-refundable origination fee in the amount of approximately $328,000. Accordingly, we recorded$10,000 that was paid in full to JPMorgan Chase upon execution of the expected AMT credit refund as a receivable, net of an anticipated sequestration reductionJPMorgan Chase Credit Facility on July 12, 2021. We also agreed to maintain our primary banking depository and such amount was includeddisbursement relationship with other long-term assets in our Consolidated Balance Sheets as of June 30, 2018.JPMorgan Chase.
35Events 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.
the JPMorgan Chase Credit Facility.However, on January 14, 2019,
Prior to obtaining the Internal Revenue Service,JPMorgan Chase Credit Facility, we and our wholly owned subsidiary, charlesandcolvard.com, LLC, collectively referred to as the Borrowers, had a $5.00 million asset-based revolving credit facility, or the IRS, announced that refund payments and refund offset transactions due to refundable minimum tax credits associated with the repeal of the corporate AMT as part of the Tax Act would not be subject to sequestration. Accordingly, following the IRS’s announcement that AMT credit refunds would not be subject to the government sequestration amount, in January 2019White Oak Credit Facility, from White Oak Commercial Finance, LLC, or White Oak, which we recognized the additional available underlying tax benefit and recorded the sequestered portion of its AMT credit refund in the amount of approximately $23,000. This amount, net of amounts received, was also included with other long-term assets in our Consolidated Balance Sheets as of June 30, 2019.
Uncertain Tax Positions – We account for the de-recognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positionsterminated in accordance with U.S. GAAP. Determining which tax positions qualifyits terms as uncertain positionsof July 9, 2021. The effective date of the White Oak Credit Facility was July 13, 2018, and it was scheduled to mature on July 13, 2021.
The White Oak Credit Facility was available for general corporate and working capital purposes, including permitted acquisitions and was guaranteed by the subsequent accounting for these positions requires significant estimates and assumptions. Our net accrued income tax liabilityBorrowers. Under the terms of the White Oak Credit Facility, the Borrowers were required to maintain at least $500,000 in excess availability at all times. The White Oak Credit Facility contained no other financial covenants.
Advances under the provisionsWhite Oak Credit Facility could have been either revolving or non-revolving. During the first year of this guidance was $493,000, $471,000 and $462,000 at June 30, 2019, June 30, 2018 and December 31, 2017, respectively. This liability is only resolved when we obtain an official ruling from the tax authority onterm of the positions or when the statute of limitations expires. Our liability forWhite Oak Credit Facility, any revolving advances would have accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and any non-revolving advances would have accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins would have been reduced upon the Company’s achievement of a specified fixed charge coverage ratio during the period of any outstanding advances. However, any advances were in all cases subject to a minimum interest rate of 5.50% and interest would have been calculated on these uncertain tax positions has increased by approximately $22,000, $10,000an actual/360 basis and $28,000payable monthly in arrears. Principal outstanding during an event of default, which again did not occur during the term of the White Oak Credit Facility, would have accrued interest at a rate 2% in excess of the rate that would have been otherwise applicable.
We had not borrowed against the White Oak Credit Facility as of June 30, 2019, June 30, 2018 and December 31, 2017, respectively.
Revenue Recognition – Effective January 1, 2018, we adoptedJuly 9, 2021, the new accounting standard in connection with revenue recognition guidance that was issued by the FASB, and as a result, we changed our accounting policy for revenue recognition. Based on our analysis of the new accounting standard, the timing and measurement of revenues under the new guidance is consistent with our prior revenue recognition policies. Therefore, no adjustment was required to our opening balance of equity as of January 1, 2018, and comparative prior period information has not been adjusted and continues to be reported under the accounting guidance in effect prior to the change of accounting.
Based on our accounting policy, revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration todate upon which we expect to be entitled in exchange for those goods or services. To achieve this principle, we performterminated the following five steps: (i) identification of a contract with a customer; (ii) identification of any separate performance obligations; (iii) determination of the transaction price; (iv) allocation of the transaction price to the performance obligations in the contract; and (v) recognition of revenue when we have satisfied the underlying performance obligations. We recognize substantially all of our revenue at a point in time when control of our goods has passed to the customer, which typically occurs upon shipment, with the exception of consigned goods. We consider our performance obligation related to the shipment of goods satisfied at the time this control is transferred. We also have a variable consideration element related to most of our contracts in the form of product return rights. At the time revenue is recognized, an allowance for estimated returns is established and any change in the allowance for returns is charged against net sales in the current period. For our Traditional segment and Online Channels segment customers (excluding those of charlesandcolvard.com), the returns policy generally allows for the return of jewels and finished jewelry with a valid reason for credit within 30 days of shipment. Our charlesandcolvard.com customers may return purchases for any reason within 60 daysWhite Oak Credit Facility in accordance with our returns policy as disclosed on the charlesandcolvard.com website. Periodically, we ship loose jewel goods and finished goods to Traditional segment customers on consignmentits terms. Under these consignment terms, the customer assumes the risk of loss and has an absolute right of return for a specified period that typically ranges from six months to one year. Our Online Channels segment and Traditional segment customers are generally required to make payments on consignment shipments within 30 days upon the customer informing us that such inventory will be kept by the customer. Accordingly, we do not recognize revenue on these consignment transactions until the earlier of (i) the customer informing us that the inventory will be kept by the customer; (ii) the expiration of the right of returns period; or (iii) the customer informing us that the inventory has been sold.
SeeMore detailed descriptions of both our JPMorgan Chase Credit Facility and former White Oak Credit Facility are included in Note 211 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K under the Change in Accounting Policy and Revenue Recognition captions for additional information regarding the adoption of the new revenue recognition accounting standard as of January 1, 2018, and the underlying required disclosures arising from contracts with customers as well as a more detailed description of our revenue recognition accounting policy.
10-K.
Recent Accounting Pronouncements -47
Liquidity and Capital Trends
We believe that our existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, and future cash expected to be provided by operating activities combined will be sufficient to meet our working capital and capital expenditure needs over the next twelve months.
Our future capital requirements and the adequacy of available funds will depend on many factors, including the ongoing uncertainty surrounding COVID-19 that could lead to further disruption and volatility in the global capital markets See Note 2as 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 consolidated financial statementsmoissanite 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 I, Item 8, “Financial Statements and Supplementary Data”,1A of this Annual Report on Form 10-K under10-K. Currently, we have the Recently Adopted/Issued Accounting Pronouncements caption for the descriptionJPMorgan Chase Credit Facility through its expiration on July 31, 2022, which we believe would mitigate these risks to our cash and liquidity position. Also, we may make investments in, or acquisitions of, recent accounting pronouncements, including the expected date of adoption and estimated effects, on our consolidated financial statements.complementary businesses, which could also require us to seek additional equity or debt financing.
Certain Operating MetricsResults of Operations
The following table sets forth certain consolidated statements of operations data for the fiscal years ended June 30, 2021 and 2020:
| | | Year Ended June 30, | |
| | | 2021 | | | 2020 | |
| Net sales | | $ | 39,235,839 | | | $ | 29,189,020 | |
| Costs and expenses: | | | | | | | | |
| Cost of goods sold | | | 20,809,690 | | | | 21,200,207 | |
| Sales and marketing | | | 8,476,716 | | | | 9,443,244 | |
| General and administrative | | | 4,441,441 | | | | 4,861,297 | |
| Total costs and expenses | | | 33,727,847 | | | | 35,504,748 | |
| Income (Loss) from operations | | | 5,507,992 | | | | (6,315,728 | ) |
| Other income (expense): | | | | | | | | |
| Gain on extinguishment of debt | | | 974,328 | | | | - | |
| Interest income | | | 5,581 | | | | 158,091 | |
| Interest expense | | | (8,953 | )
| | | (884 | ) |
| Loss on foreign currency exchange | | | (603 | )
| | | (1,829 | ) |
| Total other income (expense), net | | | 970,353 | | | | 155,378 | |
| Income (Loss) before income taxes | | | 6,478,345 | | | | (6,160,350 | ) |
| Income tax benefit (expense) | | | 6,332,421 | | | | (1,733 | ) |
| Net income (loss) | | $ | 12,810,766 | | | $ | (6,162,083 | ) |
The following operating metrics are based on financial results
Consolidated Net Sales
Consolidated net sales for the fiscal years ended June 30, 2021 and customer-related data for charlesandcolvard.com, LLC, a wholly-owned subsidiary of Charles & Colvard, Ltd.,2020 comprise the following:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 24,401,546 | | | $ | 16,777,628 | | | $ | 7,623,918 | | | | 45 | % |
| Loose jewels | | | 14,834,293 | | | | 12,411,392 | | | | 2,422,901 | | | | 20 | % |
| Total consolidated net sales | | $ | 39,235,839 | | | $ | 29,189,020 | | | $ | 10,046,819 | | | | 34 | % |
Consolidated net sales were $39.24 million for the fiscal year ended June 30, 2019:
Average order value, or AOV, is estimated2021 compared to be approximately $1,000, based on charlesandcolvard.com revenue, net of returns, divided by the total number of customer orders.
Average ad spend per new customer is estimated to be approximately $220, based on the total advertising spend focused on charlesandcolvard.com traffic divided by the number of first-time customer orders.
Repeat customers represent approximately 28% of charlesandcolvard.com’s total customer orders, based on customer email addresses.
Our calculation for AOV is sensitive to volume and product mix. Therefore, we believe that our AOV may vary widely going forward as we respond to ever changing consumer demand and provide the products – that may have widely variable price points – our audiences are looking for. Likewise, as we continue to invest in our advertising and marketing communication channels and broaden the underlying content types, we expect our average ad spend per customer to increase substantially going forward. Finally, as our Loyalty Program is revived, we expect the percentage of people enrolled in our program to continue increasing substantially over time.
The following operating metrics are based on financial results and customer-related data for charlesandcolvard.com, LLC,$29.19 million for the fiscal year ended June 30, 2019 compared2020, an increase of $10.05 million, or 34%. In addition to prior twelve-month period ended June 30, 2108 (unaudited):
51% year-over-year growth in charlesandcolvard.com revenue.
5.5% year-over-year growth in social media followers; 21% year-over-year growth in opt-in email subscribers.
For the fiscal year ended June 30, 2019, gross margin (defined as net sales less product line cost of goods sold) for our Online Channels segment was 58% of Online Channels net sales compared to 52% gross margin foradverse impact that the twelve-month period ended June 30, 2018 (unaudited).
Summary Financial Results for the Fiscal Year Ended June 30, 2019
The following is a summary of key financial results achieved for the fiscal year ended June 30, 2019 compared with the twelve months ended June 30, 2018 (unaudited):
| • | Our totalCOVID-19 pandemic had on consolidated net sales increased by $4.34 million, or 16%, to $32.24 million in the fiscal year ended June 30, 2019 from $27.91 million in the twelve-month period ended June 30, 2018 (unaudited). The increase in consolidated net sales for the fiscal year ended June 30, 2019 was due primarily to strong seasonal sales for both Valentine’s Day and the calendar year-end 2018 holidays coupled with increased demand for our Forever OneTM gemstones over the comparable period in the twelve months ended June 30, 2018 (unaudited), reflecting higher finished jewelry net sales.
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| • | Online Channels segment net sales during the fiscal year ended June 30, 2019 of $16.34 million were 25% higher than Online Channels segment net sales during the twelve months ended June 30, 2018 (unaudited). Expanded jewelry selections resulted in higher finished jewelry sales and ongoing increased demand for our Forever OneTM and Moissanite by Charles & Colvard® gemstones during the fiscal year ended June 30, 2019 as evidenced through our increased presence on e-commerce outlets, including marketplaces and through charlesandcolvard.com within our Online Channels segment.
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Traditional segment net sales for the fiscal year ended June 30, 2019 of $15.91 million were 7% higher than Traditional segment2020, the increase in consolidated net sales for the twelve monthsfiscal year ended June 30, 2018 (unaudited), primarily driven by an increase2021 compared with consolidated net sales for the prior fiscal year was also principally due to robust calendar year-end holiday sales during our fiscal quarter ended December 31, 2020, coupled with strong February Valentine’s Day sales and March St. Patrick’s Day sales during our fiscal quarter ended March 31, 2021. These higher sales for Fiscal 2021 were also related to increased consumer awareness and ongoing strong demand for our moissanite jewels, lab grown diamonds, and finished jewelry featuring both moissanite and lab grown diamonds. These increases resulted in the international distribution channel that primarily distributes loose gems to independent retail jewelershigher finished jewelry product net sales during the fiscal year ended June 30, 2019. This decrease was offset somewhat by higher gemstone sales through our international distribution network as a result of our ongoing initiatives with these customers.
| • | Finished jewelry sales for the fiscal year ended June 30, 2019 comprised 48% of our total consolidated net sales and increased 19% to $15.46 million, compared with $13.00 million for the twelve months ended June 30, 2018 (unaudited), primarily due to higher finished jewelry retail sales in our Online Channels segment as well as increased sales of Forever One™ and Moissanite by Charles & Colvard® products in our Traditional segment. Loose jewel sales comprised 52% of our total consolidated net sales for the fiscal year ended June 30, 2019 and increased 13% to $16.79 million, compared with $14.91 million for the twelve months ended June 30, 2018 (unaudited), primarily due to higher levels of loose jewel sales in both our Online Channels segment and principally through the international distribution network in our Traditional segment.
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Operating expenses increased by a net $167,000, or 1%, to $12.63 million in the fiscal year ended June 30, 2019 from $12.46 million in the twelve-month period ended June 30, 2018 (unaudited). Of this net increase, sales and marketing expenses increased $342,000, or 4%, to $7.98 million, primarily due to increased digital and social media marketing expenses associated with implementing our sales and marketing strategies, offset partially by a decrease in compensation-related expenses. Offsetting the increased sales and marketing expenses, general and administrative expenses decreased a net $176,000, or 4%, to $4.64 million primarily as a result of decreased professional services expenses, principally as a result of hiring a full-time in-house counsel, partially offset by increases in business franchise taxes, bad debt expense, insurance expenses, and compensation-related expenses.
Income before income taxes of approximately $2.27 million for the fiscal year ended June 30, 2019 improved from a loss of $1.08 million for the twelve-month period ended June 30, 2018 (unaudited). The increase in income before income taxes was due primarily to strong seasonal holiday sales as well as increased consumer awareness and demand for our moissanite gemstones and finished jewelry that resulted in higher sales2021 in both our Online Channels segment and Traditional segment. Our gross marginOne of the most profound changes in consumer buying habits over the past fiscal year was the shift to digital channels shopping from the more traditional brick-and-mortar platforms. We believe the COVID-19 pandemic accelerated this shift toward e-commerce, as consumers worldwide became more reliant on the digital channel while in isolation. Accordingly, we saw strong increases in our Online Channels segment net sales in the fiscal year ended June 30, 2021. As consumer confidence strengthened during the second half of Fiscal 2021, net sales in our Traditional segment increased over this period driven by stronger loose jewel sales in our distributor network. However, these increased loose jewel net sales in our Traditional segment were offset in part due to lower international sales during the fiscal year ended June 30, 2021.
Sales of finished jewelry represented 62% and 57% of total consolidated net sales for the fiscal years ended June 30, 2021 and 2020, respectively. For the fiscal year ended June 30, 2021, finished jewelry sales were $24.40 million compared to $16.78 million for the fiscal year ended June 30, 20192020, an increase of $7.62 million, or 45%. This increase in finished jewelry sales was 46% compareddue primarily to 40%higher finished jewelry sales of Moissanite by Charles & Colvard® and our Signature Collection line of products in our Online Channels segment as well as in our Traditional segment. Net sales of our Moissanite by Charles & Colvard®and our Signature Collection finished jewelry and loose jewels represented 15% and 9%, respectively, of total net sales for the twelve-month period ended June 30, 2018 (unaudited). These improvements were offset somewhat by a one-time gain on an insurance claim settlement that was recognized during the twelve-month period ended June 30, 2018 (unaudited).
We recorded net income of $2.28 million in the fiscal year ended June 30, 2019,2021, compared to athat of 11% and 7%, respectively, for the prior fiscal year.
Sales of loose jewels represented 38% and 43% of total consolidated net loss of $767,000 insales for the twelve-month periodfiscal years ended June 30, 2018 (unaudited). Fully diluted net income per share was $0.10 in 2021 and 2020, respectively. For the fiscal year ended June 30, 20192021, loose jewel sales were $14.83 million compared to a net loss per share of $0.04 in $12.41 million for the twelve-month periodfiscal year ended June 30, 2018 (unaudited)2020, an increase of $2.42 million, or 20%. The improvementincrease for the fiscal year ended June 30, 2021 was primarily a result of higher sales of loose jewels through our domestic distributors. However, these increased loose jewel sales were offset somewhat by lower sales of loose jewels through the international distribution network in our financial results period over period was primarilyTraditional segment.
U.S. net sales accounted for approximately 95% and 92% of total consolidated net sales during the fiscal years ended June 30, 2021 and 2020, respectively. U.S. net sales increased during the fiscal year ended June 30, 2021 principally as a result of strongincreased sales growthto U.S. customers in both our Online Channels segment and improved gross margins along with operating expensesTraditional segment.
Our largest U.S. customer during the fiscal years ended June 30, 2021 and 2020 accounted for 13% of total consolidated net sales during each of the respective periods then ended. Likewise, our second largest U.S. customer during the fiscal years ended June 30, 2021 and 2020 accounted for 12% of total consolidated net sales during each of the respective periods. It should be noted that our largest and second largest customers in Fiscal 2021 were essentially flat whenour second largest and largest customers, respectively, in Fiscal 2020. We expect that we will remain dependent on our ability, and that of our largest customers, to maintain and enhance retail and wholesale programs. A change in or loss of any of these customers or retailer relationships could have a material adverse effect on our results of operations.
International net sales accounted for approximately 5% and 8% of total consolidated net sales during the fiscal years ended June 30, 2021 and 2020, respectively. International net sales decreased to $2.01 million, or 15%, during the fiscal year ended June 30, 2021 compared to the comparable unaudited year-ago period. The improved results$2.37 million in the fiscal year ended June 30, 2019 were offset by the one-time gain on an insurance claim settlement that was recognized2020. International sales decreased during the twelve-month periodfiscal year ended June 30, 2018 (unaudited).2021, compared to the prior fiscal year primarily as a result of lower demand in our international distributor market, which was partially offset by growth in our direct-to-consumer presence internationally reflecting solid direct-to-consumer sales from our Online Channels segment in international markets. In addition, whilelight of the effects of ongoing global economic conditions and as the world continues to recover from the COVID-19 pandemic, we continue to evaluate these and other potential distributors in international markets to determine the best long-term partners. As a result, and in light of the ongoing worldwide pandemic and international trade challenges, we expect our net incomesales in these markets to continue to fluctuate significantly each reporting period.
We did not have an international customer account for 10% or more of total consolidated sales during the fiscal years ended June 30, 2021 and 2020. A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal years ended June 30, 2021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Finished jewelry | | $ | 11,272,012 | | | $ | 7,469,790 | | | $ | 3,802,222 | | | | 51 | % |
| Loose jewels | | | 6,857,755 | | | | 6,062,186 | | | | 795,569 | | | | 13 | % |
| Total product line cost of goods sold | | | 18,129,767 | | | | 13,531,976 | | | | 4,597,791 | | | | 34 | % |
| Non-product line cost of goods sold | | | 2,679,923 | | | | 7,668,231 | | | | (4,988,308 | ) | | | (65 | )% |
| Total cost of goods sold | | $ | 20,809,690 | | | $ | 21,200,207 | | | $ | (390,517 | ) | | | (2 | )% |
Total cost of goods sold was $20.81 million for the fiscal year ended June 30, 2019 reflected the impact of the recognition of a federal income tax benefit in the amount of approximately $23,000 in connection with changes in the Tax Act relating2021 compared to the realization of a recoverable portion of the AMT deferred tax credit carryforwards being reclassified from a deferred tax asset to that of an income tax receivable, our results in the twelve-month period ended June 30, 2018 (unaudited) also included a federal income tax benefit in the amount of approximately $328,000 also relating to the realization of an additional recoverable portion of the AMT deferred tax credit carryforwards that were reclassified from a deferred tax asset to that of an income tax receivable during the unaudited period then ended.
We generated net cash from operations of approximately $917,000 in $21.20 million for the fiscal year ended June 30, 2019, compared to negative cash flows2020, a net decrease of approximately $391,000, or 2%. 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 operationsour 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 $2.69 million quality issues, and damaged goods.
The decrease in total cost of goods sold for the twelve-month periodfiscal year ended June 30, 2018 (unaudited). The primary drivers2021 as compared to the fiscal year ended June 30, 2020 was driven primarily by the prior year write-off during the quarter ended March 31, 2020, of approximately $5.26 million representing the carrying value of our operating cash flowlegacy loose jewel inventory and finished goods inventory set with these legacy gemstones. This decrease in cost of goods sold for the fiscal year ended June 30, 2021, was offset in part by higher cost of goods sold principally driven by increased sales of finished jewelry, which reflect higher material and labor costs, in both our Online Channels segment and Traditional segment as a result of strong product demand during the year.
The net decrease in non-product line cost of goods sold for the fiscal year ended June 30, 2021 comprises a $5.71 million lower change in inventory valuation adjustments principally related to the prior fiscal year’s write-off of the carrying cost of the Company’s legacy material inventory of $5.26 million during the quarter ended March 31, 2020, as well as other inventory valuation adjustments related to changes in obsolescence reserves in the fiscal year ended June 30, 2019 were2021, compared to those in the prior fiscal year. This decrease in non-product line cost of goods sold was offset in part by a net income of $2.28 million and an$503,000 increase in accrued liabilities of $572,000. In addition, non-cash items totaling $1.51 million also had a favorable impact on our cash flowfreight out principally from operationsincreased shipments resulting from substantial Online Channels segment sales growth during the fiscal year ended June 30, 2019. These factors were partially offset by an2021; a $147,000 increase in non-capitalized manufacturing and production control expenses in the current year principally due to the timing when work-in-process goods are received into inventory of $2.30 million; a decrease in accounts payable of $799,000; an increase in accounts receivable of $328,000;and applicable overhead costs are allocated; and an increaseapproximate $76,000 change in prepaid expenses and other assets of $14,000.
Cash, cash equivalents and restricted cash at June 30, 2019 were $13.01 millioninventory adjustments primarily relating to adverse changes in production standard cost variances compared to cash and cash equivalents of $3.39 million at June 30, 2018. The primary reasons for this increase are the $9.06 million of cash proceeds, net of the underwriting discount and fees and expenses, from our underwritten public offering in June 2019 and the approximately $917,000 of cash provided by operations. These increases were offset by approximately $426,000 used in investing activities, principally for capital expendituresthose during the fiscal year ended June 30, 2019.
For further discussion of non-product line cost of goods sold, see Note 3 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Sales and Marketing
Sales and marketing expenses for the fiscal years ended June 30, 2021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| Sales and marketing | | $ | 8,476,716 | | | $ | 9,443,244 | | | $ | (966,528 | ) | | | (10 | )% |
Sales and marketing expenses were $8.48 million for the fiscal year ended June 30, 2021 compared to $9.44 million for the fiscal year ended June 30, 2020, a decrease of approximately $967,000, or 10%.
The decrease in sales and marketing expenses for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 was primarily due to a $1.31 million decrease in compensation-related expenses; a $164,000 decrease in professional services fees principally comprising non-recurring consulting services for cybersecurity and merchandising imaging incurred in the prior year; a $26,000 decrease in travel expenses as a result of COVID-19 cost-control measures; and a $1,000 net decrease in miscellaneous other general sales and marketing expenses. These decreases were partially offset by a $282,000 increase in advertising and digital marketing expenses; an $84,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; an $83,000 increase in general office-related expenses, which are principally related to higher credit card transaction fees from increased online sales levels; a $69,000 increase in depreciation and amortization expense relating to capitalized costs associated with information technology-related upgrades; and a $17,000 increase in employment-related recruiting fees.
Compensation expenses for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 decreased primarily as a result of a $1.25 million decrease in salaries, commissions, and related employee benefits in the aggregate as a result of our June 2020 management reorganization and workforce reduction; a $76,000 decrease in employee-related severance costs recognized in the prior year which also was a result of our June 2020 management reorganization and workforce reduction; and a $68,000 decrease in employee stock-based compensation expense associated with the modification of terms for certain participant stock options in Fiscal 2020 that resulted in the recognition of higher stock compensation expense in the prior fiscal year. These decreases were partially offset by an $84,000 increase in bonus expense reflecting improved operating results in the current year that impacts this performance-based compensation-related benefit.
The increase in digital marketing expenses for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 was primarily due to a $766,000 increase in Internet marketing costs and a $20,000 increase in print media expenses. Both increases reflect changes in our overall social media and print marketing strategies during Fiscal 2021 compared with those in Fiscal 2020. These increases were partially offset by a $386,000 decrease in outside agency fees, also as a consequence of modifications in our marketing strategy and reliance on internal resources during the current year; a $111,000 decrease in cooperative advertising; and a $7,000 decrease in promotion-related expenses.
General and Administrative
General and administrative expenses for the fiscal years ended June 30, 2021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| General and administrative | | $ | 4,441,441 | | | $ | 4,861,297 | | | $ | (419,856 | ) | | | (9 | )% |
General and administrative expenses were $4.44 million for the fiscal year ended June 30, 2021 compared to $4.86 million for the fiscal year ended June 30, 2020, a decrease of approximately $420,000, or 9%.
The decrease in general and administrative expenses for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 was primarily due to a $428,000 decrease in professional services; a $206,000 decrease in compensation-related expenses; a $7,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; and a $1,000 net decrease in miscellaneous other general and administrative expenses. These decreases were partially offset by a $58,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed in January 2021; a $50,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; a $38,000 increase in housing allowances and travel-related expenditures; a $30,000 increase in insurance expenses principally related to higher renewal premiums; a $20,000 increase in bank charges as a result of transaction fees associated with increased online transactions; a $14,000 increase in Board member retainer fees due to the temporary reduction in fees paid to our Board of Directors in connection with cost control measures implemented during the COVID-19 pandemic in the prior year; a $9,000 increase in depreciation and amortization expense; and a $3,000 increase in business taxes and licenses.
Professional services fees decreased for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 primarily due to a $283,000 decrease in legal fees resulting from non-recurring non-capitalized fees incurred in connection with our underwritten public offering and corporate governance matters in the prior year; a $101,000 decrease in consulting and other professional services primarily in connection with accounting department support in the prior year; and a $66,000 decrease in investor relations fees. These decreases were partially offset by a $22,000 increase in fees associated with audit and tax services in the current year.
Compensation expenses decreased for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 primarily due to a $282,000 decrease in severance expenses recognized in the prior year related to our June 2020 management reorganization and workforce reduction; a $184,000 decrease in salaries and related employee benefits in the aggregate which also was a result of our June 2020 management reorganization and workforce reduction; and a $54,000 decrease in employee stock-based compensation expense associated with the modification of terms for certain participant stock options in Fiscal 2020 that resulted in the recognition of higher stock compensation expense in the prior fiscal year. These decreases were offset in part by a $314,000 increase in bonus expense reflecting improved operating results in Fiscal 2021 that impacts this performance-based compensation-related benefit.
Gain on Extinguishment of Debt
Gain on extinguishment of debt for the fiscal years ended June 30, 2021 and 2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
Gain on extinguishment of debt | | $ | 974,328 | | | $ | - | | | $ | 974,328 | | | | 100 | % |
On June 18, 2020, we received the proceeds from our Paycheck Protection Program Loan, or the PPP Loan, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, as administered by the U.S. Small Business Administration, or SBA. The PPP Loan in the principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, or the Lender, pursuant to a promissory note, or the Promissory Note, dated June 15, 2020. During the period of time that the principal under the Promissory Note was outstanding, we accounted for the Promissory Note as debt within the accompanying consolidated financial statements. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of interest expense to-date in the amount of approximately $9,000 that the Company recognized during the period the principal of the PPP Loan was outstanding was also forgiven by the SBA. Accordingly, the full amount of the gain in connection with the extinguishment of this debt, including long-termthe benefit from the forgiveness of the inception to-date interest expense, was recognized in the fiscal year ended June 30, 2021.
Interest Income
Interest income for the fiscal years ended June 30, 2021 and consignment inventory,2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Interest income | | $ | 5,581 | | | $ | 158,091 | | | $ | (152,510 | ) | | | (96 | )% |
In June 2019, we completed an underwritten public offering of 6,250,000 shares of our common stock, which together with the partial exercise of the underwriters’ overallotment option for an additional 630,500 shares in July 2019, resulted in net proceeds of approximately $9.99 million. The net proceeds from this offering, along with excess operating cash, are deposited into and maintained in an interest-bearing account with a federally insured commercial bank. Accordingly, during the fiscal years ended June 30, 2021 and 2020, we earned interest from cash on deposit in this interest-bearing account. The decrease in earned interest reflects adverse changes in interest rate fluctuations during Fiscal 2021 compared with Fiscal 2020.
Interest Expense
Interest expense for the fiscal years ended June 30, 2021 and 2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Interest expense | | $ | 8,953 | | | $ | 884 | | | $ | 8,069 | | | | 913 | % |
In accordance with the terms of the Promissory Note, during the period of time the principal of the PPP Loan was $33.73outstanding through June 23, 2021, we accrued interest at a fixed rate of 1% per annum. Our accrual for interest expense associated with the PPP Loan began June 18, 2020, the date we received the proceeds for the PPP Loan from our Lender. Likewise, we accrued interest on the PPP Loan during the fiscal year ended June 30, 2021, through June 23, 2021, the date our PPP Loan was forgiven by the SBA.
Loss on Foreign Currency Exchange
Loss on foreign currency exchange related to foreign sales transacted in functional currencies other than the U.S. dollar for the fiscal years ended June 30, 2021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | 603 | | | $ | 1,829 | | | $ | (1,226 | ) | | | (67 | )% |
During the fiscal years ended June 30, 2021 and 2020, we had international sales transactions denominated in currencies other than the U.S dollar that resulted in foreign currency exchange net losses. The decrease in these losses reflects the lower level of international sales denominated in foreign currencies as well as foreign currency exchange rate fluctuations during fiscal year ended June 30, 2021 compared with those of the prior fiscal year.
Provision for Income Taxes
We recognized a net income tax benefit of approximately $6.33 million and a net income tax expense of approximately $2,000 for the fiscal years ended June 30, 2021 and 2020, respectively. Our income tax provisions in these periods contain estimated taxes, penalties, and interest associated with uncertain tax positions.
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. Beginning in 2014, we determined that negative evidence outweighed the positive and established a full valuation allowance against our deferred tax assets and we maintained such full valuation allowance through the period ended June 30, 2020. However, as of June 30, 2019, up from $31.83 million at2021, cumulative positive taxable income over the last three tax years had been generated in the U.S., as compared to the negative evidence of cumulative losses in previous years. We also determined that our expectations of future taxable income in upcoming tax years, including estimated growth rates applied to future expected taxable income that includes significant management estimates and assumptions, would be sufficient to result in full utilization of our federal net operating loss carryforwards and certain of the deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence exists as of June 30, 2018. This inventory increase2021, to conclude that it is more likely than not deferred tax assets of approximately $6.35 million are realizable, and we reduced our valuation allowance accordingly. The reduction of the valuation allowances against these deferred tax assets was in part,the main driver of the income tax benefit during the fiscal year ended June 30, 2021 of approximately $6.33 million. A valuation allowance remains against certain deferred tax assets primarily relating to state net operating loss carryforwards from our e-commerce subsidiary due to higher levelsthe timing uncertainty of consignment inventories that were producedwhen it will generate positive taxable income to meet anticipated product demand, offset by increasesutilize the associated deferred tax assets. In addition, a valuation allowance also remains against certain deferred tax assets relating to operating loss carryforwards relating to our dormant subsidiary located in inventory reservesHong Kong..
We continue to carry no long-term debt. And we believe that we will be able to continue to have access to additional working capital resources, including but not limited toOur statutory tax rate as of the White Oak Credit Facilityfiscal year ended June 30, 2021 is 22.24% and consists of the potential issuancefederal income tax rate of equity securities, to fund operations21% and our growth strategies fora blended state income tax rate of 1.24%, net of the foreseeable future.federal benefit.
Fiscal Year Ended June 30, 2019 and Twelve Months Ended June 30, 2018 (Unaudited)
The following table sets forth certain consolidated statements of operations data for the fiscal yearyears ended June 30, 20192021 and twelve-month period ended June 30, 2018 (unaudited):2020:
| | | Twelve Months Ended June 30, | | |
| | | 2019 | | | 2018 | | | Year Ended June 30, | |
| | | | | | (unaudited) | | | 2021 | | | 2020 | |
| Net sales | | $ | 32,244,109 | | | $ | 27,908,838 | | | $ | 39,235,839 | | | $ | 29,189,020 | |
| Costs and expenses: | | | | | | | | | | | | | | |
| Cost of goods sold | | 17,352,167 | | | 16,708,203 | | | | 20,809,690 | | | | 21,200,207 | |
| Sales and marketing | | 7,983,506 | | | 7,641,962 | | | | 8,476,716 | | | | 9,443,244 | |
| General and administrative | | 4,640,810 | | | 4,816,495 | | | | 4,441,441 | | | | 4,861,297 | |
| Research and development | | | 2,069 | | | | 571 | | |
| Total costs and expenses | | | 29,978,552 | | | | 29,167,231 | | | | 33,727,847 | | | | 35,504,748 | |
| Income (Loss) from operations | | 2,265,557 | | | (1,258,393 | ) | | | 5,507,992 | | | | (6,315,728 | ) |
| Other income (expense): | | | | | | | | | | | | | | |
| Gain on extinguishment of debt | | | | 974,328 | | | | - | |
| Interest income | | 11,022 | | | - | | | | 5,581 | | | | 158,091 | |
| Interest expense | | (2,198 | ) | | (742 | ) | | | (8,953 | )
| | | (884 | ) |
| Loss on foreign currency exchange | | (344 | ) | | (5 | ) | | | (603 | )
| | | (1,829 | ) |
| Gain on insurance claim settlement | | - | | | 183,217 | | |
| Other expense | | | (13 | ) | | | - | | |
| Total other income (expense), net | | | 8,467 | | | | 182,470 | | | | 970,353 | | | | 155,378 | |
| Income (Loss) before income taxes | | 2,274,024 | | | (1,075,923 | ) | | | 6,478,345 | | | | (6,160,350 | ) |
| Income tax net benefit | | | 1,443 | | | | 309,046 | | |
| Income tax benefit (expense) | | | | 6,332,421 | | | | (1,733 | ) |
| Net income (loss) | | $ | 2,275,467 | | | $ | (766,877 | ) | | $ | 12,810,766 | | | $ | (6,162,083 | ) |
Consolidated Net Sales
Consolidated net sales for the fiscal yearyears ended June 30, 20192021 and twelve months ended June 30, 2018 (unaudited)2020 comprise the following:
| | | Twelve Months Ended June 30, | | | Change | | |
| | | 2019 | | | 2018 | | | Dollars | | | Percent | | | Year Ended June 30, | | | Change | |
| | | | | | (unaudited) | | | | | | | | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 15,457,343 | | | $ | 13,001,941 | | | $ | 2,455,402 | | | 19 | % | | $ | 24,401,546 | | | $ | 16,777,628 | | | $ | 7,623,918 | | | | 45 | % |
| Loose jewels | | | 16,786,766 | | | | 14,906,897 | | | | 1,879,869 | | | 13 | % | | | 14,834,293 | | | | 12,411,392 | | | | 2,422,901 | | | | 20 | % |
| Total consolidated net sales | | $ | 32,244,109 | | | $ | 27,908,838 | | | $ | 4,335,271 | | | 16 | % | | $ | 39,235,839 | | | $ | 29,189,020 | | | $ | 10,046,819 | | | | 34 | % |
Consolidated net sales were $32.24$39.24 million for the fiscal year ended June 30, 20192021 compared to $27.91$29.19 million for the twelve monthsfiscal year ended June 30, 2018 (unaudited),2020, an increase of $4.34$10.05 million, or 16%34%. TheIn addition to the adverse impact that the COVID-19 pandemic had on consolidated net sales for the fiscal year ended June 30, 2020, the increase in consolidated net sales for the fiscal year ended June 30, 2019 was due primarily to strong seasonal2021 compared with consolidated net sales for both Valentine’s Day and the prior fiscal year was also principally due to robust calendar year-end holiday as well assales during our fiscal quarter ended December 31, 2020, coupled with strong February Valentine’s Day sales and March St. Patrick’s Day sales during our fiscal quarter ended March 31, 2021. These higher sales for Fiscal 2021 were also related to increased consumer awareness and ongoing strong demand for our moissanite gemstonesjewels, lab grown diamonds, and jewelry. These results were evidence of both strong finished jewelry product net salesfeaturing both moissanite and lab grown diamonds. These increases resulted in higher loose jewelfinished jewelry product net sales during the fiscal year ended June 30, 20192021 in our Online Channels segment. The increases inboth our Online Channels segment and Traditional segment. One of the most profound changes in consumer buying habits over the past fiscal year was the shift to digital channels shopping from the more traditional brick-and-mortar platforms. We believe the COVID-19 pandemic accelerated this shift toward e-commerce, as consumers worldwide became more reliant on the digital channel while in isolation. Accordingly, we saw strong increases in our Online Channels segment net sales in the fiscal year ended June 30, 2019 were partially offset by lower finished jewelry product2021. As consumer confidence strengthened during the second half of Fiscal 2021, net sales in our Traditional segment.segment increased over this period driven by stronger loose jewel sales in our distributor network. However, these increased loose jewel net sales in our Traditional segment were offset in part due to lower international sales during the fiscal year ended June 30, 2021.
Sales of finished jewelry represented 48%62% and 47%57% of total consolidated net sales for the fiscal yearyears ended June 30, 20192021 and the twelve-month period ended June 30, 2018 (unaudited),2020, respectively. For the fiscal year ended June 30, 2019,2021, finished jewelry sales were $15.46$24.40 million compared to $13.00$16.78 million for the twelve monthsfiscal year ended June 30, 2018 (unaudited),2020, an increase of $2.46$7.62 million, or 19%45%. This increase in finished jewelry sales was due primarily to higher finished jewelry retail sales of Moissanite by Charles & Colvard® and our Signature Collection line of products in our Online Channels segment as well as increasedin our Traditional segment. Net sales of Forever One™our and Moissanite by Charles & Colvard®products inand our Traditional segment.
Sales ofSignature Collection finished jewelry and loose jewels represented 52%15% and 53%9%, respectively, of total consolidated net sales for the fiscal year ended June 30, 20192021, compared to that of 11% and 7%, respectively, for the twelve monthsprior fiscal year.
Sales of loose jewels represented 38% and 43% of total consolidated net sales for the fiscal years ended June 30, 2018 (unaudited),2021 and 2020, respectively. For the fiscal year ended June 30, 2019,2021, loose jewel sales were $16.79$14.83 million compared to $14.91$12.41 million for the twelve monthsfiscal year ended June 30, 2018 (unaudited),2020, an increase of $1.88$2.42 million, or 13%20%. The increase for the fiscal year ended June 30, 20192021 was primarily due toa result of higher levelssales of loose jewels through our domestic distributors. However, these increased loose jewel sales in both our Online Channels segment and principallywere offset somewhat by lower sales of loose jewels through the international distribution network in our Traditional segment.
U.S. net sales accounted for approximately 87%95% and 93%92% of total consolidated net sales during the fiscal yearyears ended June 30, 20192021 and the twelve-month period ended June 30, 2018 (unaudited),2020, respectively. As a percentage of net sales, U.S. net sales decreased during fiscal 2019 as a result of increased demand in the international distributor market and the growth of our direct-to-consumer presence internationally compared to the twelve months ended June 30, 2018 (unaudited). However, U.S. net sales increased to $27.98 million, or 8%, during the fiscal year ended June 30, 2019 from $25.84 million for the twelve months ended June 30, 2018 (unaudited) primarily2021 principally as a result of ongoing increased demand and increased sales fromto U.S. customers in both our Online Channels segment and Traditional segment.
Our largest U.S. customer during the fiscal yearyears ended June 30, 20192021 and the twelve months ended June 30, 2018 (unaudited)2020 accounted for 14% and 15%13% of total consolidated net sales during each of the respective period. Ourperiods then ended. Likewise, our second largest U.S. customer during the fiscal yearyears ended June 30, 20192021 and the twelve months ended June 30, 2018 (unaudited)2020 accounted for 10% and 12% of total consolidated net sales during each of the respective period. Other thanperiods. It should be noted that our largest and second largest U.S. customers during the fiscal year ended June 30, 2019in Fiscal 2021 were our second largest and the twelve months ended June 30, 2018 (unaudited), we had no otherlargest customers, with sales that represented 10% or more of total consolidated net sales for the periods then ended.respectively, in Fiscal 2020. We expect that we will remain dependent on our ability, and that of our largest U.S. customers, to maintain and enhance retail and wholesale programs. A change in or loss of any of these customercustomers or retailer relationships could have a material adverse effect on our results of operations.
International net sales accounted for approximately 13%5% and 7%8% of total consolidated net sales during the fiscal yearyears ended June 30, 20192021 and the twelve months ended June 30, 2018 (unaudited),2020, respectively. International net sales increaseddecreased to $4.26$2.01 million, or 106%15%, during the fiscal year ended June 30, 20192021 compared to $2.07$2.37 million in the twelve monthsfiscal year ended June 30, 2018 (unaudited)2020. International sales decreased during the fiscal year ended June 30, 2021, compared to the prior fiscal year primarily as we continue to serve distributorsa result of lower demand in our international distributor market, which was partially offset by growth in our direct-to-consumer presence internationally reflecting solid direct-to-consumer sales from our Online Channels segment in international markets. Based on current levelsIn light of demand for loose jewels in the markets,effects of ongoing global economic conditions and as the world continues to recover from the COVID-19 pandemic, we continue to evaluate these and other potential distributors in these international markets to determine the best long-term partners. Additionally, during the fiscal year ended June 30, 2019, we developed a direct-to-consumer presence in Australia, Germany, Italy, France, and Spain. These international locations are in addition to the presence we developed in the UK during the twelve month-period ended June 30, 2018 (unaudited). Going forward, we anticipate the need to further develop a direct-to-consumer presence in other locations throughout the world. This international expansion will continue to require additional investment in our multi-channel digital marketing strategy to drive expected growth in these regions. As a result, over timeand in light of the ongoing worldwide pandemic and international trade challenges, we expect our sales in these international markets mayto continue to fluctuate significantly each reporting period as our growth in these regions develops.period.
NoWe did not have an international customers accountedcustomer account for 10% or more than 10% of total consolidated sales induring the fiscal 2019.years ended June 30, 2021 and 2020. A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers. Our top threeretailers international distributors by sales volume during the fiscal year ended June 30, 2019 were, in order of sales volume, located in Hong Kong, Hong Kong, and Canada..
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal yearyears ended June 30, 20192021 and twelve months ended June 30, 2018 (unaudited)2020 are as follows:
| | | Twelve Months Ended June 30, | | | Change | | |
| | | 2019 | | | 2018 | | | Dollars | | | Percent | | | Year Ended June 30, | | | Change | |
| | | | | | (unaudited) | | | | | | | | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 6,859,112 | | | $ | 7,045,126 | | | $ | (186,014 | ) | | -3 | % | | $ | 11,272,012 | | | $ | 7,469,790 | | | $ | 3,802,222 | | | | 51 | % |
| Loose jewels | | | 8,242,830 | | | | 7,761,793 | | | | 481,037 | | | 6 | % | | | 6,857,755 | | | | 6,062,186 | | | | 795,569 | | | | 13 | % |
| Total product line cost of goods sold | | 15,101,942 | | | 14,806,919 | | | 295,023 | | | 2 | % | | | 18,129,767 | | | | 13,531,976 | | | | 4,597,791 | | | | 34 | % |
| Non-product line cost of goods sold | | | 2,250,225 | | | | 1,901,284 | | | | 348,941 | | | 18 | % | | | 2,679,923 | | | | 7,668,231 | | | | (4,988,308 | ) | | | (65 | )% |
| Total cost of goods sold | | $ | 17,352,167 | | | $ | 16,708,203 | | | $ | 643,964 | | | 4 | % | | $ | 20,809,690 | | | $ | 21,200,207 | | | $ | (390,517 | ) | | | (2 | )% |
Total cost of goods sold was $17.35$20.81 million for the fiscal year ended June 30, 20192021 compared to $16.71$21.20 million for the twelve monthsfiscal year ended June 30, 2018 (unaudited), an increase2020, a net decrease of approximately $644,000,$391,000, or 4%2%. 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 valuation allowance adjustments;write-offs; and other inventory adjustments, comprising costs of quality issues, and damaged goods, and inventory write-downs.goods.
The increasedecrease in total cost of goods sold for the fiscal year ended June 30, 2021 as compared to the fiscal year ended June 30, 2020 was driven primarily by the prior year write-off during the quarter ended March 31, 2020, of approximately $5.26 million representing the carrying value of our legacy loose jewel inventory and finished goods inventory set with these legacy gemstones. This decrease in cost of goods sold for the fiscal year ended June 30, 2019 as compared to the twelve-month period ended June 30, 2018 (unaudited)2021, was due primarily to an increased level of overall product sales during fiscal 2019, offset somewhatin part by favorable costs resulting from manufacturing efficiencies achieved for finished jewelry production when compared to product linehigher cost of goods sold principally driven by increased sales of finished jewelry, which reflect higher material and labor costs, in both our Online Channels segment and Traditional segment as a result of strong product demand during the same unaudited period of 2018. year.
The net increase in total cost of goods sold was also impacted by a net unfavorable changedecrease in non-product line cost of goods sold for the fiscal year ended June 30, 2021 comprises a $5.71 million lower change in inventory valuation adjustments principally related to the prior fiscal year’s write-off of the carrying cost of the Company’s legacy material inventory of $5.26 million during the quarter ended March 31, 2020, as well as other inventory valuation adjustments related to changes in obsolescence reserves in the fiscal 2019.year ended June 30, 2021, compared to those in the prior fiscal year. This net increasedecrease in non-product line cost of goods sold compriseswas offset in part by a $437,000 increase in other inventory adjustments principally relating to production standard cost variances and book-to-physical quantity adjustments; a $62,000$503,000 increase in freight out asprincipally from increased shipments resulting from substantial Online Channels segment sales growth during the fiscal year ended June 30, 2021; a result of an increase in sales transaction volume; and an $8,000$147,000 increase in non-capitalized manufacturing and production control expenses in the current year principally due to the timing of when work-in-process isgoods are received into inventory and applicable overhead is allocated. These increases were offset in part by a $158,000 favorablecosts are allocated; and an approximate $76,000 change in other inventory valuation allowances, including inventory obsolescence, shrinkage, recuts, and repairs reserves. adjustments primarily relating to adverse changes in production standard cost variances compared to those during the fiscal year ended June 30, 2020.
For further discussion of non-product line cost of goods sold, see Note 3 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Sales and Marketing
Sales and marketing expenses for the fiscal yearyears ended June 30, 20192021 and twelve months ended June 30, 2018 (unaudited)2020 are as follows:
| | Twelve Months Ended June 30, | | Change | |
| | 2019 | | 2018 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| Sales and marketing | | $ | 7,983,506 | | | $ | 7,641,962 | | | $ | 341,544 | | | | 4 | % |
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| Sales and marketing | | $ | 8,476,716 | | | $ | 9,443,244 | | | $ | (966,528 | ) | | | (10 | )% |
Sales and marketing expenses were $7.98$8.48 million for the fiscal year ended June 30, 20192021 compared to $7.64$9.44 million for the twelve-month periodfiscal year ended June 30, 2018 (unaudited), an increase2020, a decrease of approximately $342,000,$967,000, or 4%10%.
The increasedecrease in sales and marketing expenses for the fiscal year ended June 30, 20192021 compared to the twelve monthsfiscal year ended June 30, 2018 (unaudited)2020 was primarily due to a $640,000 increase$1.31 million decrease in digital and social media marketing;compensation-related expenses; a $140,000 increase in general office-related expenses, principally due to increased credit card clearing transactions; a $137,000 increase$164,000 decrease in professional services fees;fees principally comprising non-recurring consulting services for cybersecurity and merchandising imaging incurred in the prior year; a $76,000$26,000 decrease in travel expenses as a result of COVID-19 cost-control measures; and a $1,000 net decrease in miscellaneous other general sales and marketing expenses. These decreases were partially offset by a $282,000 increase in advertising and digital marketing expenses; an $84,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; andan $83,000 increase in general office-related expenses, which are principally related to higher credit card transaction fees from increased online sales levels; a $50,000$69,000 increase in depreciation and amortization expense. These increases were partially offset by a $564,000 decrease in compensation-related expense; a $97,000 decrease in travel expense; a $37,000 decrease in recruiting fees;expense relating to capitalized costs associated with information technology-related upgrades; and a $3,000 net decrease in miscellaneous other sales and marketing expenses.
The$17,000 increase in digital and social media marketing expenses for the fiscal year ended June 30, 2019, compared to the twelve-month period ended June 30, 2018 (unaudited), comprises an $812,000 increase in Internet marketing and a $54,000 increase in cooperative advertising. These increases were partially offset by a $153,000 decrease in outside agency fees; a $50,000 decrease in promotional expenses; an $18,000 decrease in print media expenses; and a $5,000 net decrease in all other advertising expenses.employment-related recruiting fees.
Compensation expenses for the fiscal year ended June 30, 20192021 compared to the twelve-month periodfiscal year ended June 30, 2018 (unaudited)2020 decreased primarily as a result of a $714,000$1.25 million decrease in salaries, commissions, and related employee benefits in the aggregate;aggregate as a $47,000result of our June 2020 management reorganization and workforce reduction; a $76,000 decrease in employee-related severance expense;costs recognized in the prior year which also was a result of our June 2020 management reorganization and an $8,000workforce reduction; and a $68,000 decrease in relocation expense.employee stock-based compensation expense associated with the modification of terms for certain participant stock options in Fiscal 2020 that resulted in the recognition of higher stock compensation expense in the prior fiscal year. These decreases were partially offset by a $195,000an $84,000 increase in bonus expense and a $10,000 increasereflecting improved operating results in employee stock-based compensation expense.the current year that impacts this performance-based compensation-related benefit.
WhileThe increase in digital marketing expenses for the fiscal year ended June 30, 2021 compared to the fiscal year ended June 30, 2020 was primarily due to a $766,000 increase in Internet marketing costs and a $20,000 increase in print media expenses. Both increases reflect changes in our intent is to invest significantly in salesoverall social media and marketing efforts to increase sales, we believe such expenses may also increase as part of our ongoing strategy to promote overall consumer awareness of moissanite and of our brands. However, this will be dependent on overall companywideprint marketing strategies during Fiscal 2021 compared with those in Fiscal 2020. These increases were partially offset by a $386,000 decrease in outside agency fees, also as a consequence of modifications in our marketing strategy and reliance on internal resources during the current year; a $111,000 decrease in which sales channels we may choose to make such further investments.cooperative advertising; and a $7,000 decrease in promotion-related expenses.
General and Administrative
General and administrative expenses for the fiscal yearyears ended June 30, 20192021 and twelve months ended June 30, 2018 (unaudited)2020 are as follows:
| | Twelve Months Ended June 30, | | Change | |
| | 2019 | | 2018 | | Dollars | | | Percent | |
| | | | | | (unaudited) | | | | | | | |
| General and administrative | | $ | 4,640,810 | | | $ | 4,816,495 | | | $ | (175,685 | ) | | | -4 | % |
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| General and administrative | | $ | 4,441,441 | | | $ | 4,861,297 | | | $ | (419,856 | ) | | | (9 | )% |
General and administrative expenses were $4.64$4.44 million for the fiscal year ended June 30, 20192021 compared to $4.82$4.86 million for the twelve monthsfiscal year ended June 30, 2018 (unaudited),2020, a decrease of approximately $176,000,$420,000, or 4%9%.
The decrease in general and administrative expenses for the fiscal year ended June 30, 20192021 compared to the twelve monthsfiscal year ended June 30, 2018 (unaudited)2020 was primarily due to a $332,000$428,000 decrease in professional services; an $18,000a $206,000 decrease in travelcompensation-related expenses; a $12,000$7,000 decrease in equipment-related rental expense; a $9,000 decrease in bank fees, which includes fees associated with the White Oak Credit Facility and credit card clearing transactions; and a $2,000 decrease in depreciation and amortization expense. These decreases were partially offset by an $85,000 increase in business taxes and licenses, principally franchise taxes; a $33,000 increase in bad debt expense associated with our allowance for doubtful accounts reserve policy; a $29,000 increase in insurance expenses; a $20,000 increase in compensation expenses; a $19,000 increase in expenses related to the timing of our annual meeting and shareholder communications due to the change in our fiscal year-end; a $6,000 increase in board retainer fees; and a $5,000$1,000 net increasedecrease in miscellaneous other general and administrative expenses. These decreases were partially offset by a $58,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed in January 2021; a $50,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; a $38,000 increase in housing allowances and travel-related expenditures; a $30,000 increase in insurance expenses principally related to higher renewal premiums; a $20,000 increase in bank charges as a result of transaction fees associated with increased online transactions; a $14,000 increase in Board member retainer fees due to the temporary reduction in fees paid to our Board of Directors in connection with cost control measures implemented during the COVID-19 pandemic in the prior year; a $9,000 increase in depreciation and amortization expense; and a $3,000 increase in business taxes and licenses.
Professional services fees decreased for the fiscal year ended June 30, 20192021 compared to the twelve-month periodfiscal year ended June 30, 2018 (unaudited)2020 primarily due to a $283,000 decrease in legal fees of $332,000 principally asresulting from non-recurring non-capitalized fees incurred in connection with our underwritten public offering and corporate governance matters in the prior year; a result of hiring a full-time in-house counsel; a $23,000$101,000 decrease in investor and public relations expenses; and a decrease of $23,000 in consulting and other professional services primarily related to financial reporting consulting feesin connection with accounting department support in the prior period.year; and a $66,000 decrease in investor relations fees. These decreases were partially offset by ana $22,000 increase of $46,000 in accountingfees associated with audit and tax services related toin the timing of our annual and transition period audits due to the change in our fiscal year-end.current year.
Compensation expenses increaseddecreased for the fiscal year ended June 30, 20192021 compared to the twelve monthsfiscal year ended June 30, 2018 (unaudited)2020 primarily due to an $87,000 increase in bonus expense and an $11,000 increase in employee stock-based compensation expense. These increases were offset by a $43,000$282,000 decrease in severance expenses recognized in the prior year related to personnel changesour June 2020 management reorganization and workforce reduction; a $35,000$184,000 decrease in salaries and related employee benefits in the aggregate.aggregate which also was a result of our June 2020 management reorganization and workforce reduction; and a $54,000 decrease in employee stock-based compensation expense associated with the modification of terms for certain participant stock options in Fiscal 2020 that resulted in the recognition of higher stock compensation expense in the prior fiscal year. These decreases were offset in part by a $314,000 increase in bonus expense reflecting improved operating results in Fiscal 2021 that impacts this performance-based compensation-related benefit.
Gain on Extinguishment of Debt
Gain on extinguishment of debt for the fiscal years ended June 30, 2021 and 2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
Gain on extinguishment of debt | | $ | 974,328 | | | $ | - | | | $ | 974,328 | | | | 100 | % |
On June 18, 2020, we received the proceeds from our Paycheck Protection Program Loan, or the PPP Loan, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, as administered by the U.S. Small Business Administration, or SBA. The PPP Loan in the principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, or the Lender, pursuant to a promissory note, or the Promissory Note, dated June 15, 2020. During the period of time that the principal under the Promissory Note was outstanding, we accounted for the Promissory Note as debt within the accompanying consolidated financial statements. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of interest expense to-date in the amount of approximately $9,000 that the Company recognized during the period the principal of the PPP Loan was outstanding was also forgiven by the SBA. Accordingly, the full amount of the gain in connection with the extinguishment of this debt, including the benefit from the forgiveness of the inception to-date interest expense, was recognized in the fiscal year ended June 30, 2021.
Interest Income
Interest income for the fiscal years ended June 30, 2021 and 2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Interest income | | $ | 5,581 | | | $ | 158,091 | | | $ | (152,510 | ) | | | (96 | )% |
In June 2019, we completed an underwritten public offering of 6,250,000 shares of our common stock, which together with the partial exercise of the underwriters’ overallotment option for an additional 630,500 shares in July 2019, resulted in net proceeds of approximately $9.99 million. The net proceeds from this offering, along with excess operating cash, are deposited into and maintained in an interest-bearing account with a federally insured commercial bank. Accordingly, during the fiscal years ended June 30, 2021 and 2020, we earned interest from cash on deposit in this interest-bearing account. The decrease in earned interest reflects adverse changes in interest rate fluctuations during Fiscal 2021 compared with Fiscal 2020.
Interest Expense
Interest expense for the fiscal years ended June 30, 2021 and 2020 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Interest expense | | $ | 8,953 | | | $ | 884 | | | $ | 8,069 | | | | 913 | % |
In accordance with the terms of the Promissory Note, during the period of time the principal of the PPP Loan was outstanding through June 23, 2021, we accrued interest at a fixed rate of 1% per annum. Our accrual for interest expense associated with the PPP Loan began June 18, 2020, the date we received the proceeds for the PPP Loan from our Lender. Likewise, we accrued interest on the PPP Loan during the fiscal year ended June 30, 2021, through June 23, 2021, the date our PPP Loan was forgiven by the SBA.
Loss on Foreign Currency Exchange
Loss on foreign currency exchange relatingrelated to foreign sales transacted in functional currencies other than the U.S. dollar settlement for the fiscal years ended June 30, 2021 and 2020 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2021 | | | 2020 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | 603 | | | $ | 1,829 | | | $ | (1,226 | ) | | | (67 | )% |
During the fiscal years ended June 30, 2021 and 2020, we had international sales transactions denominated in currencies other than the U.S dollar that resulted in foreign currency exchange net losses. The decrease in these losses reflects the lower level of international sales denominated in foreign currencies as well as foreign currency exchange rate fluctuations during fiscal year ended June 30, 2019 and twelve months ended June 30, 2018 (unaudited) is as follows:
| | Twelve Months Ended June 30, | | Change | |
| | 2019 | | 2018 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| Loss on foreign currency exchange | | $ | 344 | | | $ | 5 | | | $ | 339 | | | | * | % |
* Not Meaningful
During2021 compared with those of the transition period ended June 30, 2018, we began developing an international direct-to-consumer presence. Accordingly, the underlying sales transactions have led to these immaterial foreign currency exchange losses.
Gain on Insurance Claim Settlement
Gain on insurance claim settlement for theprior fiscal year ended June 30, 2019 and twelve months ended June 30, 2018 (unaudited) is as follows:
| | Twelve Months Ended June 30, | | Change | |
| | 2019 | | 2018 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| Gain on insurance claim settlement | | $ | - | | | $ | 183,217 | | | $ | (183,217 | ) | | | -100 | % |
In the fourth calendar year quarter of 2017, we recognized approximately $183,000 in connection with the settlement of an outstanding insurance claim related to recovery of costs previously expensed and written off associated with insured losses incurred in connection with a shipment of work-in-process materials. The gain represented the excess recovery over amounts previously expensed and written off in the previous trailing twelve-month financial reporting period. There was no such gain during the fiscal year ended June 30, 2019.year.
Provision for Income Taxes
We recognized ana net income tax net benefit of approximately $1,400$6.33 million and a net income tax expense of approximately $2,000 for the fiscal yearyears ended June 30, 2019 compared with an income tax net benefit of approximately $309,000 for the twelve months ended June 30, 2018 (unaudited).2021 and 2020, respectively. Our income tax provisions in these periods primarily relate tocontain estimated tax,taxes, penalties, and interest associated with uncertain tax positions. During the fiscal year ended June 30, 2019 we recognized a federal income tax benefit in the amount
41
As of each reporting date, management considerswe consider new evidence, both positive and negative, that could impact itsour view with regard to future realization of deferred tax assets. Beginning in 2014, managementwe determined that negative evidence outweighed the positive and established a full valuation allowance against our deferred tax assets. Weassets and we maintained asuch full valuation allowance through the period ended June 30, 2020. However, as of June 30, 20192021, cumulative positive taxable income over the last three tax years had been generated in the U.S., as compared to the negative evidence of cumulative losses in previous years. We also determined that our expectations of future taxable income in upcoming tax years, including estimated growth rates applied to future expected taxable income that includes significant management estimates and assumptions, would be sufficient to result in full utilization of our federal net operating loss carryforwards and certain of the deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence exists as of June 30, 2018.2021, to conclude that it is more likely than not deferred tax assets of approximately $6.35 million are realizable, and we reduced our valuation allowance accordingly. The reduction of the valuation allowances against these deferred tax assets was the main driver of the income tax benefit during the fiscal year ended June 30, 2021 of approximately $6.33 million. A valuation allowance remains against certain deferred tax assets primarily relating to state net operating loss carryforwards from our e-commerce subsidiary due to the timing uncertainty of when it will generate positive taxable income to utilize the associated deferred tax assets. In addition, a valuation allowance also remains against certain deferred tax assets relating to operating loss carryforwards relating to our dormant subsidiary located in Hong Kong.
Our statutory tax rate as of the fiscal year ended June 30, 20192021 is 22.16%22.24% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.16%1.24%, net of the federal benefit.
The Tax Act, which was signed into law in December 2017, among other things lowered the U.S. corporate income tax rate from 35% to that of 21% effective January 1, 2018. For further discussion of the effects of the Tax Act on our provision for income taxes and deferred tax assets, see Note 12 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Summary Results of Operations for the Transition Period Ended June 30, 2018 and the Six Months Ended
June 30, 2017 (Unaudited)Certain Operating Metrics
The following table sets forthWe believe that certain consolidated statementsmetrics are key to our business, including but not limited to monitoring our average order value, or AOV. We use the AOV computation in part to make strategic digital marketing related decisions and to monitor the performance and return on investment of operationsour marketing activities. Our AOV is based on financial results and customer-related data for charlesandcolvard.com, LLC, our wholly owned subsidiary and through which we operate our primary transactional website. Our calculation for AOV is sensitive to several factors, including sales volume and product mix. Therefore, we believe that this metric may vary widely going forward as we respond to ever changing consumer demand and provide the transition periodproducts – that may have widely variable price points – which our audiences are seeking.
For the fiscal year ended June 30, 20182021, our AOV, based on charlesandcolvard.com revenue, net of returns, divided by the total number of customer orders, is estimated to be approximately $1,000.
An additional metric that we use to manage charlesandcolvard.com operations and to make strategic digital marketing decisions for our transactional website is period-over-period revenue growth. Accordingly, we believe this level of growth reinforces our current year’s digital marketing program and affirms our decision to increase our investment in consumer-driven marketing efforts in charlesandcolvard.com during Fiscal 2021. While we believe this metric is sensitive to many factors and may vary in future periods, we expect to continue to monitor and base our marketing-related investments in part on charlesandcolvard.com revenue growth going forward.
For the six monthsfiscal year ended June 30, 2017 (unaudited):
| | | Six Months Ended June 30, | |
| | | 2018 | | | 2017 | |
| | | | | | (unaudited) | |
| Net sales | | $ | 13,163,048 | | | $ | 12,287,174 | |
| Costs and expenses: | | | | | | | | |
| Cost of goods sold | | | 8,298,286 | | | | 7,060,701 | |
| Sales and marketing | | | 3,856,796 | | | | 3,692,188 | |
| General and administrative | | | 2,601,554 | | | | 2,474,882 | |
| Research and development | | | - | | | | 3,143 | |
| Total costs and expenses | | | 14,756,636 | | | | 13,230,914 | |
| Loss from operations | | | (1,593,588 | ) | | | (943,740 | ) |
| Other expenses: | | | | | | | | |
| Interest expense | | | (293 | ) | | | (92 | ) |
| Loss on foreign currency exchange | | | (5 | ) | | | - | |
| Total other expenses | | | (298 | ) | | | (92 | ) |
| Loss before income taxes | | | (1,593,886 | ) | | | (943,832 | ) |
| Income tax net benefit (expense) | | | 318,060 | | | | (18,595 | ) |
| Net loss | | $ | (1,275,826 | ) | | $ | (962,427 | ) |
Consolidated Net Sales
Consolidated net sales2021, we experienced a 45% year-over-year growth in charlesandcolvard.com revenue compared to revenue for the transition periodfiscal year ended June 30, 2018 and the six months ended June 30, 2017 (unaudited) comprise the following:2020.
| | Six Months Ended June 30, | | Change | |
| | 2018 | | 2017 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| Loose jewels | | $ | 6,999,998 | | | $ | 8,672,363 | | | $ | (1,672,365 | ) | | | -19 | % |
| Finished jewelry | | | 6,163,050 | | | | 3,614,811 | | | | 2,548,239 | | | | 70 | % |
| Total consolidated net sales | | $ | 13,163,048 | | | $ | 12,287,174 | | | $ | 875,874 | | | | 7 | % |
Consolidated net sales were $13.16 million for the transition period ended June 30, 2018 compared to $12.29 million for the six months ended June 30, 2017 (unaudited), an increase of $876,000, or 7%. The increase in consolidated net sales for the transition period ended June 30, 2018 was due primarily to increased consumer awareness and demand for moissanite resulting in higher finished jewelry product net sales during the transition period ended June 30, 2018 in both our Online Channels segment and Traditional segment brick-and-mortar customers. However, this increase in the transition period ended June 30, 2018 was partially offset by lower loose jewel sales in our Traditional segment.
Sales of loose jewels represented 53% of total consolidated net sales for the transition period ended June 30, 2018, compared to 71% of total consolidated net sales for the six months ended June 30, 2017 (unaudited). For the transition period ended June 30, 2018, loose jewel sales were $7.00 million compared to $8.67 million for the six months ended December 31, 2017 (unaudited), a decrease of $1.67 million, or 19%. The decrease for the transition period ended June 30, 2018 was primarily due to lower loose jewel sales in our Traditional segment, driven by a large wholesale customer that had a one-time change in its inventory management practices across vendors.
Sales of finished jewelry represented 47% of total consolidated net sales for the transition period ended June 30, 2018, compared to 29% of total consolidated net sales for the six months ended June 30, 2017 (unaudited). For the transition period ended June 30, 2018, finished jewelry sales were $6.16 million compared to $3.61 million for the six months ended June 30, 2017 (unaudited), an increase of $2.55 million, or 70%. This increase was due primarily to strong finished jewelry sales in both our Online Channels segment and Traditional segment brick-and-mortar customers, which we believe resulted from leveraging our strategy to continue driving sales in 2018 through multiple channels. These results reflect the ongoing increased presence within our e-commerce outlets including marketplaces and through charlesandcolvard.com in our Online Channels segment and our expanded presence in Helzberg Diamonds stores in our Traditional segment.
U.S. net sales accounted for approximately 92% and 93% of total consolidated net sales during the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited), respectively. While the proportion of our consolidated net sales in the U.S. was essentially flat during the transition period ended June 30, 2018 compared with the six months ended June 30, 2017 (unaudited), U.S. net sales increased to $12.12 million, or 6%, during the transition period ended June 30, 2018 compared to $11.46 million in the six months ended June 30, 2017 (unaudited) as a result of increased sales to U.S. customers in both our Online Channels segment and Traditional segment.
Our largest U.S. customer during the transition period ended June 30, 2018 accounted for 12% of our total consolidated sales compared to 26% during the six months ended June 30, 2017 (unaudited). A second U.S. customer also accounted for 12% of our total consolidated net sales during the transition period ended June 30, 2018 but did not have net sales that represented 10% or more of total net sales for the six months ended June 30, 2017 (unaudited). No additional U.S. customers accounted for more than 10% of total consolidated sales during the transition period ended June 30, 2018 or the six months ended June 30, 2017 (unaudited).
International net sales accounted for approximately 8% and 7% of total consolidated net sales during the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited), respectively. While the proportion of our consolidated net sales in the international market was essentially flat during the transition period ended June 30, 2018 compared with the six months ended June 30, 2017 (unaudited), international net sales increased to $1.04 million, or 25%, during the transition period ended June 30, 2018 compared to $832,000 in the six months ended June 30, 2017 (unaudited) as we continue to serve distributors in international markets.
No international customers accounted for more than 10% of total consolidated sales during the transition period ended June 30, 2018 or the six months ended June 30, 2017 (unaudited). A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers. Our top three international distributors by sales volume during the transition period ended June 30, 2018 were, in order of sales volume, located in Hong Kong, Hong Kong, and India.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited) are as follows:
| | | Six Months Ended June 30, | | | Change | |
| | | 2018 | | | 2017 | | | Dollars | | | Percent | |
| | | | | | (unaudited) | | | | | | | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Loose jewels | | $ | 3,640,224 | | | $ | 4,403,274 | | | $ | (763,050 | ) | | | -17 | % |
| Finished jewelry | | | 3,435,233 | | | | 1,616,767 | | | | 1,818,466 | | | | 112 | % |
| Total product line cost of goods sold | | | 7,075,457 | | | | 6,020,041 | | | | 1,055,416 | | | | 18 | % |
| Non-product line cost of goods sold | | | 1,222,829 | | | | 1,040,660 | | | | 182,169 | | | | 18 | % |
| Total cost of goods sold | | $ | 8,298,286 | | | $ | 7,060,701 | | | $ | 1,237,585 | | | | 18 | % |
Total cost of goods sold was $8.30 million for the transition period ended June 30, 2018 compared to $7.06 million for the six months ended June 30, 2017 (unaudited), an increase of approximately $1.24 million, or 18%. Product line cost of goods sold is defined as product cost of goods sold in each of our Traditional segment and Online Channels 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 valuation allowance adjustments; and other inventory adjustments, comprising costs of quality issues, damaged goods, and inventory write-downs.
The increase in cost of goods sold for the transition period ended June 30, 2018, as compared to the six months ended June 30, 2017 (unaudited) was due primarily to increased sales of finished jewelry during the first six months of 2018, which reflect higher material and labor costs, when compared to cost of goods sold in the same unaudited period of 2017 during which period we sold a higher level of loose jewels. The net increase in non-product line cost of goods sold comprises a $100,000 increase in freight out as a result of an increase in sales transaction volume; an $82,000 increase in non-capitalized manufacturing and production control expenses principally due to the timing when work-in-process is received into inventory and overhead is allocated; and a $47,000 increase in other inventory adjustments principally relating to production standard cost variances. These increases were offset in part by a $47,000 favorable change in inventory valuation allowances, including inventory obsolescence, shrinkage, recuts, and repairs reserves. For further discussion of non-product line cost of goods sold, see Note 3 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Sales and Marketing
Sales and marketing expenses for the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited) are as follows:
| | Six Months Ended June 30, | | | Change | |
| | 2018 | | 2017 | | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | | |
| Sales and marketing | | $ | 3,856,796 | | | $ | 3,692,188 | | | $ | 164,608 | | | | 4 | % |
Sales and marketing expenses were $3.86 million for the transition period ended June 30, 2018 compared to $3.69 million for the six months ended June 30, 2017 (unaudited), an increase of approximately $165,000, or 4%.
The increase in sales and marketing expenses for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited), was primarily due to a $235,000 increase in advertising and digital marketing expenses; a $37,000 increase in professional services fees; a $37,000 increase in general office-related expenses; a $25,000 increase in software-related costs principally in connection with maintenance agreements associated with our migration to a cloud-based data storage arrangement as well as other software-related agreements; and a $4,000 increase in depreciation and amortization expense. These increases were partially offset by a $113,000 decrease in compensation-related expense; a $22,000 decrease in recruiting fees; a $20,000 decrease in market research expenses; and an $18,000 decrease in travel expense.
The increase in advertising and digital marketing expenses for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) comprises a $118,000 increase in cooperative advertising; a $78,000 increase in outside agency fees; a $55,000 increase in Internet marketing; and a $14,000 increase in all other advertising expenses. These increases were partially offset by an $18,000 decrease in promotional expenses; and a $12,000 decrease in print media expenses.
Compensation-related expenses for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) decreased primarily as a result of a $189,000 decrease in severance expense primarily related to the departure of our Chief Revenue Officer during the first quarter of 2017; a $134,000 decrease in bonus expense; and a $20,000 decrease in relocation expense. These decreases were partially offset by a $229,000 increase in salaries, commissions, and related employee benefits in the aggregate; and a $1,000 increase in employee stock-based compensation expense.
General and Administrative
General and administrative expenses for the transition period ended June 30, 2018 and the six months ended June 30, 2017 (unaudited) are as follows:
| | Six Months Ended June 30, | | Change | |
| | 2018 | | 2017 | | Dollars | | | Percent | |
| | | | (unaudited) | | | | | | |
| General and administrative | | $ | 2,601,554 | | | $ | 2,474,882 | | | $ | 126,672 | | | | 5 | % |
General and administrative expenses were $2.60 million for the transition period ended June 30, 2018 compared to $2.47 million for the six months ended June 30, 2017 (unaudited), an increase of approximately $127,000, or 5%.
The increase in general and administrative expenses for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) was primarily due to a $215,000 increase in compensation expenses; a $98,000 increase in professional services; a $16,000 increase in board retainer fees; a $6,000 increase in miscellaneous other general and administrative expenses; and a $4,000 increase in depreciation and amortization expense. These increases were partially offset by an $86,000 decrease in bank fees, which includes fees associated with our prior credit facility with Wells Fargo and credit card clearing transactions; a $46,000 decrease in business taxes and licenses; a $38,000 decrease in computer and software related expenses; a $34,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; a $5,000 decrease in equipment-related rental expense; and a $3,000 decrease in insurance expenses.
Compensation expenses increased for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) primarily due to a $173,000 increase in salaries and related employee benefits in the aggregate; a $29,000 increase in employee stock-based compensation expense; and a $16,000 increase in bonus expense. These increases were partially offset by a decrease of $3,000 in severance expenses.
Professional services increased for the transition period ended June 30, 2018 compared to the six months ended June 30, 2017 (unaudited) primarily due to an increase of $87,000 in accounting services; an increase in legal fees of $51,000; and an increase of $21,000 in investor and public relations expenses. These increases were partially offset by a decrease of $61,000 in consulting and other professional services.
Provision for Income Taxes
We recognized an income tax net benefit of approximately $318,000 for the transition period ended June 30, 2018, compared with an income tax net expense of approximately $19,000 for the six months ended June 30, 2017 (unaudited). Our income tax provisions in these periods primarily relate to estimated tax, penalties, and interest associated with uncertain tax positions. However, during the transition period ended June 30, 2018, we recognized a federal income tax benefit in the amount of approximately $328,000 relating to the realization of the recoverable portion of the AMT deferred tax credit carryforwards being reclassified from a deferred tax asset to that of an income tax receivable, offset by approximately $10,000 of income tax expense relating to estimated tax, penalties, and interest associated with uncertain tax positions.
Our statutory tax rate as of the transition period ended June 30, 2018 was 22.13% and consisted of the federal income tax rate of 21% and a blended state income tax rate of 1.13%, net of the federal benefit.
Liquidity and Capital Resources
The full impact of the COVID-19 pandemic on the global and domestic economy remains uncertain and the world continues adapting to the ongoing pandemic and evolving viral variants and its adverse effects on global economics and worldwide business operations. The impact of the COVID-19 pandemic continues to place unprecedented pressures on global and U.S. businesses including our own. Depending on future developments, including the success of the global vaccine efforts to control the spread of the underlying virus and evolving variants, the pandemic could materially adversely impact our capital resources and liquidity in the future. We require cashremain increasingly focused on the COVID-19 pandemic and are continually evaluating its potential effect on our business and liquidity and capital resources.
Capital Structure and Long-Term Debt
On June 18, 2020, we received the proceeds from the PPP Loan pursuant to fundthe Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of $965,000 was disbursed by the Lender pursuant to a promissory note, or the Promissory Note, issued by us on June 15, 2020. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our operating expensesPPP Loan forgiveness was approved and working capital requirements,processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of the gain in connection with the extinguishment of this debt, including outlays for capital expenditures. Asthe forgiveness of accrued and unpaid interest of approximately $9,000, was recognized in the fiscal year ended June 30, 2021.
The CARES Act provided that existing AMT credit carryforwards were eligible for acceleration and refundable AMT credits were to be completely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, we elected to have our principal sourcesthen existing AMT tax completely refunded and filed a refund claim for the remaining portion of liquidity were cash, cash equivalents and restricted cash totaling $13.00 million, trade accounts receivableour AMT tax credit. Accordingly, the remaining balance of $1.96 million, and net current inventoryour AMT credit refund in the amount of $11.91 million, as compared to cash and cash equivalents totaling $3.39 million, trade accounts receivable of $1.77 million, and net current inventory of $10.98 million as ofapproximately $270,000 was completely refunded during the fiscal year ended June 30, 2018;2021.
We took advantage of available COVID-19 related payroll tax credits for certain wages and cashpaid leave provided by us during the pandemic. A portion of these eligible tax credits are determined by qualified emergency paid sick and cash equivalents totaling $4.59 million, trade accounts receivableexpanded family and medical leave wages pursuant to FFCRA. In addition, the Consolidated Appropriations Act, 2021, provides that employers who received a PPP loan may also qualify for the Employee Retention Credit (the “ERC”). Previously, pursuant to the 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 qualify for certain employer-related tax benefits pursuant to the ERC and expect to amend our applicable federal payroll tax returns for such benefit. Further, as permitted by the NC COVID-19 Relief Act, we expect to receive an incremental tax credit towards our contributions to the North Carolina Unemployment Insurance Fund. Accordingly, we will recognize any payroll tax credits related to these federal and state legislative actions in the period such benefits are received.
For further discussion of $3.38 million,the effects of the CARES Act, the Consolidated Appropriations Act, 2021, and net current inventorythe NC COVID-19 Relief Act on our provision for income taxes and deferred tax assets, see Note 13 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of $11.21 million as of December 31, 2017. this Annual Report on Form 10-K.
As described more fully below, the cash, cash equivalents and restricted cash as of June 30, 2019, includes the net proceeds of approximately $9.06 million from the recent offeringa component of our common stockliquidity and capital structure, we also have access to our $5.00 million White Oak Credit Facility.
We have an effective shelf registration statement on Form S-3 on file with the SEC whichthat 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 approximately $13.99 million remains available after giving effect toall is available. However, we may offer and sell no more than one-third of our June 2019 public offering, includingfloat (which is the impactaggregate market value of the partial exercise of the underwriters’ over-allotment option, described below.our outstanding common stock held by non-affiliates) in any 12-month period. Our ability to issue equity securities under its effectivethe shelf registration statement is subject to market conditions.conditions, which may be in turn, subject to, among other things, the potential disruption and volatility that may be caused by ongoing effects of the COVID-19 pandemic. Any capital raise is not assured and may not be at terms that would be acceptable to us.
OnFinancing Activities
In June 11, 2019, we completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the public of $1.60 per share, pursuant to our effective shelf registration statement on Form S-3. Net proceeds from the offering were approximately $9.06 million, net of the underwriting discount and fees and expenses. Pursuant to the terms of the underwriting agreement entered into in connection with this offering, the underwriters were granted a 30-day option to buy up to an additional 937,500 shares of our common stock to cover over-allotments. Pursuant to the partial exercise of the underwriters’ over-allotment option, onin July 3, 2019, we issued an additional 630,500 shares of our common stock at a price of $1.60 per share for net proceeds of approximately $0.93 million,$932,000, net of the underwriting discount and fees and expenses. of approximately $77,000. After giving effect to the partial exercise of the over-allotment option, we sold an aggregate of 6,880,500 shares of our common stock at a price of $1.60 per share with total gross proceeds of approximately $11.01 million, before deducting the underwriting discount and fees and expenses of approximately $1.02 million. We intend to useEarly during Fiscal 2020, we began using the aggregate net proceeds of approximately $9.99 million from the offering for marketing and for general corporate and working capital purposes. In response to the COVID-19 pandemic and its impact on consumer confidence and spending, management drastically reduced related advertising and digital marketing expenditures in mid-March 2020. However, we continue to monitor and adjust our advertising and digital marketing and professional services expenditure levels to correspond to market changes. As a result, we increased these expenditures during the fiscal year ended June 30, 2021, and may continue seeing an increase in these expenditure levels during Fiscal 2022 and beyond.
As discussed above, on June 18, 2020, we received the proceeds from the PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of $965,000 was disbursed by the Lender pursuant to a Promissory Note issued by us on June 15, 2020. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000. The full amount of the gain in connection with the extinguishment of this debt, including the forgiveness of accrued and unpaid interest of approximately $9,000, was recognized in the fiscal year ended June 30, 2021.
Operating Activities and Cash Flows
We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of June 30, 2021, our principal sources of liquidity were cash, cash equivalents, and restricted cash totaling $21.45 million, trade accounts receivable of $1.66 million, and net current inventory of $11.45 million, as compared to cash, cash equivalents, and restricted cash totaling $14.62 million, trade accounts receivable of $671,000, and net current inventory of $7.44 million as of June 30, 2020. We also had access during Fiscal 2021 to a $5.00 million asset-based revolving credit facility with White Oak, or the White Oak Credit Facility, which we terminated in accordance with its terms as of July 9, 2021. As described more fully herein, effective July 7, 2021, we obtained from JPMorgan Chase Bank, N.A., or JPMorgan Chase, a $5.00 million cash collateralized line of credit facility, or the JPMorgan Chase Credit Facility. Also as described more fully herein, we had long-term debt in the form of a PPP Loan in the amount of $965,000, of which $193,000 was classified as current as of June 30, 2020. Effective June 23, 2021, the Company’s PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000 as well as forgiveness of accrued and unpaid interest of approximately $9,000.
During the fiscal year ended June 30, 2019,2021, our working capital increased by approximately $10.91$12.72 million to $23.17$30.14 million from $12.27$17.42 million at June 30, 2018. During the transition period ended June 30, 2018, our working capital decreased by approximately $2.44 million to $12.27 million from $14.70 million at December 31, 2017.2020. As described more fully below, the increase in working capital at June 30, 20192021 is primarily attributable to an increase in our cash, cash equivalents, and restricted cash, principally resulting from cash provided by our operations, 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 receivable, a decrease in our accounts payable, an increase in connection with the issuance of a short-term note receivable, a decrease in the current portion of our long-term debt, resulting from the forgiveness of our PPP Loan, and a decrease in our short-term operating lease liabilities. These factors were offset partially by an increase in our accrued expenses and other liabilities and a decrease in our prepaid expenses and other assets.
During the fiscal year ended June 30, 2020, our working capital decreased by approximately $5.75 million to $17.42 million from $23.17 million at June 30, 2019. As described more fully below, the decrease in working capital at June 30, 2020 is primarily attributable to a decrease in our allocation of inventory from long-term to short-term, a decrease in accounts receivable, an increase in short-term operating lease liabilities resulting from the adoption of the new lease accounting standard as of July 1, 2019, an increase in accrued expenses and other liabilities, an increase in accounts payable, and an increase in the current maturity of our long-term debt. These factors were offset partially by an increase in our cash, cash equivalents, and restricted cash resulting from cash provided by operating and financing activities from our public offering described above and cash provided by our operations, increases in accounts receivable and in our allocation of inventory to short-term from long-term as well asan increase in prepaid expenses and other assets. The increase in working capital is also attributable to decreases in accounts payable. These factors were offset partially by increases in accrued expenses and other liabilities. As described more fully below, the decrease in working capital at June 30, 2018 is primarily attributable to a decrease in our cash and cash equivalents resulting from cash used in our operations and decreases in accounts receivable as well as in our allocation of inventory to short-term from long-term and in prepaid expenses and other assets. These factors were offset partially by decreases in accounts payable and accrued expenses and other liabilities.
During the fiscal year ended June 30,
2019, $917,0002021, approximately $6.47 million of cash was provided by our operations. The primary drivers of
theour cash
generated by ourflows from operations were
the favorable effect of net income
in the amount of
$2.28 million$12.81 million; an increase in accrued expenses and other liabilities of $3.71 million; a decrease in inventory of $1.31 million; and an increase in accrued
income taxes in the amount of $2,000. These factors were offset partially by an increase in prepaid expenses and other assets of $3.14 million; an increase in accounts receivable of $955,000; and a decrease in accounts payable of $974,000. In addition, the net effect of non-cash items included in net income totaling $6.29 million, driven by the benefit recognized for deferred income taxes in the amount of approximately $6.35 million in connection with the release of our valuation allowance and the gain on extinguishment of debt resulting from the forgiveness of our PPP Loan, including forgiveness of accrued and unpaid interest, in the amount of approximately $974,000, also unfavorably impacted net cash provided by operating activities during the fiscal year ended June 30, 2021.
During the fiscal year ended June 30, 2020, approximately $249,000 of cash was provided by our operations. The primary drivers underlying the cash provided by our operating activities were a decrease in accounts receivable of $1.32 million; a decrease in prepaid expenses and other assets of $490,000; an increase in accounts payable of $469,000; and an increase in accrued expenses and other liabilities of $572,000.$109,000. In addition, non-cash items totaling $1.51$6.78 million also had a favorable impact on our cash flow from operations during the fiscal year ended June 30, 2019.2020. These factors were offset partially offset by the unfavorable effect of our net loss in the amount of $6.16 million and an increase in inventory of $2.30 million;approximately $2.76 million resulting from lower quantities of inventory items sold as a decrease in accounts payableresult of $799,000; an increase in accounts receivable of $328,000; and an increase in prepaid expenses and other assets of $14,000. During the transitionlower period ended June 30, 2018, $1.04 million of cash was used by our operations. The primary drivers of our use of cash were a net loss of $1.28 million; an increase in inventory of $855,000; an increase in prepaid expenses and other assets of $271,000; a decrease in accounts payable of $295,000; and a decrease in accrued liabilities of $423,000. These factors were partially offset by a decrease in accounts receivable of $1.48 million. In addition, non-cash items totaling $594,000 partially offsetsales stemming from the impact of the net loss and had a favorable impact on cash flow from continuing operations during the transition period ended June 30, 2018. The inventory increases during the fiscal year ended June 30, 2019 and the transition period ended June 30, 2018 were, in part, due to the purchaseCOVID-19 pandemic.
44
During the fiscal year ended June 30, 2019,2021, accounts receivable increased principally as a result ofdue to the increased level of sales during our third and fourth fiscal quarters. Cash collections on sales made during our first and second fiscal quarters, which reflect robust year-end holiday sales, remained strong. During the transition periodthree months ended June 30, 2018, accounts receivable decreased principally due to increased cash collections2021, as compared with the sales during the transition period endedleading up to June 30, 2018 on sales made during2020. As a result of the third and fourth calendar quarters of 2017, which reflect year-end holiday sales levels. We did not offer any Traditional segment customers extended payment terms during the fiscal year ended June 30, 2019 or the transition period ended June 30, 2018; however, we may offer these termsCOVID-19 pandemic, from time to time whichwe offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers during Fiscal 2021 and the second half of Fiscal 2020. 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. Wesales, 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 andduring the current global economic environment. We believe that our net sales have been favorably impacted. Wewe are unable to estimate the impact of this programthese actions on our net sales, but we believe that if we ceased providing extended payment terms, in select instances, we believe we would not be at a competitive disadvantage for some Traditional segment customers in the marketplace during this economic period and that our net sales and profits could decrease.would likely be adversely impacted.
During the fiscal year ended June 30, 2019,2021, prepaid expenses and other assets decreased principally as a result of the timing of payments, primarily for insurance-related premium expenses, in advance of goods or services received. During the fiscal year ended June 30, 2021, accrued expenses and other liabilities increased principally due toas a result of the increase in our operating lease liability associated with the new lease amendment for our corporate headquarters facilities that was executed in January 2021. During the fiscal year ended June 30, 2021, accounts payable decreased primarily as a result of the timing of payments related to accrued compensation and related benefits, including year-end bonuses, as well as increased accrued sales and use taxesfor costs associated with higher current sales levelsinventory-related purchases and additional liabilities for jurisdictions whereprofessional services incurred. As a result of the pandemic, we have reached sales tax nexus. from time-to-time paid certain vendor business partners in advance of their payment terms to secure and achieve supply chain needs.
During the transition periodfiscal year ended June 30, 2018,2020, prepaid expenses and other assets increased principally as a result of an increase in other assets relating to the adoption of the new revenue recognition accounting standard as of January 1, 2018, and the timing of payments, principally for insurance-related expenses, in advance of goods or services received. During the transition periodfiscal year ended June 30, 20182020, accounts payable decreasedincreased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors’ payment terms. Likewise, accrued expenses and other liabilities decreasedincreased principally due to the timing of paymentsseverance accrual in connection with our June 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to accrued year-end bonuses.payments received prior to shipment of good from customers.
We manufactured approximately $14.09$7.63 million and $7.36$10.64 million in loose jewels and $7.66$12.72 million and $7.61$7.82 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 fiscal yearyears ended June 30, 20192021 and the transition period ended June 30, 2018,2020, respectively. We expect our purchases of precious metals and labor to increase as we increasefluctuate in conjunction with the levels of our finished jewelry business. In addition, we are subject to the worldwide fluctuation of the price of gold that, ifhas increased would resultsignificantly over the past decade, resulting in higher retail price points for gold jewelry. Because the market price of gold and other precious metals is beyond our control, the upward price trends could continue and have a negative impact on our operating cash flow as we manufacture finished jewelry.
Historically, our raw material inventories of SiC crystals had been purchased under exclusive supply agreements with a limited number of suppliers. Because the supply agreements restricted the sale of these crystals exclusively to us, the suppliers negotiated minimum purchase commitments with us that, when combined with our reduced sales levels during theprior periods whenin which the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As of June 30, 20192021 and June 30, 2018, $21.822020, $17.72 million and $20.85$23.19 million, respectively, of our inventories were classified as long-term assets. FinishedLoose jewel sales and finished jewelry that we manufacture and loose jewel sales 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 $3.81$1.78 million and $4.49 million as of June 30, 2019 and June 30, 2018, respectively, and new raw material that we are purchasingpurchase pursuant to the Supply Agreement.
Our inventory principally comprises the following two types of materials: (i) new material that has been produced since September 2015 to the present, which is the raw materials for our Forever OneTM and Moissanite by Charles & Colvard® products with colorless and near colorless gemstones, or New Material; and (ii) legacy material that was produced through the period ended August 2015, which is the raw materials for our Forever ClassicTM, Forever Brilliant® and lower grade gemstones, or Legacy Material. Of our total inventory as of June 30, 2019, 79% of the total inventory was New Material, while 21% was Legacy Material, as compared to percentages of total inventory of 70% of New Material and 30% of Legacy Material at June 30, 2018. We are actively selling goods set with the Legacy Material gemstones through our omni-channel sales strategy in such outlets as marketplaces, drop-ship and pure-play retailers. A more detailed description of our inventories is included in Note 56 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
We made income tax payments of approximately $15,000 and $2,000 during the fiscal years ended June 30, 2021 and 2020, respectively. As of June 30, 2021, all of our remaining federal income tax credits had expired or been utilized, and therefore, are not available to be carried forward to offset future income taxes. As of June 30, 2021 and 2020, we had federal tax net operating loss carryforwards of approximately $19.00 million and $23.72 million, respectively, expiring between 2034 and 2037, or that have no expiration, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $19.87 million and $20.12 million, respectively, expiring between 2023 and 2035; and various other state tax net operating loss carryforwards expiring between 2023 and 2040, which can be used to offset against future state taxable income.
Contractual Commitment
On December 12, 2014, we entered into the Supply Agreement with Cree. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of our required SiC materials in quarterly installments that must equal or exceed a set minimum order quantity. The initial term of the Supply Agreement was scheduled to expire on June 24, 2018, unless extended by the parties. Effective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement, as amended, also provides for the exclusive production of our premium moissanite product, Forever One™One™ and to provideprovided 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 was amended further to establishestablished a process by which Cree 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 Cree 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 20232025 is approximately $52.9$52.95 million, of which approximately $43.98$32.85 million remains to be purchased as of June 30, 2019. As of June 30, 2018,2021.
For more information regarding the second amendment to our total purchase commitment under the Supply Agreement, was the full amountexecuted on August 26, 2020, see Note 10 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of the purchase commitment of approximately $52.9 million.this Annual Report on Form 10-K.
During the fiscal
yearyears ended June 30,
20192021 and
the transition period ended June 30, 2018,2020, we purchased approximately
$8.91$3.78 million and
$4.89$7.47 million, respectively, of SiC crystals from Cree.
These purchases of SiC crystals from Cree during the transition period ended June 30, 2018 were pursuant to the terms and conditions of the Supply Agreement prior to the effective date of its amendment as of June 22, 2018. Going forward, we expect to use existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, together with future cash expected to be provided by operating activities
and, if necessary, our White Oak Credit Facility, to finance our purchase commitment under the Supply Agreement, as amended.
We made income tax paymentsLine of
$74,000 and $44,000 during the fiscal year ended June 30, 2019 and the transition period ended June 30, 2018, respectively. As of June 30, 2019 and June 30, 2018, we had approximately $102,000 and $313,000, respectively, of remaining federal income tax credits that expire between 2020 and 2021 and all of which can be carried forward to offset future income taxes. As of June 30, 2019 and June 30, 2018, we also had federal tax net operating loss carryforwards of approximately $23.39 million and $26.28 million, respectively, expiring between 2030 and 2037, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $20.20 million and $20.24 million, respectively, expiring between 2023 and 2033; and various other state tax net operating loss carryforwards expiring between 2021 and 2034, which can be used to offset against future state taxable income.Credit
OnEffective July 13, 2018,7, 2021, we andobtained from JPMorgan Chase our wholly-owned subsidiary, charlesandcolvard.com, LLC, collectively, referred to as the Borrowers, obtained the $5.00 million asset-based revolving White Oakcash collateralized JPMorgan Chase Credit Facility. The White OakJPMorgan Chase Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions. acquisitions and certain additional indebtedness for borrowed money, installment obligations, and obligations under capital and operating leases. The JPMorgan Chase Credit Facility is secured by a cash deposit in the amount of $5.05 million held by JPMorgan Chase as collateral for the line of credit facility.
Each advance accrues interest at a rate equal to JPMorgan Chase’s monthly London Interbank Offered Rate, or LIBOR, multiplied by a statutory reserve rate for eurocurrency funding to which JPMorgan Chase is subject with respect to the adjusted LIBOR rate as established by the U.S. Federal Reserve Board, plus a margin of 1.25% per annum. Interest is calculated monthly on an actual/360 day basis and payable monthly in arrears. Principal outstanding during an event of default, at JPMorgan Chase’s option, accrues interest at a rate of 3% per annum in excess of the above rate. Any advance may be prepaid in whole or in part at any time. See Note 2, under the caption of Recently Issued Accounting Pronouncements, to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K for more detailed information relating to concerns about structural risks of interbank offered rates, or IBORs, and, particularly, the risk of cessation of the LIBOR.
The JPMorgan Chase Credit Facility is evidenced by a credit agreement between us and JPMorgan Chase, or the JPMorgan Chase Credit Agreement, dated as of July 12, 2021, 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, 2022, 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, and changes in control.
In connection with the JPMorgan Chase Credit Facility, 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. We also agreed to maintain our primary banking depository and disbursement relationship with JPMorgan Chase.
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.
On July 12, 2021, upon its execution, we did not request any advances pursuant to the terms of the JPMorgan Chase Credit Facility.
Prior to obtaining the JPMorgan Chase Credit Facility, we and our wholly owned subsidiary, charlesandcolvard.com, LLC, collectively referred to as the Borrowers, had a $5.00 million asset-based revolving credit facility, or the White Oak Credit Facility, from White Oak Commercial Finance, LLC, or White Oak, which we terminated in accordance with its terms as of July 9, 2021. The effective date of the White Oak Credit Facility was July 13, 2018, and it was scheduled to mature on July 13, 2021.
The White Oak Credit Facility which matures on July 13, 2021, iswas available for general corporate and working capital purposes, including permitted acquisitions and was guaranteed by Charles & Colvard Direct, LLC, another of our wholly-owned subsidiaries and which is referred to as the Guarantor.Borrowers. Under the terms of the White Oak Credit Facility, the Borrowers mustwere required to maintain at least $500,000 in excess borrowing availability at all times. The White Oak Credit Facility containscontained no other financial covenants.
Advances under the White Oak Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers’ eligible accounts receivable and inventory, plus the value of precious metal jewelry components, less reserves. The inclusion of inventory and precious metal jewelry components in the borrowing base was subject to the completion of an inventory appraisal, which was completed subsequent to the execution of the White Oak Credit Facility. Eligible inventory is further limited to 60% of the net borrowing base, while precious metal jewelry components are limited to $500,000.
Advances may becould have been either revolving or non-revolving. Non-revolving advances are limited to $1.00 million in aggregate principal amount outstanding and must be repaid on each January 15 (which may be effected by conversion to revolving advances, absent an event of default). There are no other mandatory prepayments or line reductions. We may elect to prepay advances in whole or in part at any time without penalty. In addition, the White Oak Credit Facility may be terminated by us at any time, subject to a $100,000 fee in the first year of the term of the White Oak Credit Facility, a $50,000 fee in the second year, and no fee thereafter. In connection with the White Oak Credit Facility, we will incur a non-refundable origination fee in the amount of $125,000 that is due and payable to White Oak in three installments. The first installment in the amount of $41,667 was paid upon execution of the White Oak Credit Facility on July 13, 2018 and the second installment in the amount of $41,667 was paid on July 13, 2019. The third and final installment in the amount of $41,666 will be due and payable on July 13, 2020, or the date of termination, whichever is sooner.
During the first year of the term of the White Oak Credit Facility, any revolving advances will accruewould have accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and any non-revolving advances will accruewould have accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins will reducewould have been reduced upon ourthe Company’s achievement of a specified fixed charge coverage ratio.ratio during the period of any outstanding advances. However, any advances arewere in all cases subject to a minimum interest rate of 5.50%. Interest is and interest would have been calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default, accrueswhich again did not occur during the term of the White Oak Credit Facility, would have accrued interest at a rate 2% in excess of the rate that would have been otherwise applicable.applicable.
The White Oak Credit Facility is secured by a lien on substantially all assets of the Borrowers, each of which is jointly and severally liable for all obligations thereunder. White Oak’s security interest in certain SiC material is subordinate to Cree’s security interest in such material pursuant to the Company’s Supply Agreement and an Intercreditor Agreement by and among the Borrowers and the Guarantor with White Oak. In addition, White Oak’s security interest in certain of our tangible personal property is subordinate to our landlord’s security interest in such tangible personal property.
The White Oak Credit Facility is evidenced by a credit agreement, dated as of July 13, 2018, or the Credit Agreement, a security agreement, dated as of July 13, 2018, or the Security Agreement, and customary ancillary documents. The Credit Agreement, Security Agreement, and ancillary documents contain customary covenants, representations, fees, and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, liens, loans, investments, mergers, acquisitions, divestitures, and affiliate transactions.
Events of default under the White Oak Credit Facility include, without limitation, a change in control, an event of default under other indebtedness of the Borrowers or Guarantor in excess of $250,000, a material adverse change in the business of the Borrowers or Guarantor or in their ability to perform their obligations under the White Oak Credit Facility, and other defined circumstances that White Oak believes may impair the prospect of repayment. If an event of default occurs, White Oak is entitled to take enforcement action, including acceleration of amounts due under the White Oak Credit Facility and foreclosure upon collateral. The Credit Agreement contains other customary terms that include indemnity, collateral monitoring fee, minimum interest charge, expense reimbursement, yield protection, and confidentiality provisions.
We had not borrowed against the White Oak Credit Facility as of
June 30, 2019.
Prior toJuly 9, 2021, the
execution ofdate upon which we terminated the White Oak Credit Facility
we and our wholly owned subsidiaries, Charles & Colvard Direct, LLC, and Moissanite.com, LLC (now charlesandcolvard.com, LLC), collectively referred to as the Wells Fargo Borrowers, had obtained a credit facility from Wells Fargo Bank, National Association, or Wells Fargo, hereinafter referred to as the Wells Fargo Credit Facility. The Wells Fargo Credit Facility was available for general corporate and working capital purposes, including transaction fees and expenses incurred in connection therewith, and the issuance of letters of credit up to a $1.00 million sublimit. The effective date of the Wells Fargo Credit Facility was June 25, 2014, and it was scheduled to mature on June 25, 2017. However, effective June 22, 2017, the Wells Fargo Credit Facility was amended to, among other things, extend the maturity date to June 25, 2018, the date upon which it matured in accordance with its terms.
Any advance would have accrued interest at a rate equal to either (i) Wells Fargo’s three-month LIBOR rate plus 2.00%, or (ii) Wells Fargo’s Prime Rate plus 1%, each calculated on an actual/360 basisMore detailed descriptions of both our JPMorgan Chase Credit Facility and would have been payable monthly in arrears. Principal outstanding during an event of default, which did not occur during the term of the Wells Fargo Credit Facility, would have accrued interest at a rate of 3% in excess of the above rate. Any advance could have been prepaid in whole or in part at any time and there were no mandatory prepayments or line reductions.
We had not borrowed against the Wells Fargo Credit Facility as of June 25, 2018, the date upon which the Wells Fargo Credit Facility matured and was terminated in accordance with its terms.
As evidenced by what we believe is a vote of confidence by our shareholders and the financial success of the recent underwritten public offering of our common stock, we continue to execute our strategy to build and reinvest in our business. We plan to continue making various significant investments to drive near- and long-term sales growth, while balancing these initiatives with what we believe to be the overarching goal of generating ongoing and sustainable earnings improvement. While these steps have resulted from time to time in unprofitable financial results during the transition period ended June 30, 2018 and the year ended December 31, 2017, we will continue to be prudent about our investments by implementing a strategy that we believe will enable us to move nimbly, measure risks carefully and make data-driven decisions. When compared to the terms and covenants underlying our previous line of credit arrangement, we also believe that ourformer White Oak Credit Facility
coupled withare included in Note 11 to our
potential ongoing access to the capital markets, combine to empower us to be more flexibleconsolidated financial statements in Item 8, “Financial Statements and
even more nimble when executing our strategic plans. We will continue to analyze each investment decision with the intent to grow our business while achieving our goalSupplementary Data”, of
maintaining profitable financial resultsthis Annual Report on Form 10-K.
Liquidity and generating positive operating cash flows.Capital Trends
We believe that our existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, together withand future cash expected to be provided by operating activities combined will be sufficient to meet our working capital and capital expenditure needs over the next twelve months.
Our future capital requirements and the adequacy of available funds will depend on many factors, includingthe 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 I, Item 1A of this Annual Report on Form 10-K. Currently, we have the White OakJPMorgan Chase Credit Facility thatthrough its expiration on July 31, 2022, which we believe would mitigate these risks to our cash and liquidity position. Also, we may make investments in, or acquisitions of, complementary businesses, which could also require us to seek additional equity or debt financing.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which we prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The future effects of the COVID-19 pandemic on our results of operations, cash flows, and financial position remain unclear. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosures of contingent assets and liabilities. “Critical accounting policies and estimates” are defined as those most important to the financial statement presentation and that require the most difficult, subjective, or complex judgments. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Under different assumptions and/or conditions, including the impact of the COVID-19 pandemic and the related responses, those actual results of operations may materially differ. The most significant estimates impacting our consolidated financial statements relate to the valuation and classification of inventories, accounts receivable reserves, deferred tax assets, 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.
Valuation and Classification of Inventories
Inventories are stated at the lower of cost or net realizable value on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs.
Any inventory on hand at the measurement date in excess of our current requirements based on historical and anticipated levels of sales is classified as long-term on our Consolidated Balance Sheets. The classification of our inventory as either current or long-term inventory requires us to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized in cost of sales over the next 12 months.
Our work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. Our moissanite jewel manufacturing process involves the production of intermediary shapes, called “preforms”, that vary depending upon the expected size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of June 30, 2021 and 2020, work-in-process inventories issued to active production jobs approximated $2.23 million and $1.34 million, respectively.
Each accounting period we evaluate the valuation and classification of inventories including the need for potential adjustments to inventory-related reserves and valuation allowances, which also include significant estimates by management.
See Note 2 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K under the Inventories caption for a further description of our inventories accounting policy and see Note 6 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K for more detailed information relating to our accounting for inventory-related reserves and valuation allowances.
Revenue Recognition
Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To achieve this principle, we perform the following five steps: (i) identification of a contract with a customer; (ii) identification of any separate performance obligations; (iii) determination of the transaction price; (iv) allocation of the transaction price to the performance obligations in the contract; and (v) recognition of revenue when we have satisfied the underlying performance obligations. We recognize substantially all of our revenue at a point in time when control of our goods has passed to the customer with the exception of consigned goods. We consider our performance obligation related to the shipment of goods satisfied at the time this control is transferred. We also have a variable consideration element related to most of our contracts in the form of product return rights. At the time revenue is recognized, an allowance for estimated returns is established and any change in the allowance for returns is charged against net sales in the current period. For our customers (excluding those of charlesandcolvard.com), the returns policy generally allows for the return of jewels and finished jewelry with a valid reason for credit within 30 days of shipment, except for returns during the COVID-19 pandemic during which we generally extended the return period for an additional 30 days. Customers in both our charlesandcolvard.com and moissaniteoutlet.com websites may generally return purchases within 60 days and 30 days, respectively, of the shipment date in accordance with our returns policies as disclosed on our charlesandcolvard.com and moissaniteoutlet.com websites. Periodically, we ship loose jewel goods and finished goods to Traditional segment customers on consignment terms. Under these consignment terms, the customer assumes the risk of loss and has an absolute right of return for a specified period that typically ranges from six months to one year. Our Online Channels segment and Traditional segment customers are generally required to make payments on consignment shipments within 30 to 60 days upon the customer informing us that such inventory will be kept by the customer. Accordingly, we do not recognize revenue on these consignment transactions until the earlier of (i) the customer informing us that the inventory will be kept by the customer; (ii) the expiration of the right of returns period; or (iii) the customer informing us that the inventory has been sold.
See Note 2 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K under the Revenue Recognition caption for additional information regarding the underlying required disclosures arising from contracts with customers as well as a more detailed description of our revenue recognition accounting policy.
Accounts Receivable Reserves
Estimates are used to determine the amount of two reserves against trade accounts receivable. The first reserve is an allowance for sales returns. At the time revenue is recognized, we estimate future returns using a historical return rate that is reviewed quarterly with consideration of any contractual return privileges granted to customers, including any current extenuating economic conditions resulting from the COVID-19 pandemic, and we reduce sales and trade accounts receivable by this estimated amount. Our allowance for sales returns was $675,000 and $704,000 at June 30, 2021 and 2020, respectively.
The second reserve is an allowance for uncollectible accounts for the measurement of estimated credit losses resulting from the failure of our customers to make required payments. This allowance reduces trade accounts receivable to an amount expected to be collected. We use a current expected credit loss (“CECL”) model whereby we estimate credit losses expected over the life of our pool of exposures based on historical percentages of uncollectible accounts, changes in payment history, and facts and circumstances, including any current extenuating economic conditions, for example those resulting from the COVID-19 pandemic, regarding specific accounts that become known to, or forecasted by, us when evaluating the adequacy of the allowance for uncollectible accounts. We determine a credit loss percentage based on the age of the receivable that we deem uncollectible related to potential credit losses. We record an allowance for such credit losses, which includes a provision for expected losses based on historical write-offs, adjusted for current conditions as deemed necessary, reasonable and supportable forecasts about future conditions, and a specific reserve for accounts deemed at risk. The allowance is our estimate for accounts receivable as of the balance sheet date that ultimately will not be collected. Any changes in the allowance are reflected in the results of operations in the period in which the change occurs. We write-off accounts receivable and the related allowance recorded previously when it becomes probable, based upon customer facts and circumstances, that such amounts will not be collected. We generally use internal collection efforts, which may include our sales personnel as deemed appropriate. After all internal collection efforts have been exhausted, we generally write-off the underlying account receivable.
Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstances of the specific underlying customer account. During our review for the fiscal years ended June 30, 2021 and 2020, we determined no additional reserves were necessary for specific accounts. Based on these criteria, we determined that allowances for uncollectible accounts receivable of $71,000 and $79,000 at June 30, 2021 and 2020, respectively, were required.
Deferred Tax Assets
As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of available deferred tax assets. As of the fiscal year ended June 30, 2020, we did not recognize an income tax benefit for any of our deferred tax assets, primarily related to net operating loss carryforwards and inventory valuation reserves, because management determined that sufficient negative evidence continued to exist to conclude it was uncertain that we would have sufficient future taxable income to utilize our deferred tax assets.
However, as of June 30, 2021, cumulative positive taxable income over the last three tax years had been generated in the U.S., as compared to the negative evidence of cumulative losses in previous years. We also determined that our expectation of future taxable income in upcoming tax years, including estimated growth rates applied to future expected taxable income that includes significant management estimates and assumptions, would be sufficient to result in full utilization of our federal net operating loss carryforwards and certain of the deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence exists as of June 30, 2021, to conclude that it is more likely than not deferred tax assets of approximately $6.35 million are realizable, and we reduced our valuation allowance accordingly. The reduction of the valuation allowances against these deferred tax assets was the main driver of the income tax benefit during the fiscal year ended June 30, 2021 of approximately $6.33 million. A valuation allowance remains against certain deferred tax assets primarily relating to state net operating loss carryforwards from our e-commerce subsidiary due to the timing uncertainty of when it will generate positive taxable income to utilize the associated deferred tax assets. In addition, as detailed below, a valuation allowance also remains against certain deferred tax assets relating to operating loss carryforwards relating to our dormant subsidiary located in Hong Kong.
As of June 30, 2021, all of our remaining federal income tax credits had expired or been utilized, and therefore, are not available to be carried forward to offset future income taxes. As of June 30, 2021 and 2020, we had federal tax net operating loss carryforwards of approximately $19.00 million and $23.72 million, respectively, expiring between 2034 and 2037, or that have no expiration, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $19.87 million and $20.12 million, respectively, 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.
As of each of June 30, 2021 and 2020, there was approximately $6.03 million in net operating loss carryforwards in Hong Kong. In accordance with the Hong Kong tax code, these amounts can be carried forward indefinitely to offset future taxable income in Hong Kong. Our deferred tax assets in Hong Kong were fully reserved with a valuation allowance of $996,000 as of each of June 30, 2021 and 2020, and had been fully reserved in all prior fiscal periods due to the uncertainty of future taxable income in this jurisdiction to utilize the deferred tax assets. Charles & Colvard (HK) Ltd., our Hong Kong subsidiary, was entered into dormancy as of September 30, 2020, following its re-activation in December 2017. Charles & Colvard (HK) Ltd. previously became dormant in the second quarter of 2009 and has had no operating activity since 2008. If we use any portion of our deferred tax assets in future periods, the valuation allowance would need to be reversed and may impact our future operating results.
For discussion of the effects of the CARES Act, the Consolidated Appropriations Act, 2021, and the NC COVID-19 Relief Act on our provision for income taxes and deferred tax assets, see Note 13 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Uncertain Tax Positions
We account for the de-recognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positions in accordance with U.S. GAAP. Determining which tax positions qualify as uncertain positions and the subsequent accounting for these positions requires significant estimates and assumptions. Our net accrued income tax liability under the provisions of this guidance was approximately $10,000 and $8,000 at June 30, 2021 and 2020, respectively. This liability is only resolved when we obtain an official ruling from the tax authority on the positions or when the statute of limitations expires. Our liability for accrued interest on these uncertain tax positions has increased by approximately $2,000 for each of the fiscal years ended June 30, 2021 and 2020.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K under the Recently Issued Accounting Pronouncements caption for the description of recent accounting pronouncements, including the expected date of adoption and estimated effects, on our consolidated financial statements.
Off-Balance Sheet Arrangements
We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As of June 30, 20192021 and June 30, 2018,2020, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.arrangements.
We have entered into an operating lease for approximately 36,350 square feet of mixed-use space, which we currently occupy, from an unaffiliated third-party for our offices and manufacturing facility in the normal course of business. This type of arrangement is often referred to as a form of off-balance sheet financing.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Not applicable.
| Item 8. | Financial Statements and Supplementary Data |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| Page Number |
| |
| 53 |
| | |
Report of Independent Registered Public Accounting Firm
| 54 |
| |
| 55 |
| |
| 56 |
| | |
| 57 |
| |
| 58 |
| |
| 59
|
Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
Charles & Colvard, Ltd.
Morrisville, North Carolina
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Charles & Colvard, Ltd. (the “Company”) as of June 30, 2019, June 30, 20182021, and December 31, 2017,2020, the related consolidated statements of operations, shareholders’ equity, and cash flows for the yearyears then ended, June 30, 2019, the six-month transition period ended June 30, 2018 and the year ended December 31, 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at June 30, 2019, June 30, 20182021 and December 31, 2017,2020, and the results of its operations and its cash flows for the yearyears then ended, June 30, 2019, the six-month transition period ended June 30, 2018 and the year ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
Inventories Net Realizable Value
As described in Notes 2 and 6 to the Company’s consolidated financial statements, inventories totaled approximately $29.2 million at June 30, 2021. Inventories are stated at the lower of cost or net realizable value. Each accounting period, the Company evaluates the valuation of inventories including the need for potential adjustments to inventory-related reserves, which includes significant estimates by management.
We identified management’s estimates of the net realizable value of inventories, including inventory-related reserves, as a critical audit matter. Certain of the Company’s inventories are subject to various market factors, including changes in styling trends, that could indicate a decline in the net realizable value. Given the inherent uncertainty in estimating the future marketability of the Company’s products, auditing management’s estimates of the net realizable value of inventories required a high degree of auditor judgment and increased audit effort.
The primary procedures we performed to address this critical audit matter included:
Evaluating the reasonableness of the inputs used in management’s inventory reserve calculation as compared to historical demand and prices for similar products recently sold by the Company, current and expected margins based on current period sales of inventories on hand, and industry trends.
Analyzing the reserve calculations to determine whether management identified evidence of potential declines in marketability, including slow moving inventory, for which carrying value may exceed estimates of net realizable value and appropriately evaluated potential reserves.
Realizability of Deferred Tax Assets Previously Offset by Valuation Allowances
As described in Notes 2 and 13 to the Company’s consolidated financial statements, at each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of available deferred tax assets. The Company determined that sufficient evidence exists as of June 30, 2021, that it is more likely than not that deferred tax assets of approximately $6.4 million would be realized and released a portion of the Company’s valuation allowance. The release of the valuation allowance against these deferred tax assets was the main driver of the income tax benefit during the fiscal year ended June 30, 2021 of approximately $6.3 million.
We identified management’s judgments related to the future realization of deferred tax assets as a critical audit matter. Management uses significant judgment and estimation to assess the future realization of deferred tax assets. This assessment includes an estimate of future taxable income which involves significant uncertainty, the auditing of which requires a high degree of judgment and an increased effort, including the involvement of professionals with special skills.
The primary procedures we performed to address this critical audit matter included:
Evaluating the reasonableness of management’s estimates of future taxable income, including consideration against historical performance of the Company and whether the information was materially consistent with evidence obtained in other areas of the audit.
Utilizing personnel with specialized skill and knowledge in income taxes to assist in the evaluation of the appropriateness of the Company’s tax positions and analysis of management’s conclusion that certain of the Company’s deferred tax assets are more likely than not to be utilized.
/s/ BDO USA, LLP
We have served as the Company’s auditor since 2010.
Raleigh, North Carolina
September 5, 20192, 2021
CONSOLIDATED BALANCE SHEETS
| | | June 30, | | | December 31, | |
| | | 2019 | | | 2018 | | | 2017 | |
| ASSETS | | | | | | | | | |
| Current assets: | | | | | | | | | |
| Cash and cash equivalents | | $ | 12,465,483 | | | $ | 3,393,186 | | | $ | 4,594,007 | |
| Restricted cash | | | 541,062 | | | | - | | | | - | |
| Accounts receivable, net | | | 1,962,471 | | | | 1,765,722 | | | | 3,377,451 | |
| Inventory, net | | | 11,909,792 | | | | 10,979,891 | | | | 11,208,658 | |
| Prepaid expenses and other assets | | | 989,559 | | | | 916,162 | | | | 969,857 | |
| Total current assets | | | 27,868,367 | | | | 17,054,961 | | | | 20,149,973 | |
| Long-term assets: | | | | | | | | | | | | |
| Inventory, net | | | 21,823,928 | | | | 20,848,647 | | | | 19,764,959 | |
| Property and equipment, net | | | 1,026,098 | | | | 1,144,198 | | | | 1,242,200 | |
| Intangible assets, net | | | 97,373 | | | | 34,833 | | | | 8,597 | |
| Other assets | | | 330,615 | | | | 389,868 | | | | 64,978 | |
| Total long-term assets | | | 23,278,014 | | | | 22,417,546 | | | | 21,080,734 | |
| TOTAL ASSETS | | $ | 51,146,381 | | | $ | 39,472,507 | | | $ | 41,230,707 | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | | |
| Current liabilities: | | | | | | | | | |
| Accounts payable | | $ | 3,372,172 | | | $ | 4,170,952 | | | $ | 4,466,163 | |
| Accrued expenses and other liabilities | | | 1,325,608 | | | | 618,945 | | | | 980,800 | |
| Total current liabilities | | | 4,697,780 | | | | 4,789,897 | | | | 5,446,963 | |
| Long-term liabilities: | | | | | | | | | | | | |
| Deferred rent | | | 236,745 | | | | 393,051 | | | | 463,526 | |
| Accrued income taxes | | | 492,832 | | | | 471,126 | | | | 461,592 | |
| Total long-term liabilities | | | 729,577 | | | | 864,177 | | | | 925,118 | |
| Total liabilities | | | 5,427,357 | | | | 5,654,074 | | | | 6,372,081 | |
| Commitments and contingencies (Note 9) | | | | | | | | | | | | |
| Shareholders’ equity: | | | | | | | | | | | | |
Common stock, no par value; 50,000,000 shares authorized; 28,027,569, 21,705,173 and 21,580,102 shares issued and outstanding at June 30, 2019, June 30, 2018 and December 31, 2017, respectively | | | 54,342,864 | | | | 54,243,816 | | | | 54,243,816 | |
| Additional paid-in capital | | | 24,488,147 | | | | 14,962,071 | | | | 14,726,438 | |
| Accumulated deficit | | | (33,111,987 | ) | | | (35,387,454 | ) | | | (34,111,628 | ) |
| Total shareholders’ equity | | | 45,719,024 | | | | 33,818,433 | | | | 34,858,626 | |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | | $
| 51,146,381 | | | $ | 39,472,507 | | | $ | 41,230,707 | |
| | | June 30, | |
| | | 2021 | | | 2020 | |
| ASSETS | | | | | | |
| Current assets: | | | | | | |
| Cash and cash equivalents | | $ | 21,302,317 | | | $ | 13,993,032 | |
| Restricted cash | | | 144,634 | | | | 624,202 | |
| Accounts receivable, net | | | 1,662,074 | | | | 670,718 | |
| Inventory, net | | | 11,450,141 | | | | 7,443,257 | |
| Note receivable | | | 250,000 | | | | - | |
| Prepaid expenses and other assets | | | 952,065 | | | | 1,177,860 | |
| Total current assets | | | 35,761,231 | | | | 23,909,069 | |
| Long-term assets: | | | | | | | | |
| Inventory, net | | | 17,722,579 | | | | 23,190,702 | |
| Property and equipment, net | | | 875,897 | | | | 999,061 | |
| Intangible assets, net | | | 209,658 | | | | 170,151 | |
| Operating lease right-of-use assets | | | 3,952,146 | | | | 584,143 | |
| Deferred income taxes, net | | | 6,350,830 | | | | - | |
| Other assets | | | 49,658 | | | | 51,461 | |
| Total long-term assets | | | 29,160,768 | | | | 24,995,518 | |
| TOTAL ASSETS | | $ | 64,921,999 | | | $ | 48,904,587 | |
| | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
| Current liabilities: | | | | | | | | |
| Accounts payable | | $ | 2,774,373 | | | $ | 3,748,235 | |
| Operating lease liabilities, current portion | | | 566,083 | | | | 622,493 | |
| Current maturity of long-term debt | | | - | | | | 193,000 | |
| Accrued expenses and other liabilities | | | 2,281,807 | | | | 1,922,332 | |
| Total current liabilities | | | 5,622,263 | | | | 6,486,060 | |
| Long-term liabilities: | | | | | | | | |
| Long-term debt, net | | | - | | | | 772,000 | |
| Noncurrent operating lease liabilities | | | 3,600,842 | | | | 203,003 | |
| Accrued income taxes | | | 9,878 | | | | 7,947 | |
| Total long-term liabilities | | | 3,610,720 | | | | 982,950 | |
| Total liabilities | | | 9,232,983 | | | | 7,469,010 | |
| Commitments and contingencies (Note 10) | | | | | | | | |
| Shareholders’ equity: | | | | | | | | |
| Common stock, no par value; 50,000,000 shares authorized; 29,913,095 and 28,949,410 shares issued and outstanding at June 30, 2021 and 2020, respectively | | | 56,057,109 | | | | 54,342,864 | |
| Additional paid-in capital | | | 25,608,593 | | | | 25,880,165 | |
| Accumulated deficit | | | (25,976,686 | ) | | | (38,787,452 | ) |
| Total shareholders’ equity | | | 55,689,016 | | | | 41,435,577 | |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | | $ | 64,921,999 | | | $ | 48,904,587 | |
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | Year Ended June 30, | |
| | | | | | | | | | | | 2021 | | | 2020 | |
| Net sales | | $ | 32,244,109 | | | $ | 13,163,048 | | | $ | 27,032,964 | | | $ | 39,235,839 | | | $ | 29,189,020 | |
| Costs and expenses: | | | | | | | | | | | | | | | | | |
| Cost of goods sold | | 17,352,167 | | | 8,298,286 | | | 15,470,617 | | | | 20,809,690 | | | | 21,200,207 | |
| Sales and marketing | | 7,983,506 | | | 3,856,796 | | | 7,477,354 | | | | 8,476,716 | | | | 9,443,244 | |
| General and administrative | | 4,640,810 | | | 2,601,554 | | | 4,689,823 | | | | 4,441,441 | | | | 4,861,297 | |
| Research and development | | | 2,069 | | | | - | | | | 3,714 | | |
| Total costs and expenses | | | 29,978,552 | | | | 14,756,636 | | | | 27,641,508 | | | | 33,727,847 | | | | 35,504,748 | |
| Income (Loss) from operations | | 2,265,557 | | | (1,593,588 | ) | | (608,544 | ) | | | 5,507,992 | | | | (6,315,728 | ) |
| Other income (expense): | | | | | | | | | | | | | | | | | |
| Gain on extinguishment of debt | | | | 974,328 | | | | - | |
| Interest income | | 11,022 | | | - | | | - | | | | 5,581 | | | | 158,091 | |
| Interest expense | | (2,198 | ) | | (293 | ) | | (541 | ) | | | (8,953 | ) | | | (884 | ) |
| Loss on foreign currency exchange | | (344 | ) | | (5 | ) | | - | | | | (603 | ) | | | (1,829 | ) |
| Gain on insurance claim settlement | | - | | | - | | | 183,217 | | |
| Other expense | | | (13 | ) | | | - | | | | - | | |
| Total other income (expense), net | | | 8,467 | | | | (298 | ) | | | 182,676 | | | | 970,353 | | | | 155,378 | |
| Income (Loss) before income taxes | | 2,274,024 | | | (1,593,886 | ) | | (425,868 | ) | | | 6,478,345 | | | | (6,160,350 | ) |
| Income tax benefit (expense) | | | 1,443 | | | | 318,060 | | | | (27,609 | ) | | | 6,332,421 | | | | (1,733 | ) |
| Net income (loss) | | $ | 2,275,467 | | | $ | (1,275,826 | ) | | $ | (453,477 | ) | | $ | 12,810,766 | | | $ | (6,162,083 | ) |
| | | | | | | | | | | | | | | | | | |
| Net income (loss) per common share: | | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.10 | | | $ | (0.06 | ) | | $ | (0.02 | ) | | $ | 0.44 | | | $ | (0.22 | ) |
| Diluted | | 0.10 | | | (0.06 | ) | | (0.02 | ) | | | 0.42 | | | | (0.22 | ) |
| | | | | | | | | | | | | | | | | | |
| Weighted average number of shares used in computing net income (loss) per common share: | | | | | | | | | | | | | | | | | |
| Basic | | 21,860,699 | | | 21,406,487 | | | 21,193,793 | | | | 29,144,820 | | | | 28,644,133 | |
| Diluted | | 22,111,223 | | | 21,406,487 | | | 21,193,793 | | | | 30,232,567 | | | | 28,644,133 | |
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
| | | Common Stock | | | | | | | | | | | | Common Stock | | | | | | | | | | |
| | | Number of Shares | | | Amount | | | Additional Paid-in Capital | | | Accumulated Deficit | | | Total Shareholders’ Equity | | | Number of Shares | | | Amount | | | Additional Paid-in Capital | | | Accumulated Deficit | | | Total Shareholders’ Equity | |
| Balance at December 31, 2016 | | 21,369,885 | | | $ | 54,243,816 | | | $ | 14,282,956 | | | $ | (33,658,151 | ) | | $ | 34,868,621 | | |
| Balance at June 30, 2019 | | | | 28,027,569 | | | $ | 54,342,864 | | | $ | 24,488,147 | | | $ | (32,625,369 | ) | | $ | 46,205,642 | |
| Issuance of common stock, net of offering costs | | | | 630,500 | | | | - | | | | 932,480 | | | | - | | | | 932,480 | |
| Stock-based compensation | | - | | | - | | | 443,482 | | | - | | | 443,482 | | | | - | | | | - | | | | 459,538 | | | | - | | | | 459,538 | |
| Issuance of restricted stock | | 210,217 | | | - | | | - | | | - | | | - | | | | 325,000 | | | | - | | | | - | | | | - | | | | - | |
| Retirement of restricted stock | | | | (33,659 | ) | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | (453,477 | ) | | | (453,477 | ) | | | - | | | | - | | | | - | | | | (6,162,083 | ) | | | (6,162,083 | ) |
| Balance at December 31, 2017 | | 21,580,102 | | | $ | 54,243,816 | | | $ | 14,726,438 | | | $ | (34,111,628 | ) | | $ | 34,858,626 | | |
| Balance at June 30, 2020 | | | | 28,949,410 | | | $ | 54,342,864 | | | $ | 25,880,165 | | | $ | (38,787,452 | ) | | $ | 41,435,577 | |
| Stock-based compensation | | - | | | - | | | 235,633 | | | - | | | 235,633 | | | | - | | | | - | | | | 352,583 | | | | - | | | | 352,583 | |
| Issuance of restricted stock | | 125,071 | | | - | | | - | | | - | | | - | | | | 178,750 | | | | - | | | | - | | | | - | | | | - | |
| Net loss | | | - | | | | - | | | | - | | | | (1,275,826 | ) | | | (1,275,826 | ) | |
| Balance at June 30, 2018 | | 21,705,173 | | | $ | 54,243,816 | | | $ | 14,962,071 | | | $ | (35,387,454 | ) | | $ | 33,818,433 | | |
| Issuance of common stock | | 6,250,000 | | | - | | | 9,058,568 | | | - | | | 9,058,568 | | |
| Stock-based compensation | | - | | | - | | | 502,805 | | | - | | | 502,805 | | |
| Issuance of restricted stock | | 19,896 | | | - | | | - | | | - | | | - | | |
| Retirement of restricted stock | | | | (162,500 | ) | | | - | | | | - | | | | - | | | | - | |
| Stock option exercises | | 52,500 | | | 99,048 | | | (35,297 | ) | | - | | | 63,751 | | | | 947,435 | | | | 1,714,245 | | | | (624,155 | ) | | | - | | | | 1,090,090 | |
| Net income | | | - | | | | - | | | | - | | | | 2,275,467 | | | | 2,275,467 | | | | - | | | | - | | | | - | | | | 12,810,766 | | | | 12,810,766 | |
| Balance at June 30, 2019 | | | 28,027,569 | | | $ | 54,342,864 | | | $ | 24,488,147 | | | $ | (33,111,987 | ) | | $ | 45,719,024 | | |
| Balance at June 30, 2021 | | | | 29,913,095 | | | $ | 56,057,109 | | | $ | 25,608,593 | | | $ | (25,976,686 | ) | | $ | 55,689,016 | |
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | Year Ended June 30, | |
| | | Year Ended June 30, 2019 | | Six Months Ended June 30, 2018 | | Year Ended December 31, 2017 | | | 2021 | | | 2020 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | | | | | | | |
| Net income (loss) | | $ | 2,275,467 | | | $ | (1,275,826 | ) | | $ | (453,477 | ) | | $ | 12,810,766 | | | $ | (6,162,083 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | | | | | | |
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | | | | | | | | |
| Depreciation and amortization | | | 481,319 | | | | 229,993 | | | | 422,018 | | | | 567,122 | | | | 490,235 | |
| Stock-based compensation | | | 502,805 | | | | 235,633 | | | | 443,482 | | | | 352,583 | | | | 459,538 | |
| Provision for (recovery of) uncollectible accounts | | | 27,056 | | | | (4,511 | ) | | | 28,000 | | |
| Provision for sales returns | | | 98,000 | | | | 110,390 | | | | 122,000 | | |
| Provision for inventory reserves | | | 393,000 | | | | - | | | | 598,000 | | |
| Provision for accounts receivable discounts | | | 6,275 | | | | 22,802 | | | | - | | |
| Gain on insurance claim settlement | | | - | | | | - | | | | (183,217 | ) | |
| Provision for uncollectible accounts | | | | 2,030 | | | | 8,788 | |
| Recovery of sales returns | | | | (29,000 | ) | | | (42,000 | ) |
| Inventory write-downs | | | | 150,000 | | | | 5,863,991 | |
| (Recovery of) Provision for accounts receivable discounts | | | | (9,153 | ) | | | 3,751 | |
| Gain on extinguishment of debt | | | | (974,328 | ) | | | - | |
| Benefit for deferred income taxes, net | | | | (6,350,830 | ) | | | - | |
| Changes in operating assets and liabilities: | | | | | | | | | | | | | | | | | | | | |
| Accounts receivable | | | (328,080 | ) | | | 1,483,048 | | | | (732,825 | ) | | | (955,233 | ) | | | 1,321,214 | |
| Inventory | | | (2,298,182 | ) | | | (854,921 | ) | | | (3,503,032 | ) | | | 1,311,239 | | | | (2,764,230 | ) |
| Prepaid expenses and other assets, net | | | (14,144 | ) | | | (271,195 | ) | | | (36,250 | ) | | | (3,140,405 | ) | | | 490,438 | |
| Accounts payable | | | (798,780 | ) | | | (295,211 | ) | | | 489,014 | | | | (973,862 | ) | | | 468,687 | |
| Deferred rent | | | (156,306 | ) | | | (70,475 | ) | | | (131,390 | ) | |
| Accrued income taxes | | | 21,706 | | | | 9,534 | | | | 27,609 | | | | 1,931 | | | | 1,733 | |
| Accrued expenses and other liabilities | | | 706,663 | | | | (361,855 | ) | | | 349,693 | | | | 3,710,232 | | | | 109,123 | |
| Net cash provided by (used in) operating activities | | | 916,799 | | | | (1,042,594 | ) | | | (2,560,375 | ) | |
| Net cash provided by operating activities | | | | 6,473,092 | | | | 249,185 | |
| | | | | | | | | | | | | | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | | | | | | | | | | | | |
| Purchases of property and equipment | | | (361,440 | ) | | | (130,649 | ) | | | (271,390 | ) | | | (437,069 | ) | | | (458,854 | ) |
| Payment to fund note receivable | | | | (250,000 | ) | | | - | |
| Payments for intangible assets | | | (64.319 | ) | | | (27,578 | ) | | | (1,501 | ) | | | (46,396 | ) | | | (77,122 | ) |
| Net cash used in investing activities | | | (425,759 | ) | | | (158,227 | ) | | | (272,891 | ) | | | (733,465 | ) | | | (535,976 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | | | | | | | | | | | | |
| Stock option exercises | | | | 1,090,090 | | | | - | |
| Proceeds from long-term debt | | | | - | | | | 965,000 | |
| Issuance of common stock, net of offering costs | | | 9,058,568 | | | | - | | | | - | | | | - | | | | 932,480 | |
| Stock option exercises | | | 63,751 | | | | - | | | | - | | |
| Net cash provided by financing activities | | | 9,122,319 | | | | - | | | | - | | | | 1,090,090 | | | | 1,897,480 | |
| | | | | | | | | | | | | | | | | | | | | |
| NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH | | | 9,613,359 | | | | (1,200,821 | ) | | | (2,833,266 | ) | |
| CASH, CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING OF PERIOD | | | 3,393,186 | | | | 4,594,007 | | | | 7,427,273 | | |
| CASH, CASH EQUIVALENTS AND RESTRICTED CASH, END OF PERIOD | | $ | 13,006,545 | | | $ | 3,393,186 | | | $ | 4,594,007 | | |
| NET INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH | | | | 6,829,717 | | | | 1,610,689 | |
| CASH, CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING OF YEAR | | | | 14,617,234 | | | | 13,006,545 | |
| CASH, CASH EQUIVALENTS AND RESTRICTED CASH, END OF YEAR | | | $ | 21,446,951 | | | $ | 14,617,234 | |
| | | | | | | | | | |
Supplemental disclosure of non-cash investing and financing activities: | | | | | | | | | |
| Additions to right-of-use assets obtained from new operating lease liabilities | | | $ | 3,908,249 | | | $ | - | |
| Forgiveness of PPP Loan principal | | | | 965,000 | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Supplemental disclosure of cash flow information: | | | | | | | | | | | | | | | | | | | | |
| Cash paid during the period for interest | | $ | 2,198 | | | $ | 293 | | | $ | 541 | | |
| Cash paid during the period for income taxes | | $ | 73,562 | | | $ | 43,774 | | | $ | 84,786 | | |
| Cash paid during the year for interest | | | $ | - | | | $ | 884 | |
| Cash paid during the year for income taxes | | | $ | 14,704 | | | $ | 2,050 | |
See Notes to Consolidated Financial Statements.
CHARLES & COLVARD, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 1. | DESCRIPTION OF BUSINESS |
Charles & Colvard, Ltd. (the “Company”), a North Carolina corporation,
was founded in
1995,1995. The Company manufactures, markets, and distributes
Charles & Colvard Created Moissanite® (hereinafter referred to as moissanite or moissanite jewels) and finished jewelry featuring moissanite,
including Forever One™, the Company’s premium moissanite gemstone brand, for sale in the worldwide
fine jewelry market. The Company also markets and distributes Caydia® lab grown diamonds and finished jewelry featuring lab grown diamonds for sale in the worldwide fine jewelry market. Moissanite, also known by its chemical name silicon carbide (“SiC”), is a rare mineral first discovered in a meteorite crater. Because naturally occurring SiC crystals are too small for commercial use, larger crystals must be grown in a laboratory.
Lab grown diamonds are also grown using technology that replicates the natural diamond growing process. The only differentiation between that of a lab grown diamond and a mined diamond is its origin. The result is a man-made diamond that is chemically, physically, and optically the same as those grown beneath the earth’s surface.
The Company sells loose moissanite jewels, loose lab grown diamonds, and finished jewelry featuring both moissanite and lab grown diamonds at wholesale prices to distributors, manufacturers, retailers, and designers, including some of the largest distributors and jewelry manufacturers in the world. The Company’s finished jewelry and loose moissanite jewels and lab grown diamonds that are mounted into fine jewelry by other manufacturers are sold at retail outlets and via the Internet. The Company sells at retail prices to end-consumers through its wholly owned operating subsidiary, charlesandcolvard.com, LLC, third-party online marketplaces, drop-ship, and other pure-play, exclusively e-commerce outlets. The Company also sells at discount retail prices to end-consumers on its own transactional website, moissaniteoutlet.com, through charlesandcolvard.com, LLC.
| 2. | BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES |
Basis of Presentation and Principles of Consolidation – The accompanying consolidated financial statements as of and for the fiscal yearyears ended June 30, 2019, as of2021 and for the six months ended June 30, 2018 and as of and for the calendar year ended December 31, 20172020, include the accounts of the Company and its wholly owned subsidiaries charlesandcolvard.com, LLC (formerly Moissanite.com, LLC), formed in 2011;LLC; Charles & Colvard Direct, LLC, formed in 2011;LLC; and Charles & Colvard (HK) Ltd., the Company’s Hong Kong subsidiary, which was re-activatedentered into dormancy as of September 30, 2020 following its re-activation in December 2017. Charles & Colvard Direct, LLC had no operating activity during the fiscal year ended June 30, 2019, the six-month period ended June 30, 2018 and the calendar year ended December 31, 2017. Charles & Colvard (HK) Ltd. previously became dormant in the second quarter of 2009 and has had no operating activity since its operations ceased in 2008. Charles & Colvard Direct, LLC, had no operating activity during the fiscal years ended June 30, 2021 or 2020. All intercompany accounts have been eliminated.eliminated.
Change in Fiscal Year-End – In January 2018, the Board of Directors of the Company approved a change in the Company’s fiscal year from that of a calendar year-end beginning on January 1 and ending on December 31 of each year to a fiscal year beginning on July 1 of each year and ending on June 30 of the following calendar year. This change to the fiscal year reporting cycle began July 1, 2018. As a result of the change, the Company had a six-month transition period from January 1, 2018 to June 30, 2018 (the “transition period ended June 30, 2018”). Accordingly, the Company is filing its audited financial results as of and for the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the calendar year ended December 31, 2017 in this Annual Report on Form 10-K with the U.S. Securities and Exchange Commission (the “SEC”).
Use of Estimates – The future effects of the COVID-19 pandemic on the Company’s results of operations, cash flows, and financial position continue to remain unclear. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (
“U.S. GAAP
”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The most significant estimates impacting the Company’s consolidated financial statements relate to
the valuation and classification of inventories, accounts receivable reserves, deferred tax assets,
uncertain tax positions, cooperative advertising,stock-based compensation, and revenue recognition. Actual results could differ materially from those estimates.
ChangeChanges in Accounting Policy – TheEffective July 1, 2020, the Company adopted the new accounting standard
in connection with revenue recognitionrelated to the measurement and disclosure of credit losses on financial instruments. The new guidance
includes a current expected credit loss (“CECL”) model that
was issued byrequires an entity to estimate credit losses expected over the
Financial Accounting Standards Board (the “FASB”) with a datelife of
an exposure or pool of exposures based on historical information, current conditions, and supportable forecasts at the
initial application of January 1, 2018. As a result,time the
Company changed its accounting policy for revenue recognition during the transition period ended June 30, 2018, as detailed below under the Revenue Recognition caption.
asset is recognized and is measured at each reporting period. The Company applied this new accounting standard using the modified retrospective approach. Based onguidance principally aligns the Company’s analysis, the timing and measurement of revenues under the new revenue recognition guidance is consistentaccounting for its trade accounts receivable with the Company’s prior policies. Accordingly, no adjustment was required to the Company’s opening balanceeconomics of equity asextending credit and improves its financial reporting by requiring timelier recording of January 1, 2018. Except for required disclosures of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, the changes resulting from therelated credit losses.
The adoption of the new accounting standard did not have a material effectimpact on the Company’s consolidated financial statements. Comparative prior period informationposition or results of operations and the Company did not record a cumulative-effect adjustment to retained earnings. The Company amended its allowance for credit losses policy, as set forth below, for the calendar year ended December 31, 2017 has not been adjusted and continues to be reported underimplementation of the new accounting guidance in effect prior to the change of accounting.standard.
59
The Company records an allowance for credit losses, which includes a provision for expected losses based on historical write-offs, adjusted for current conditions as deemed necessary, reasonable and supportable forecasts about future conditions that affect the expected collectability of the reported amount of the financial asset, and a specific reserve for accounts deemed at risk. The allowance is the Company’s estimate for accounts receivable as of the balance sheet date that ultimately will not be collected. Any changes in the allowance are reflected in the results of operations in the period in which the change occurs. The Company writes-off accounts receivable and the related allowance recorded previously when it becomes probable, based upon customer facts and circumstances, that such amounts will not be collected.
Effective July 1, 2020, the Company also adopted the new accounting standard in connection with accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. The new standard provides guidance to determine the accounting for fees paid in connection with a cloud computing arrangement that may include a software license. The adoption of this new accounting standard did not have a material impact on the Company’s financial position or results of operations.
Cash and Cash Equivalents – All highly liquid investments with an original maturity of three months or less from the date of purchase are considered to be cash equivalents. The Company’s cash and cash equivalents include cash on deposit and a money market fund. See the Restricted Cash caption below for further details on the nature and classifications of the Company’s restricted cash balances.
Restricted Cash – In accordance with cash management process requirements
relatingrelated to the Company’s asset-based revolving credit facility from
White Oak Commercial Finance, LLC (“White Oak”),
there arewhich was terminated by the Company on July 9, 2021 in accordance with its terms, such credit facility contained access and usage restrictions on certain cash deposit balances for periods of up to two business days during which time
suchthe deposits
arewere held by White Oak for the benefit of the Company. During the period these cash deposits
arewere held by White Oak, such amounts
arewere classified as restricted cash for
financial reporting purposes on the Company’s Consolidated Balance Sheets.
In
For additional information regarding termination of the event that the Company has an outstanding balance on itsCompany’s asset-based revolving credit facility fromwith White Oak, see Note 11, “Debt.”
In accordance with the terms of the Company’s cash collateralized $5.00 million credit facility from JPMorgan Chase Bank, N.A. (“JPMorgan Chase”), which the Company entered into on July 12, 2021, the Company is required to keep $5.05 million in a cash deposit account held by JPMorgan Chase. Such amount is held as security for the Company’s credit facility from JPMorgan Chase. Accordingly, this cash deposit held by JPMorgan Chase will be classified as restricted cash balances held by White Oak would be applied to reduce such outstanding amounts.for financial reporting purposes on the Company’s Consolidated Balance Sheets.
The Company has full access to its cash balances without restriction following the period of time such cash is held by White Oak. For additional information regarding the Company’s asset-based revolvingcash collateralized credit facility with JPMorgan Chase, see Note 10, “Line of Credit.11, “Debt” and Note 16, “Subsequent Event.”
The reconciliation of cash, cash equivalents, and restricted cash, as presented on the Consolidated Statements of Cash Flows, consists of the following as of the dates presented:
| | | June 30, | |
| | 2021 | | | 2020 | |
| Cash and cash equivalents | | $ | 21,302,317 | | | $ | 13,993,032 | |
| Restricted cash | | | 144,634 | | | | 624,202 | |
| Total cash, cash equivalents, and restricted cash | | $ | 21,446,951 | | | $ | 14,617,234 | |
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| Cash and cash equivalents | | $ | 12,465,483 | | | $ | 3,393,186 | | | $ | 4,594,007 | |
| Restricted cash | | | 541,062 | | | | - | | | | - | |
| Total cash, cash equivalents and restricted cash | | $ | 13,006,545 | | | $ | 3,393,186 | | | $ | 4,594,007 | |
Concentration of Credit Risk – Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash on deposit and cash equivalents held with one bank and trade accounts receivable. At times, cash and cash equivalents balances may exceed the Federal Deposit Insurance Corporation (“FDIC”) insurable limits. The Company’s money market fund investment account (recognized as cash and cash equivalents) is with what the Company believes to be a high-quality issuer. The Company has never experienced any losses related to these balances. Non-interest-bearing amounts on deposit in
excess of FDIC insurable limits at June 30,
2019, June 30, 20182021 and
December 31, 20172020 approximated
$2.12 million, $3.11$10.32 million and
$4.32$2.01 million, respectively. Interest-bearing amounts on deposit in excess of FDIC insurable limits at June 30,
2019, June 30, 20182021 and
December 31, 20172020 approximated
$10.01$10.64 million
$0 and
$0,$11.64 million, respectively.
Trade receivables potentially subject the Company to credit risk. Payment terms on trade receivables for the Company’s Traditional segment customers are generally between 30 and 90 days, though it may offer extended terms with specific customers and on significant orders from time to time.time. The Company extends credit to its customers based upon a number of factors, including an evaluation of the customer’s financial condition and credit history that is verified through trade association reference services, the customer’s payment history with the Company, the customer’s reputation in the trade, and/or an evaluation of the Company’s opportunity to introduce its moissanite jewels or finished jewelry featuring moissanite to new or expanded markets. Collateral is not generally required from customers. The need for an allowance for doubtful accounts is determined based upon factors surrounding the credit risk of specific customers, historical trends, and other information.
See Note
13,14, “Major Customers and Concentration of Credit Risk”, for further discussion of credit risk within trade accounts receivable.
Accounts Receivable Reserves – Estimates are used to determine the amount of two reserves against trade accounts receivable. The first reserve is an allowance for sales returns. At the time revenue is recognized, the Company estimates future returns using a historical return rate that is reviewed quarterly with consideration of any contractual return privileges granted to customers,
including any current extenuating economic conditions resulting from the COVID-19 pandemic, and it reduces sales and trade accounts receivable by this estimated amount. The
Company’s allowance for sales returns was
$746,000, $648,000$675,000 and
$537,000$704,000 at June 30,
2019, June 30, 20182021 and
December 31, 2017,2020, respectively.
The following are reconciliations of the allowance for sales returns balances as of the periods presented:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| Balance, beginning of period | | $ | 648,000 | | | $ | 537,000 | | | $ | 415,000 | |
| Additions charged to operations | | | 4,533,077 | | | | 2,462,049 | | | | 3,878,736 | |
| Sales returned | | | (4,435,077 | ) | | | (2,351,049 | ) | | | (3,756,736 | ) |
| Balance, end of period | | $ | 746,000 | | | $ | 648,000 | | | $ | 537,000 | |
| | | Year Ended June 30, | |
| | | 2021 | | | 2020 | |
| Balance, beginning of year | | $ | 704,000 | | | $ | 746,000 | |
| Additions charged to operations | | | 5,631,415 | | | | 4,710,943 | |
| Sales returns | | | (5,660,415 | ) | | | (4,752,943 | ) |
| Balance, end of year | | $ | 675,000 | | | $ | 704,000 | |
The second reserve is
an allowance for doubtfuluncollectible accounts for the measurement of estimated credit losses resulting from the failure of the Company’s customers to make required payments. This allowance reduces trade accounts receivable to an amount expected to be collected.Based The Company uses a CECL model whereby management estimates credit losses expected over the life of its pool of exposures based on historical percentages of uncollectible accounts, by aging category, changes in payment history, and facts and circumstances, including any current extenuating economic conditions, for example those resulting from the COVID-19 pandemic, regarding specific accounts that become known to, or forecasted by, management when evaluating the adequacy of the allowance for doubtful accounts, theuncollectible accounts. The Company determines a credit loss percentage based on the age of the receivable that it deems uncollectible.uncollectible related to potential credit losses. The Company records an allowance for such credit losses, which includes a provision for expected losses based on historical write-offs, adjusted for current conditions as deemed necessary, reasonable and supportable forecasts about future conditions, and a specific reserve for accounts deemed at risk. The allowance is then calculated by applying the appropriate percentage to eachCompany’s estimate for accounts receivable as of the Company’sbalance sheet date that ultimately will not be collected. Any changes in the allowance are reflected in the results of operations in the period in which the change occurs. The Company writes-off accounts receivable aging categories, with consideration given to individualand the related allowance recorded previously when it becomes probable, based upon customer account activity subsequent to the current period, including cash receipts, in determining the appropriate allowance for doubtful accounts in the current period. Any increases or decreases to this allowance are charged or credited, respectively, as a bad debt expense to generalfacts and administrative expenses.circumstances, that such amounts will not be collected. The Company generally uses an internal collection effort,efforts, which may include its sales personnel as it deems appropriate. After all internal collection efforts have been exhausted, the Company generally writes offwrites-off the underlying account receivable.
Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstances of the specific underlying customer account. During its review for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017,2020, the Company determined no additional reserves were necessary for specific accounts. Based on these criteria, management determined that allowances for doubtfuluncollectible accounts receivable of $249,000, $233,000$71,000 and $254,000$79,000 at June 30, 2019, June 30, 20182021 and December 31, 20172020, , respectively, were required.
The following are reconciliations of the allowance for doubtfuluncollectible accounts balances as of the periods presented:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| Balance, beginning of period | | $ | 233,000 | | | $ | 254,000 | | | $ | 226,000 | |
| Additions (reductions) charged to operations | | | 27,056 | | | | (4,511 | ) | | | 28,000 | |
| Write-offs, net of recoveries | | | (11,056 | ) | | | (16,489 | ) | | | - | |
| Balance, end of period | | $ | 249,000 | | | $ | 233,000 | | | $ | 254,000 | |
| | | Year Ended June 30, | |
| | | 2021 | | | 2020 | |
| Balance, beginning of year | | $ | 79,000 | | | $ | 249,000 | |
| Additions charged to operations | | | 2,030 | | | | 8,788 | |
| Write-offs, net of recoveries | | | (10,030 | ) | | | (178,788 | ) |
| Balance, end of year | | $ | 71,000 | | | $ | 79,000 | |
Although the Company believes that its reserves are adequate, if the financial condition of its customers deteriorates, resulting in an impairment of their ability to make payments, or if it underestimates the allowances required, additional allowances may be necessary, which would result in increased expense in the period in which such determination is made.
Inventories - Inventories are stated at the lower of cost or net realizable value on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs. Any inventory on hand at the measurement date in excess of the Company’s current requirements based on historical and anticipated levels of sales is classified as long-term on the Company’s Consolidated Balance Sheets. The Company’s classification of its inventory as either current or long-term inventory requires it to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized in cost of sales over the next 12 months.
Each accounting period, the Company evaluates the valuation and classification of inventories including the need for potential adjustments to inventory-related reserves, which also include significant estimates by management. The Company’s inventory-related valuation allowances are recorded in the aggregate rather than an individual item approach for each obsolescence, rework, and shrinkage valuation allowance.
Property and Equipment – Property and equipment are stated at cost and are depreciated over their estimated useful lives using the straight-line method as follows:
| Machinery and equipment | 5 to 12 years |
| Computer hardware | 3 to 5 years |
| Computer software | 3 years |
| Furniture and fixtures | 5 to 10 years |
| Leasehold improvements | Shorter of the estimated useful life or the lease term |
Intangible Assets – The Company capitalizes costs associated with obtaining or defending patents issued or pending for inventions and license rights related to the manufacture of moissanite jewels. Such costs are amortized over the life of the patent, generally 15 years. The Company also capitalizes licenses it obtains for the use of certain advertising images and external costs incurred for trademarks. Such costs are amortized over the period of the license or estimated useful life of the trademark, respectively.
Impairment of Long-Lived Assets – The Company evaluates the recoverability of its long-lived assets by reviewing them for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of the asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment is measured as the amount by which the carrying amount exceeds the fair value and is recognized as an operating expense in the period in which the determination is made. Assets to be disposed are reported at the lower of the carrying amount or fair value less costs to sell once the held-for-sale criteria are met. As of June 30, 2019,2021, the Company did not identify any indicators of long-lived asset impairment.
In addition to the recoverability assessment, the Company routinely reviews the remaining estimated useful lives of its long-lived assets. Any reduction in the useful-life assumption will result in increased depreciation and amortization expense in the period when such determination is made, as well as in subsequent periods.
Revenue Recognition – Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. To achieve this principle, the Company performs the following five steps: (i)(i) identification of a contract with a customer; (ii)(ii) identification of any separate performance obligations; (iii)(iii) determination of the transaction price; (iv)(iv) allocation of the transaction price to the performance obligations in the contract; and (v)(v) recognition of revenue when the Company has satisfied the underlying performance obligations. The Company recognizes substantially all of its revenue at a point in time when control of the Company’s goods has passed to the customer which typically occurs upon shipment, with the exception of consigned goods. The Company considers its sole performance obligation related to the shipment of goods satisfied at the time this control is transferred. Customer payment terms for these shipments typically range between 30- and 90-days. Customers purchasing items through the Company’s websites pay amounts in advance of the Company transferring control of the goods. Amounts received in advance of the transfer of control are included in deferred revenue within accrued expenses and other liabilities on the consolidated balance sheets until the time of the transfer of control of the goods. All amounts included in deferred revenue at June 30, 2020 were recorded in net sales during the fiscal year ended June 30, 2021. The Company has elected to treat shipping and handling performed after control has transferred to customers as a fulfillment activity, and additionally, has elected the practical expedient to report sales taxes on a net basis. The Company records shipping and handling expense related to product sales as cost of sales.
The Company has a variable consideration element related to most of its contracts in the form of product return rights. At the time revenue is recognized, an allowance for estimated returns is established and any change in the allowance for returns is charged against net sales in the current period. For the Company’s Traditional segment and Online Channels segment customers (excluding those of charlesandcolvard.com), the returns policy generally allows for the return of jewels and finished jewelry with a valid reason for credit within 30 days of shipment. TheCustomers in both of the Company’s charlesandcolvard.com customers canand moissaniteoutlet.com websites may generally return purchases for any reason within 60 days and 30 days, respectively, of such purchasethe shipment date in accordance with the Company’s returns policypolicies as disclosed on theits charlesandcolvard.com website.and moissaniteoutlet.com websites.
Periodically, the Company ships loose jewel goods and finished goods to Traditional segment customers on consignment terms. Under these consignment terms, the customer assumes the risk of loss and has an absolute right of return for a specified period that typically ranges from six months to one year. The Company’s Online Channels segment and Traditional segment customers are generally required to make payments on consignment shipments within 30 to 60 days upon the customer informing the Company that it will keep the inventory. Accordingly, the Company does not recognize revenue on these consignment transactions until the earlier of (i)(i) the customer informing the Company that it will keep the inventory; (ii)(ii) the expiration of the right of return period; or (iii)(iii) the customer informing the Company that the inventory has been sold.
Certain Traditional segment finished jewelry customers have migrated from consignment arrangements whereby the terms were strictly consignment-only to that of a blended program whereby the terms comprise both consignment and sale of asset arrangements. The structure of these new blended programs allows the Company to recognize the finished jewelry sale and related revenue in accordance with the Company’s revenue recognition accounting policy for the asset portion of these programs upon transfer of the Company’s finished jewelrysold to the retail customer.
In March 2019, the Company entered into a nonmonetary transaction with a Raleigh, North Carolina, based professional sports team. In accordance with the terms of the agreement, in exchange for a specific quantity of finished jewelry items the Company received certain sponsorship and advertising benefits, which based on the sports team’s current sponsorship and advertising market rate card prices, are valued at approximately $117,000. The Company’s finished jewelry in connection with this transaction, the cost of which is based on the Company’s stated inventory average cost accounting method, was designed and produced to meet discrete specifications and branding requirements of the professional sports team. In accordance with the Company’s revenue recognition policy, it recognized the full amount of the sponsorship and advertising benefits as gross revenue upon delivery of the finished jewelry in April 2019 and the deferred cost of the advertising is recorded and classified within prepaid expenses and other assets in the Company’s Consolidated Balance Sheet and is being amortized and recognized in sales and marketing expenses over the professional sports team’s current competitive season that runs from April through September 2019.end consumer.
The Company presents disaggregated net sales by its Online Channels segment and its Traditional segment for both finished jewelry and loose jewels product lines. The Company also presents disaggregated net sales by geographic area between the United States and international locations. For financial reporting purposes, disaggregated net sales amounts are presented in Note 3, “Segment Information and Geographic Data.”
Returns Asset and Refund Liabilities
In connection with the Company’s adoption of the revenue recognition accounting standard issued by the FASB as of the initial application date of January 1, 2018, theThe Company establishedmaintains a returns asset account and a refund liabilities account to record the effects of its estimated product returns and sales returns allowance. The Company’s returns asset and refund liabilities are updated at the end of each financial reporting period and the effect of such changes are accounted for in the period in which such changes occur.
The Company estimates anticipated product returns in the form of a refund liability based on historical return percentages and current period sales levels. The Company also accrues a related returns asset for goods expected to be returned in salable condition, less any expected costs to recover such goods, including return shipping costs that the Company may incur. As of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, the Company’s refund liabilities balances were $746,000, $648,000$675,000 and $537,000,$704,000, respectively, and are included as allowances for sales returns within accounts receivable, net, in the accompanying Consolidated Balance Sheets.consolidated balance sheets. As of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, the Company’s returns asset balances were $279,000, $250,000$252,000 and $0,$289,000, respectively, and are included within prepaid expenses and other assets in the accompanying Consolidated Balance Sheets. Prior to the adoptionconsolidated balance sheets.
63
Cost of Goods Sold – Cost of goods sold is primarily composed of inventory sold during the period; inventory written offwritten-off during the period due to ongoing quality reviews or through customer returns;and obsolescence reviews; salaries and payroll-related expenses for personnel involved in preparing and shipping product to customers; an allocation of shared expenses such as rent, utilities, communication expenses, and depreciation related to preparing and shipping product to customers; and outbound freight charges.
Advertising Costs – Advertising production costs are expensed as incurred. Media placement costs are expensed the first time the underlying advertising appears.
The Company also offers a cooperative advertising program to certain of its distributor and retail partners that reimburses, via a credit towards future purchases, a portion of their marketing costs based on the customers’ net purchases from the Company and is subject to the customer providing documentation of all advertising performed that includes the Company’s products. For the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017,2020, these approximate amounts were $381,000, $154,000$380,000 and $210,000,$491,000, respectively, and are included as a component of sales and marketing expenses. Because the Company receives a distinct good or service in exchange for consideration and the fair value of the benefit can be reasonably estimated, these transactions are reflected as sales and marketing expenses.
Advertising expenses, inclusive of the cooperative advertising program, for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017,2020, were approximately $2.82 million, $1.09$4.25 million and $1.94$3.96 million, respectively.
Sales and Marketing – Sales and marketing costs are expensed as incurred. These costs include all expenses of promoting and selling the Company’s products and include such items as the salaries, payroll-related expenses, and travel of sales and marketing personnel; digital marketing; advertising; trade shows; market research; sales commissions; and an allocation of overhead expenses attributable to these activities. Except for an allocation to general and administrative expenses, these costs also include the operating expenses of charlesandcolvard.com, LLC, the Company’s wholly owned operating subsidiary.
General and Administrative – General and administrative costs are expensed as incurred. These costs include the salaries and payroll-related expenses of executive, finance, information technology, and administrative personnel; legal, investor relations, and professional fees; general office and administrative expenses; Board of Directors fees; rent; bad debts; and insurance.
Research and Development – Research and development costs are expensed as incurred. These costs primarily comprise salary allocations, samples of competitive products entering the market, and consultant fees associated with the study of product enhancement and manufacturing process efficiencies.
Stock-Based Compensation – The Company recognizes compensation expense for stock-based awards based on estimated fair values on the date of grant. The Company uses the Black-Scholes-Merton option pricing model to determine the fair value of stock options. The fair value of other stock-based compensation awards is determined by the market price of the Company’s common stock on the date of grant. The expense associated with stock-based compensation is recognized on a straight-line basis over the requisite service period of each award.
Fair value of stock options using the Black-Scholes-Merton option pricing model is estimated on the date of grant utilizing certain assumptions for dividend yield, expected volatility, risk-free interest rate, and expected lives of the awards, as follows:
Dividend Yield. Although the Company issued dividends in prior years, a dividend yield of zero is used due to the lack of recent dividend payments and the uncertainty of future dividend payments;
Expected Volatility. Volatility is a measure of the amount by which a financial variable such as share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company estimates expected volatility giving primary consideration to the historical volatility of its common stock;
Risk-Free Interest Rate. The risk-free interest rate is based on the published yield available on U.S. Treasury issues with an equivalent term remaining equal to the expected life of the stock option; and
Expected Lives. The expected lives of the issued stock options represent the estimated period of time until exercise or forfeiture and are based on the simplified method of using the mid-point between the vesting term and the original contractual term.The simplified method is used because the Company does not have sufficient historical option exercise experience.
The assumptions used in calculating the fair value of share-basedstock-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and the Company uses different assumptions, the Company’s stock-based compensation expense could be materially different in the future. In addition, the Company is required to estimate the expected forfeiture rates of stock-based awards and only recognize expense for those shares expected to vest. In estimating the Company’s forfeiture rates, the Company analyzedanalyzes its historical forfeiture rates, the remaining lives of unvested stock-based awards, and the number of vested awards as a percentage of total awards outstanding.rates. If the Company’s actual forfeiture rates are materially different from its estimates, or if the Company re-evaluates the forfeiture rates in the future, the stock-based compensation expense could be significantly different from what the Company has recorded in the current period.
Income Taxes – Deferred income taxes are recognized for the income tax consequences of “temporary” differences by applying enacted statutory income tax rates applicable to future years to differences between the financial statement carrying amounts and the income tax bases of existing assets and liabilities. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount that is more likely than not to be realized.
In light of the Tax Cuts and Jobs Act (the “Tax Act”) enacted in December 2017, the Company provisionally recorded its U.S. deferred taxes as of the calendar year ended December 31, 2017, based on the federal corporate income tax rate of 21%. In June 2018, the Company filed its 2017 U.S. corporate income tax return, and in conjunction therewith, finalized its accounting policy with respect to accounting for its deferred income taxes as of and for the transition period ended June 30, 2018. For further discussion of the effects of the Tax Act on our deferred tax assets, see Note 12, “Income Taxes.”
Net Income (Loss) per Common Share – Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the periods. Diluted net income (loss) per common share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the periods. Common equivalent shares consist of stock options and unvested restricted shares that are computed using the treasury stock method. Anti-dilutive stock awards consist of stock options that would have been anti-dilutive in the application of the treasury stock method.
TheAs of the dates presented, the following table reconciles the differences between the basic and diluted net income (loss) per share presentations:
| | | | Year Ended June 30, | |
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | 2021 | | | 2020 | |
| Numerator: | | | | | | | | | | | | | | | |
| | $ | 2,275,467 | | | $ | (1,275,826 | ) | | $ | (453,477 | ) | | $ | 12,810,766 | | | $ | (6,162,083 | ) |
| | | | | | | | | | | | | | | | | | |
| Denominator: | | | | | | | | | | | | | | | | | |
| Weighted average number of common shares outstanding: | | | | | | | | | | |
| Weighted average common shares outstanding: | | | | | | | | | |
| Basic | | 21,860,699 | | | 21,406,487 | | | 21,193,793 | | | | 29,144,820 | | | | 28,644,133 | |
| Effect of dilutive securities | | | 250,524 | | | | - | | | | - | | | | 1,087,747 | | | | - | |
| Diluted | | | 22,111,223 | | | | 21,406,487 | | | | 21,193,793 | | | | 30,232,567 | | | | 28,644,133 | |
| | | | | | | | | | | | | | | | | | |
| Net income (loss) per common share: | | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.10 | | | $ | (0.06 | ) | | $ | (0.02 | ) | | $ | 0.44 | | | $ | (0.22 | ) |
| Diluted | | 0.10 | | | (0.06 | ) | | (0.02 | ) | | $ | 0.42 | | | $ | (0.22 | ) |
For the fiscal year ended June 30, 2019, the six-month period ended June 30, 2018, and the calendar year ended December 31, 2017,2021, stock options to purchase approximately 2.331.24 million 2.39 million and 2.38 million shares, respectively, were excluded from the computation of diluted net income (loss) per common share because the exercise price of the stock options was greater than the average market price of the common shares or the effect of inclusion of such amounts would be anti-dilutive to net income (loss) per common share. For the fiscal year ended June 30,
2019, no restricted2020, stock options to purchase approximately 2.81 million shares
that were issued but not yet vested were excluded from the computation of diluted net income per common share. For the transition period ended June 30, 2018 and the calendar year ended December 31, 2017, approximately 264,000 and 355,000, respectively, of restricted shares that were issued but not yet vested were excluded from the computation of diluted net loss per common share
because the effect of inclusion of such amounts would be anti-dilutive to net loss per common share. The quantity of 162,500 shares of unvested restricted stock were excluded from the computation of diluted net loss per common share as of June 30, 2020 because the shares were performance-based and the underlying conditions had not been met as of the year presented and the effects of the inclusion of such
number of shares would
behave been anti-dilutive to net
income or loss per common share.
Additionally, the underwriters’ over-allotment option to purchase 630,500There are no such performance-based shares
isof unvested restricted stock excluded from the computation of
basic and diluted net income per
common share as of June 30,
2019,2021 because the
effectsunderlying performance conditions for these restricted stock shares were met as of
inclusion would be anti-dilutive to net income per common share.June 30, 2021. Recently Adopted/Issued Accounting Pronouncements – In
February 2016, as amended in July 2018 and amended further in December
2018 and March 2019, the Financial Accounting Standards Board (the “FASB”) issued guidance
which requires lessees to recognize a right-of-use (“ROU”) asset and lease liability on the balance sheet for most lease arrangements and expands disclosures about leasing arrangements for both lessees and lessors, among other items. The new standard is effective for fiscal years beginning after December 15, 2018, which makes the new standard effective for the Company on July 1, 2019. The Company may apply the transition provisions of the new guidance, as amended, either at the beginning of the earliest period presented in the Company’s Form 10-K for the fiscal year ending June 30, 2020, which would be July 1, 2018, or on the effective date of adoption, which would be July 1, 2019. Among other requirements, the transition provisions require the lessee to recognize an ROU asset and liability for most existing lease arrangements on the date the transition provisions are applied. The Company has elected to apply the transition provisions of this new standard on July 1, 2019. Therefore, periods prior to the effective date of adoption will continue to be reported consistent with simplifying the accounting
guidance in effect prior to the change of accounting. All of the Company’s existing lease arrangements are classified as operating leases, which will continue to be classified as operating under the new guidance. Upon adoption of the new standard on July 1, 2019, the Company will record an ROU asset and lease liability in amounts that will be material on its Consolidated Balance Sheet for the Company’s lease arrangements. The Company has identified all of its leases and is finalizing the analysis of its incremental borrowing rate in order to quantify the amounts to be recorded upon adoption of the new accounting guidance. Management does not anticipate that adoption of this new guidance will have a significant impact on the Company’s net earnings or cash flows.
In June 2018, the FASB issued guidanceincome taxes that is intended to reduce
cost andthe complexity
and to improvewhile maintaining or improving the usefulness of tax disclosure information in financial reporting for share-based payments to nonemployees. Thisstatements. The new guidance is effective for fiscal years beginning after December 15,
2018.2020. The Company
will adopt the new guidance as of July 1, 2019, as required, anddoes not expect the impact of the
adoption is not expectednew guidance to
behave a material
impact to the Company’s financial statements.
In March 2020, in response to concerns about structural risks of interbank offered rates (“IBORs”), and, particularly, the risk of cessation of the London Interbank Offered Rate (“LIBOR”), the FASB issued new guidance to ease the burden in accounting for or recognizing the effects of referenced interest rate reform on financial reporting. The new guidance is effective as of March 12, 2020 through December 31, 2022. As described in more detail in Note 11, “Debt”, borrowings under the Company’s line of credit would have been based on a rate equal to the one-month LIBOR. As of June 30, 2021, the Company had not borrowed against its line of credit, and therefore, is not subject to recognizing or disclosing any effect of referenced rate reform as of its fiscal year ended June 30, 2021.
| 3. | SEGMENT INFORMATION AND GEOGRAPHIC DATA |
The Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of the Company’s operating and reportable segments.
The Company manages its business through two operating and reportable segments based on its distribution channels to sell its product lines, –loose jewels and finished jewelry and loose jewels:jewelry: its “Online Channels” segment, which consists of e-commerce outlets including charlesandcolvard.com, moissaniteoutlet.com, third-party online marketplaces, drop-ship retail, and other pure-play, exclusively e-commerce outlets; and its “Traditional” segment, which consists of wholesale and retail customers. The accounting policies of the Online Channels segment and Traditional segment are the same as those described in Note 2, “Basis of Presentation and Significant Accounting Policies.”
The Company evaluates the financial performance of its segments based on net sales; product line gross profit, or the excess of product line sales over product line cost of goods sold; and operating income (loss).income. The Company’s product line cost of goods sold is defined as product cost of goods sold, excluding non-capitalized expenses from the Company’s manufacturing and production control departments, comprising personnel costs, depreciation, rent,leases, utilities, and corporate overhead allocations; freight out; inventory valuation allowance adjustments;write-downs; and other inventory adjustments, comprising costs of quality issues, and damaged goods, and inventory write-downs.goods.
The Company allocates certain general and administrative expenses between its Online Channels segment and its Traditional segment based on net sales and number of employees to arrive at segment operating income (loss). Unallocated expenses remain in its Traditional segment.
Summary financial information by reportable segment for the periods presented is as follows:
| | | Year Ended June 30, 2019 | | | Year Ended June 30, 2021 | |
| | | Online Channels | | Traditional | | Total | | | Online Channels | | | Traditional | | | Total | |
| Net sales | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 12,641,687 | | | $ | 2,815,656 | | | $ | 15,457,343 | | | $ | 19,905,199 | | | $ | 4,496,347 | | | $ | 24,401,546 | |
| Loose jewels | | | 3,697,069 | | | | 13,089,697 | | | | 16,786,766 | | | | 3,304,439 | | | | 11,529,854 | | | | 14,834,293 | |
| Total | | $ | 16,338,756 | | | $ | 15,905,353 | | | $ | 32,244,109 | | | $ | 23,209,638 | | | $ | 16,026,201 | | | $ | 39,235,839 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Product line cost of goods sold | | | | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 5,220,551 | | | $ | 1,638,561 | | | $ | 6,859,112 | | | $ | 8,235,797 | | | $ | 3,036,215 | | | $ | 11,272,012 | |
| Loose jewels | | | 1,583,404 | | | | 6,659,426 | | | | 8,242,830 | | | | 1,216,942 | | | | 5,640,813 | | | | 6,857,755 | |
| Total | | $ | 6,803,955 | | | $ | 8,297,987 | | | $ | 15,101,942 | | | $ | 9,452,739 | | | $ | 8,677,028 | | | $ | 18,129,767 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Product line gross profit | | | | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 7,421,136 | | | $ | 1,177,095 | | | $ | 8,598,231 | | | $ | 11,669,402 | | | $ | 1,460,132 | | | $ | 13,129,534 | |
| Loose jewels | | | 2,113,665 | | | | 6,430,271 | | | | 8,543,936 | | | | 2,087,497 | | | | 5,889,041 | | | | 7,976,538 | |
| Total | | $ | 9,534,801 | | | $ | 7,607,366 | | | $ | 17,142,167 | | | $ | 13,756,899 | | | $ | 7,349,173 | | | $ | 21,106,072 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income | | $ | 1,643,552 | | | $ | 622,005 | | | $ | 2,265,557 | | | $ | 3,739,553 | | | $ | 1,768,439 | | | $ | 5,507,992 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | $ | 172,819 | | | $ | 308,500 | | | $ | 481,319 | | | $ | 248,995 | | | $ | 318,127 | | | $ | 567,122 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Capital expenditures | | $ | 69,975 | | | $ | 291,465 | | | $ | 361,440 | | | $ | 253,935 | | | $ | 183,134 | | | $ | 437,069 | |
| | | Six Months Ended June 30, 2018 | | | Year Ended June 30, 2020 | |
| | | Online Channels | | | Traditional | | | Total | | | Online Channels | | | Traditional | | | Total | |
| Net sales | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 4,490,984 | | | $ | 1,672,066 | | | $ | 6,163,050 | | | $ | 13,680,440 | | | $ | 3,097,188 | | | $ | 16,777,628 | |
| Loose jewels | | | 1,878,388 | | | | 5,121,660 | | | | 6,999,998 | | | | 2,944,100 | | | | 9,467,292 | | | | 12,411,392 | |
| Total | | $ | 6,369,322 | | | $ | 6,793,726 | | | $ | 13,163,048 | | | $ | 16,624,540 | | | $ | 12,564,480 | | | $ | 29,189,020 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Product line cost of goods sold | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 1,972,862 | | | $ | 1,462,371 | | | $ | 3,435,233 | | | $ | 5,760,413 | | | $ | 1,709,377 | | | $ | 7,469,790 | |
| Loose jewels | | | 951,664 | | | | 2,688,560 | | | | 3,640,224 | | | | 1,198,275 | | | | 4,863,911 | | | | 6,062,186 | |
| Total | | $ | 2,924,526 | | | $ | 4,150,931 | | | $ | 7,075,457 | | | $ | 6,958,688 | | | $ | 6,573,288 | | | $ | 13,531,976 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Product line gross profit | | | | | | | | | | | | | | | | | | | | | |
| Finished jewelry | | $ | 2,518,122 | | | $ | 209,695 | | | $ | 2,727,817 | | | $ | 7,920,027 | | | $ | 1,387,811 | | | $ | 9,307,838 | |
| Loose jewels | | | 926,674 | | | | 2,433,100 | | | | 3,359,774 | | | | 1,745,825 | | | | 4,603,381 | | | | 6,349,206 | |
| Total | | $ | 3,444,796 | | | $ | 2,642,795 | | | $ | 6,087,591 | | | $ | 9,665,852 | | | $ | 5,991,192 | | | $ | 15,657,044 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Operating loss | �� | $ | (243,832 | ) | | $ | (1,349,756 | ) | | $ | (1,593,588 | ) | | $ | (249,016 | ) | | $ | (6,066,712 | ) | | $ | (6,315,728 | ) |
| | | | | | | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | $ | 59,409 | | | $ | 170,584 | | | $ | 229,993 | | | $ | 177,703 | | | $ | 312,532 | | | $ | 490,235 | |
| | | | | | | | | | | | | | | | | | | | | | |
| Capital expenditures | | $ | 29,689 | | | $ | 100,960 | | | $ | 130,649 | | | $ | 305,570 | | | $ | 153,284 | | | $ | 458,854 | |
| | | Year Ended December 31, 2017 | |
| | | Online Channels | | | Traditional | | | Total | |
| Net sales | | | | | | | | | |
| Finished jewelry | | $ | 7,936,773 | | | $ | 2,515,443 | | | $ | 10,452,216 | |
| Loose jewels | | | 3,149,972 | | | | 13,430,776 | | | | 16,580,748 | |
| Total | | $ | 11,086,745 | | | $ | 15,946,219 | | | $ | 27,032,964 | |
| | | | | | | | | | | | | |
| Product line cost of goods sold | | | | | | | | | | | | |
| Finished jewelry | | $ | 3,615,815 | | | $ | 1,610,845 | | | $ | 5,226,660 | |
| Loose jewels | | | 1,526,358 | | | | 6,998,485 | | | | 8,524,843 | |
| Total | | $ | 5,142,173 | | | $ | 8,609,330 | | | $ | 13,751,503 | |
| | | | | | | | | | | | | |
| Product line gross profit | | | | | | | | | | | | |
| Finished jewelry | | $ | 4,320,958 | | | $ | 904,598 | | | $ | 5,225,556 | |
| Loose jewels | | | 1,623,614 | | | | 6,432,291 | | | | 8,055,905 | |
| Total | | $ | 5,944,572 | | | $ | 7,336,889 | | | $ | 13,281,461 | |
| | | | | | | | | | | | | |
| Operating income (loss) | | $ | 228,253 | | | $ | (836,797 | ) | | $ | (608,544 | ) |
| | | | | | | | | | | | | |
| Depreciation and amortization | | $ | 121,710 | | | $ | 300,308 | | | $ | 422,018 | |
| | | | | | | | | | | | | |
| Capital expenditures | | $ | 147,446 | | | $ | 123,944 | | | $ | 271,390 | |
The Company does not allocate any assets to the reportable segments, and therefore, no asset information is reported to the chief operating decision-maker or disclosed in the financial information for each segment.
The reconciliations of the Company’s product line cost of goods sold to cost of goods sold, as reported in the consolidated financial statements for the periods presented, are as follows:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | Year Ended June 30, | |
| | | | | | | | | | | | 2021 | | | 2020 | |
| Product line cost of goods sold | | $ | 15,101,942 | | | $ | 7,075,457 | | | $ | 13,751,503 | | | $ | 18,129,767 | | | $ | 13,531,976 | |
| Non-capitalized manufacturing and production control expenses | | 1,442,446 | | | 805,400 | | | 1,352,311 | | | | 1,591,114 | | | | 1,443,698 | |
| Freight out | | 578,772 | | | 272,790 | | | 417,074 | | | | 1,013,275 | | | | 510,612 | |
| Inventory valuation allowances | | 393,000 | | | - | | | 598,000 | | |
| Inventory write-downs | | | | 150,000 | | | | 5,863,991 | |
| Other inventory adjustments | | | (163,993 | ) | | | 144,639 | | | | (648,271 | ) | | | (74,466 | ) | | | (150,070 | ) |
| Cost of goods sold | | $ | 17,352,167 | | | $ | 8,298,286 | | | $ | 15,470,617 | | | $ | 20,809,690 | | | $ | 21,200,207 | |
The Company recognizes sales by geographic area based on the country in which the customer is based. Sales to international end consumers made through ourthe Company’s transactional website,websites, charlesandcolvard.com and moissaniteoutlet.com, are included in international sales for financial reporting purposes. During periods prior to the quarterly period ended December 31, 2018, sales to international end consumers made through charlesandcolvard.com were included in U.S. sales because products were shipped and invoiced to a U.S.-based intermediary party that assumed all international shipping and credit risks. A portion of the Company’s Traditional segment sales made to international wholesale distributors represents products sold internationally that may be re-imported to U.S. retailers.
All intangible assets, andas well as property and equipment, as of June 30, 2019, June 30, 20182021 and December 31, 20172020, are held and located in the United States.
The following presents net sales data by geographic area for the periods presented:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | Year Ended June 30, | |
| Net sales: | | | | | | | | | | |
| | | | 2021 | | | 2020 | |
| Net sales | | | | | | | |
| United States | | $ | 27,979,835 | | | $ | 12,121,003 | | | $ | 25,176,220 | | | $ | 37,225,519 | | | $ | 26,814,024 | |
| International | | | 4,264,274 | | | | 1,042,045 | | | | 1,856,744 | | | | 2,010,320 | | | | 2,374,996 | |
| Total | | $ | 32,244,109 | | | $ | 13,163,048 | | | $ | 27,032,964 | | | $ | 39,235,839 | | | $ | 29,189,020 | |
| 4. | FAIR VALUE MEASUREMENTS |
UnderUnder U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability.
The fair value hierarchy consists of three levels based on the reliability of inputs, as follows:
Level 11. - Quoted prices in active markets for identical assets and liabilities;
Level 22. - Inputs other than Level 1 quoted prices that are directly or indirectly observable; and
Level 33. - Unobservable inputs that are not corroborated by market data.
The Company evaluates assets and liabilities subject to fair value measurements on a recurring and non-recurring basis to determine the appropriate level to classify them for each reporting period. This determination requires significant judgments to be made by management of the Company. The financial instruments identified as subject to fair value measurements on a recurring basis are cash, and cash equivalents, and restricted cash, notes receivable, trade accounts receivable, and trade accounts payable. All financial instruments are reflected in the Consolidated Balance Sheetsconsolidated balance sheets at carrying value, which approximates fair value due to the short-term nature of these financial instruments.
Assets that are measured at fair value on a non-recurring basis include property and equipment, leasehold improvements, and intangible assets, comprising patents, license rights, and trademarks. These items are recognized at fair value when they are considered to be impaired. As of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, no assets were identified for impairment. Level 3 inputs are primarily based on the estimated future cash flows of the asset determined by market inquiries to establish fair market value of used machinery or future revenue expected to be generated with the assistance of patents and trademarks.
On March 5, 2021, the Company entered into a $250,000 convertible promissory note agreement (the “Convertible Promissory Note”) with an unrelated third-party strategic marketing partner. The Convertible Promissory Note is unsecured and matures on March 5, 2022 (the “Maturity Date”). The Company has accounted for the Convertible Promissory Note as a current note receivable within the accompanying consolidated financial statements. Interest is accrued at a simple rate of 0.14% per annum and will accrue until the Convertible Promissory Note is converted in accordance with the conversion privileges contained within the Convertible Promissory Note or is repaid. Principal outstanding during an event of default accrues interest at the rate of 5% per annum. Accrued and unpaid interest on the Convertible Promissory Note is classified as a current asset and included in prepaid expenses and other assets in the accompanying consolidated financial statements.
Subject to the borrower’s completion of a specified equity financing transaction (an “Equity Financing”) on or prior to the Maturity Date, the unpaid principal amount, including accrued and unpaid interest, automatically converts into equity units of the most senior class of equity securities issued to investors in the Equity Financing at the lesser of 80% of the per unit price of the units purchased by investors or the price equal to $33,500,000 divided by the aggregate number of outstanding units of the borrower immediately prior to the closing of the financing. Unless converted as provided in the Convertible Promissory Note, the principal amount, including accrued and unpaid interest, will, on the Maturity Date, at the Company’s option either (i) become due and payable to the Company, or (ii) convert into equity units at the specified conversion price in accordance with the terms of the Convertible Promissory Note.
The Company’s total inventories, net of reserves, are as followsconsisted of the following as of the dates presented:
| | | June 30, | | | December 31, | |
| | | 2019 | | | 2018 | | | 2017 | |
| Raw materials | | $ | 4,450,478 | | | $ | 5,083,436 | | | $ | 4,853,049 | |
| Work-in-process | | | 10,871,823 | | | | 10,659,786 | | | | 9,219,383 | |
| Finished goods | | | 18,557,224 | | | | 17,483,773 | | | | 17,896,992 | |
| Finished goods on consignment | | | 2,086,084 | | | | 523,971 | | | | 1,093,752 | |
| Supplies inventory | | | 129,111 | | | | 45,572 | | | | 75,441 | |
| Less: inventory reserves | | | (2,361,000 | ) | | | (1,968,000 | ) | | | (2,165,000 | ) |
| Total classified inventories | | $ | 33,733,720 | | | $ | 31,828,538 | | | $ | 30,973,617 | |
| | | | | | | | | | | | | |
| Short-term portion | | $ | 11,909,792 | | | $ | 10,979,891 | | | $ | 11,208,658 | |
| Long-term portion | | | 21,823,928 | | | | 20,848,647 | | | | 19,764,959 | |
| Total short- and long-term inventories | | $ | 33,733,720 | | | $ | 31,828,538 | | | $ | 30,973,617 | |
| | | June 30, | |
| | | 2021 | | | 2020 | |
| Finished jewelry: | | | | | | |
| Raw materials | | $ | 1,476,514 | | | $ | 821,536 | |
| Work-in-process | | | 779,593 | | | | 602,390 | |
| Finished goods | | | 8,025,816 | | | | 6,019,985 | |
| Finished goods on consignment | | | 2,050,372 | | | | 2,297,907 | |
| Total finished jewelry | | | 12,332,295 | | | | 9,741,818 | |
| Loose jewels: | | | | | | | | |
| Raw materials | | | 1,775,505 | | | | 3,526,399 | |
| Work-in-process | | | 9,893,443 | | | | 10,453,586 | |
| Finished goods | | | 4,942,192 | | | | 6,619,487 | |
| Finished goods on consignment | | | 154,968 | | | | 204,635 | |
| Total loose jewels | | | 16,766,108 | | | | 20,804,107 | |
| Total supplies inventory | | | 74,317 | | | | 88,034 | |
| Total inventory | | $ | 29,172,720 | | | $ | 30,633,959 | |
As of the dates presented, the Company’s total inventories, net of reserves, are classified as follows:
| | | June 30, | |
| | | 2021 | | | 2020 | |
| Short-term portion | | $ | 11,450,141 | | | $ | 7,443,257 | |
| Long-term portion | | | 17,722,579 | | | | 23,190,702 | |
| Total inventory | | $ | 29,172,720 | | | $ | 30,633,959 | |
The Company’s work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurredincurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. The Company’s moissanite jewel manufacturing process involves the production of intermediary shapes, called “preforms,” that vary depending upon the expected size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, work-in-process inventories issued to active production jobs approximated $1.23 million, $2.45$2.23 million and $2.99$1.34 million, respectively.
The Company’s moissanite and lab grown diamond jewels do not degrade in quality over time and inventory generally consists of the shapes and sizes most commonly used in the jewelry industry. In addition, the majority of jewel inventory is not mounted in finished jewelry settings and is therefore not subject to fashion trends, norand product obsolescence is obsolescence a significant factor.closely monitored and reviewed by management as of and for each financial reporting period.
The Company manufactures finished jewelry featuring moissanite.moissanite and lab grown diamonds. Relative to loose moissanite jewels and lab grown diamonds, finished jewelry is more fashion-oriented and subject to styling trends that could render certain designs obsolete over time. The majority of the Company’s finished jewelry featuring moissanite and lab grown diamonds is held in inventory for resale and largely consists of such core designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets that tend not to be subject to significant obsolescence risk due to their classic styling. In addition, the Company generally holds smaller quantities of designer-inspired and trend moissanite fashion jewelry that is available for resale through retail companies and through its Online Channels segment. The Company also carries a limited amount of inventory as part of its sample line that is usedthe Company uses in the selling process to its customers.
The Company’s continuing operating subsidiary carriessubsidiaries carry no net inventories, and inventory is transferred without intercompany markup from the parent entity as product line cost of goods sold when sold to the end consumer.
The Company’s total inventories net of reserves, consisted ofare stated at the following as of the dates presented:
| | | June 30, | | | December 31, | |
| | | 2019 | | | 2018 | | | 2017 | |
| Finished jewelry: | | | | | | | | | |
| Raw materials | | $ | 643,797 | | | $ | 595,649 | | | $ | 564,689 | |
| Work-in-process | | | 487,680 | | | | 1,196,268 | | | | 890,664 | |
| Finished goods | | | 6,332,533 | | | | 5,517,951 | | | | 6,304,747 | |
| Finished goods on consignment | | | 1,867,549 | | | | 476,648 | | | | 1,007,471 | |
| Total finished jewelry | | | 9,331,559 | | | | 7,786,516 | | | | 8,767,571 | |
| Loose jewels: | | | | | | | | | | | | |
| Raw materials | | | 3,806,681 | | | | 4,487,787 | | | | 4,288,360 | |
| Work-in-process | | | 10,384,143 | | | | 9,463,518 | | | | 8,328,719 | |
| Finished goods | | | 9,878,691 | | | | 10,015,822 | | | | 9,487,245 | |
| Finished goods on consignment | | | 203,535 | | | | 29,323 | | | | 26,281 | |
| Total loose jewels | | | 24,273,050 | | | | 23,996,450 | | | | 22,130,605 | |
| Total supplies inventory | | | 129,111 | | | | 45,572 | | | | 75,441 | |
| Total inventory | | $ | 33,733,720 | | | $ | 31,828,538 | | | $ | 30,973,617 | |
Total net finished jewelry inventories at June 30, 2019, June 30, 2018 and December 31, 2017, including inventory on consignment net of reserves and finished jewelry featuring moissanite manufactured by the Company, were $9.33 million, $7.79 million, and $8.77 million, respectively. Total net loose jewel inventories at June 30, 2019, June 30, 2018 and December 31, 2017, including inventory on consignment net of reserves, were $24.27 million, $24.00 million and $22.13 million, respectively.
As of June 30, 2019, June 30, 2018 and December 31, 2017, management established an obsolescence reserve of $1.79 million, $1.30 million and $1.42 million, respectively. Typically, in the jewelry industry, slow-moving or discontinued lines are sold as closeouts or liquidated in alternative sales channels. Regularly, management reviews both the finished jewelry inventory and the legacy loose jewel inventory for any lower of cost or net realizable value
on an average cost basis. Each accounting period the Company evaluates the valuation and
obsolescence issues. Accordingly, asclassification of
June 30, 2019, June 30, 2018inventories including the need for potential adjustments to inventory-related reserves, which also include significant estimates by management, including the effect of market factors and
December 31, 2017, management identified certain finished jewelry that was obsolete due to damage and other factors that indicate the finished jewelry is unsaleable, and established an obsolescence reserve of $19,000, $7,000 and $91,000, respectively, for the carrying costs in excess of any estimated scrap values. Likewise, with respectsales trends. Changes to the Company’s
loose jewels inventory
based on currentreserves and allowances are accounted for in the accounting period
demand,in which a change in such reserves and
ongoing feedback from distribution customers onallowances is observed and deemed appropriate, including changes in management’s estimates used in the
value of some of these goods, management identified someprocess to determine such reserves and valuation allowances.
As a result of the remainingdeterioration of marketability of the Company’s legacy inventory during the fiscal year ended June 30, 2020, management determined that this segment of these lower qualitythe Company’s inventory had lost its revenue-generating ability and its net realizable value fell below that of its historical carrying cost. Accordingly, the Company recognized a loss in net realizable value in the quarterly period ended March 31, 2020, for its legacy material inventory, i.e., raw materials, or boules, preforms, work-in-process gemstones, finished gemstones, and gemstones set in finished jewelry, the carrying cost of which was approximately $5.26 million.
Included in cost of goods that could not be sold at its current carrying value. Accordingly, management’s analysis of items sold during the fiscal year ended June 30, 2019, resulted in an increase in2020, was the lowerabove-referenced write-off of cost or net realizableapproximately $5.26 million representing the carrying value reserve on this remainingof the Company’s legacy loose jewel inventory to approximately $1.77and finished jewelry inventory set with these legacy gemstones. Total inventory write-downs were $150,000 and $5.86 million as offor the fiscal years ended June 30, 2019 from $1.29 million as of June 30, 2018. This reserve balance was $1.33 million as of December 31, 2017.
As of June 30, 2019, June 30, 20182021 and December 31, 2017, management established a rework reserve for recut and repairs of $460,000, $534,000 and $557,000, respectively. Finished jewelry inventories at June 30, 2019, June 30, 2018 and December 31, 2017 include a repairs reserve of $0, $116,000 and $89,000, respectively. The loose jewel inventories at June 30, 2019, June 30, 2018 and December 31, 2017 included recut reserves of $460,000, $418,000 and $468,000, respectively.
As of June 30, 2019, June 30, 2018 and December 31, 2017, management established a shrinkage reserve of $112,000, $136,000 and $191,000, respectively. Finished jewelry inventories at June 30, 2019, June 30, 2018 and December 31, 2017 include shrinkage reserves of $105,000, $88,000 and $173,000, respectively. The loose jewel inventories at June 30, 2019, June 30, 2018 and December 31, 2017 include shrinkage reserves of $7,000, $48,000 and $18,000,2020, respectively.
Periodically, the Company ships finished goods inventory to certain Traditional segment customers on consignment terms. Under these terms, the customer assumes the risk of loss and has an absolute right of return for a specified period. Included in the total shrinkage reserve is the shrinkage reserve for finished goods on consignment of $15,000, $18,000 and $60,000 as of June 30, 2019, June 30, 2018 and December 31, 2017, respectively, to allow for certain finished jewelry and loose jewels on consignment with certain Traditional segment customers that may not be returned or may be returned in a condition that does not meet the Company’s current grading or quality standards. Finished jewelry inventories on consignment at June 30, 2019, June 30, 2018 and December 31, 2017 include shrinkage reserves of $14,000, $7,000 and $55,000, respectively. The loose jewel inventories on consignment at June 30, 2019, June 30, 2018 and December 31, 2017 include shrinkage reserves of $1,000, $11,000 and $5,000, respectively.
The need for adjustments to inventory reserves is evaluated on a period-by-period basis.
6.7. | PROPERTY AND EQUIPMENT |
Property and equipment, net, consists of the following as of the dates presented:
| | | June 30, | | | December 31, | | | June 30, | |
| | | 2019 | | | 2018 | | | 2017 | | | 2021 | | | 2020 | |
| Computer software | | $ | 1,512,533 | | | $ | 1,253,894 | | | $ | 1,206,465 | | | $ | 2,015,548 | | | $ | 1,827,581 | |
| Machinery and equipment | | 1,100,629 | | | 1,048,288 | | | 1,026,736 | | | | 1,250,345 | | | | 1,145,525 | |
| Computer hardware | | 1,064,302 | | | 1,026,987 | | | 1,009,008 | | | | 1,274,561 | | | | 1,158,559 | |
| Leasehold improvements | | 1,158,218 | | | 1,151,659 | | | 1,126,553 | | | | 1,162,995 | | | | 1,158,807 | |
| Furniture and fixtures | | | 343,808 | | | | 337,210 | | | | 318,627 | | | | 371,883 | | | | 347,872 | |
| Total | | 5,179,490 | | | 4,818,038 | | | 4,687,389 | | | | 6,075,332 | | | | 5,638,344 | |
| Less: accumulated depreciation | | | (4,153,392 | ) | | | (3,673,840 | ) | | | (3,445,189 | ) | |
| Less accumulated depreciation | | | | (5,199,435 | ) | | | (4,639,283 | ) |
| Property and equipment, net | | $ | 1,026,098 | | | $ | 1,144,198 | | | $ | 1,242,200 | | | $ | 875,897 | | | $ | 999,061 | |
Depreciation expense for the fiscal
yearyears ended June 30,
2019, the transition period ended June 30, 20182021 and
the calendar year ended December 31, 20172020 was approximately
$480,000, $229,000,$560,000 and
$420,000,$486,000, respectively.
Intangible assets, net, consist of the following as of the dates presented:
| | | |
| | | Weighted Average Remaining Amortization Period (in Years) | |
|
|
|
|
| |
June 30, | | December 31, | | Weighted Average
Remaining Amortization Period | | June 30,
|
| | 2019 | | 2018 | | 2017 | | (in Years) | 2021 | | | 2020 |
| Patents | | $ | 1,007,497 | | | $ | 969,632 | | | $ | 958,604 | | | | 15.0 | | | $ | 1,017,007 | | | $ | 1,024,267 | | | | 13.6 | |
| Trademarks | | | 100,331 | | | | 73,877 | | | | 57,325 | | | | 9.5 | | | | 214,339 | | | | 160,683 | | | | 12.9 | |
| License rights | | | 6,718 | | | | 6,718 | | | | 6,718 | | | | - | | | | 6,718 | | | | 6,718 | | | | - | |
| Total | | | 1,114,546 | | | | 1,050,227 | | | | 1,022,647 | | | | | | | | 1,238,064 | | | | 1,191,668 | | | | | |
| Less accumulated amortization | | | (1,017,173 | ) | | | (1,015,394 | ) | | | (1,014,050 | ) | | | | | | | (1,028,406 | ) | | | (1,021,517 | ) | | | | |
| | $ | 97,373 | | | $ | 34,833 | | | $ | 8,597 | | | | | | | $ | 209,658 | | | $ | 170,151 | | | | | |
Amortization expense for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 20172020 was approximately $2,000, $1,000$7,000 and $2,000,$4,000, respectively. Amortization expense on existing intangible assets is estimated to be approximately $9,000$17,000 for each of the fiscal years ending June 30, 2020, 2021 and 2022 and $8,0002023 and approximately $16,000 for each of the fiscal years ending June 30, 20232024, 2025, and 2024. The amortization expense for the remaining unamortized balance of the total intangible assets, net, will be recognized in fiscal years ending after June 30, 2024.2026.
8.9. | ACCRUED EXPENSES AND OTHER LIABILITIES |
Total accrued expenses and other liabilities consist of the following as of the dates presented:
| | | June 30, | | | December 31, | | | June 30, | |
| | | 2019 | | | 2018 | | | 2017 | | | 2021 | | | 2020 | |
| Accrued compensation and related benefits | | $ | 760,324 | | | $ | 359,077 | | | $ | 652,177 | | | $ | 866,705 | | | $ | 395,006 | |
| Deferred revenue | | | | 774,891 | | | | 794,740 | |
| Accrued sales tax | | | | 555,547 | | | | 295,651 | |
| Accrued cooperative advertising | | 73,033 | | | 60,784 | | | 134,018 | | | | 68,185 | | | | 89,517 | |
| Deferred rent | | 156,306 | | | 139,558 | | | 131,389 | | |
| Accrued sales tax | | 286,864 | | | 17,149 | | | 20,844 | | |
| Accrued income taxes | | | | 16,478 | | | | - | |
| Accrued severance | | | | - | | | | 338,355 | |
| Other | | | 49,081 | | | | 42,377 | | | | 42,372 | | | | 1 | | | | 9,063 | |
| Accrued expenses and other liabilities | | $ | 1,325,608 | | | $ | 618,945 | | | $ | 980,800 | | | $ | 2,281,807 | | | $ | 1,922,332 | |
9.10. | COMMITMENTS AND CONTINGENCIES |
Lease CommitmentsArrangements
On December 9, 2013, the Company entered into a Lease Agreement, as amended on December 23, 2013,
and April 15, 2014,
and January 29, 2021 (the “Lease Agreement”), for its corporate headquarters, which occupies approximately 36,350 square feet of office, storage and light manufacturing
space. space and is classified as an operating lease for financial reporting purposes. The expiration date of the base term of the Lease Agreement in effect as of June 30, 2021 is October 31, 2026 and the terms of the Lease Agreement contain no early termination provisions. Provided there is no outstanding uncured event of default under the Lease Agreement, the Company has an option to extend the lease term for a period of five years. The Company’s option to extend the term of the Lease Agreement must be exercised in writing on or before 270 days prior to expiration of the then-current term. If the option is exercised, the monthly minimum rent for the extended term will be adjusted to the then-prevailing fair market rate. The renewal option was not assumed to be exercised for purposes of calculating the lease term and the related operating lease liability.
The Company took possession of the leased property on May 23, 2014, once certain improvements to the leased space were completed and did not have access to the property before this date.
TheseUpon execution of the third amendment to the Lease Agreement (the “Lease Amendment”) on January 29, 2021, the Lease Amendment included a rent abatement in the amount of approximately $214,000, which is reflected in the rent payments used in the calculation of the right-of-use (“ROU”) asset and lease liability once remeasured upon the execution of the Lease Amendment to extend the lease term. The Lease Amendment also included an allowance for leasehold improvements
and other lease signing and moving incentives offered by the landlord
totaledin an amount not to exceed approximately
$550,000$545,000. Once such costs have been incurred, the Company will be reimbursed for qualified costs by the landlord and
$73,000, respectively, which are being amortizedthe Company will reduce the remaining ROU asset and lease liability by the amount of the reimbursement. Such reductions of the ROU asset and lease liability will be recognized prospectively by the Company over the
liferemaining term of the
lease until October 31, 2021. Included in the Lease Agreement is a seven-month rent abatement period effective June 2014 through December 2014.lease.
The Company recognizes rent expense on a straight-line basis, giving consideration to the rent holidays and escalations, the lease signing and moving allowance to be paid to the Company, and the rent abatement.
As of June 30, 2019,2021, the Company’s balance sheet classifications of its leases are as follows:
| Operating Leases: | | | |
Noncurrent operating lease ROU assets | | $ | 3,952,146 | |
| | | | | |
| Current operating lease liabilities | | $ | 566,083 | |
| Noncurrent operating lease liabilities | | | 3,600,842 | |
| Total operating lease liabilities | | $ | 4,166,925 | |
The Company’s total operating lease cost was approximately $610,000 and $469,000 for the fiscal years ended June 30, 2021 and 2020.
As of June 30, 2021, the Company’s estimated incremental borrowing rate used and assumed discount rate with respect to operating leases was 2.81% and the remaining operating lease term was 5.33 years.
As of June 30, 2021, the Company’s remaining future
minimum payments under
the operating leases
werefor each fiscal year ending June 30 are as follows:
| | $ | 625,788 | |
2021 | | | 642,997 | |
2022 | | | 219,723 | |
| Total | | $ | 1,488,508 | |
| 2022 | | $ | 575,591 | |
| 2023 | | | 869,742 | |
| 2024 | | | 893,660 | |
| 2025 | | | 918,236 | |
| 2026 | | | 943,487 | |
| 2027 | | | 317,327 | |
| Total lease payments | | | 4,518,043 | |
| Less: imputed interest | | | 351,118 | |
| Present value of lease payments | | | 4,166,925 | |
| Less: current lease liability | | | 566,083 | |
| Total long-term lease liability | | $ | 3,600,842 | |
The Company makes cash payments for amounts included in the measurement of its lease liabilities. During the fiscal year ended June 30, 2019,2021 and 2020, cash paid for operating leases was approximately $688,000 and $668,000, respectively. Upon the transition periodexecution of the Lease Amendment, the Company recorded additional ROU assets in the amount of approximately $3.9 million obtained in exchange for the additional operating lease liability during the fiscal year ended June 30, 2018 and the calendar year ended December 31, 2017 was approximately $528,000, $260,000 and $510,000, respectively.2021.
On December 12, 2014, the Company entered into an exclusive supply agreement (the “Supply Agreement”) with Cree, Inc. (“Cree”). Under the Supply Agreement, subject to certain terms and conditions,
including a security interest as defined, the Company agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of the Company’s 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 was also amended to
(i)(i) provide the Company with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following expiration of the initial term;
(ii)(ii) establish a process by which Cree may begin producing alternate SiC material based on the Company’s specifications that will give the Company the flexibility to use the materials in a broader variety of its products; and
(iii)(iii) permit the Company to purchase certain amounts of SiC materials from third parties under limited conditions.
Effective June 30, 2020, the Supply Agreement was further amended to extend the expiration date to June 29, 2025, which may be extended again by mutual agreement of the parties. The Supply Agreement was also amended to, among other things, (73i) spread the Company’s 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 Cree has agreed to accept purchase orders in excess of the agreed-upon minimum purchase commitment, subject to certain conditions; and (iii) permit the Company to purchase revised amounts of SiC materials from third parties under limited conditions.
The Company’s total purchase commitment under the Supply Agreement, as amended, until June 20232025 is approximately $52.95 million, of which approximately $43.98 million$32.85 remains to be purchased as of June 30, 2019. 2021. Over the life of the Supply Agreement, as amended, the Company’s future minimum annual purchase commitments of SiC crystals range from approximately $9$4 million to $12$10 million each year.year.
During the fiscal
yearyears ended June 30,
2019, the transition period ended June 30, 20182021 and
the calendar year ended December 31, 2017,2020, the Company purchased approximately
$8.91 million, $4.89$3.78 million and
$9.39$7.47 million, respectively, of SiC crystals from Cree.
COVID-19
In March 2020, the novel strain of coronavirus, known as COVID-19, was declared a pandemic by the World Health Organization and declared a national emergency by the U.S. Government, and has continued to negatively affect the U.S. and global economies. In response to the pandemic, federal, state, county and local governments, and public health organizations and authorities around the world have implemented a variety of measures intended to control the spread of the virus including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing, and hygiene requirements. While some of these measures have been lifted or eased in certain jurisdictions, other jurisdictions have seen increases in new COVID-19 cases, resulting in restrictions being reinstated or new restrictions being imposed.
The Company has continued taking measures to protect the health and safety of its employees, including updating the Company’s return-to-work policies, as necessary, working with its customers and suppliers to minimize disruptions, and supporting its community in addressing the challenges posed by this ongoing global pandemic. During Fiscal 2021, the Company experienced impacts in its business related to COVID-19, primarily in continued increased coronavirus-related costs, interruptions in supplier deliveries, impacts of travel and delivery restrictions, site access and quarantine restrictions, and the impacts of remote work and adjusted work schedules.
The COVID-19 pandemic continues to present business challenges and the Company expects these to continue into Fiscal 2022. The Company’s purchasesmanagement has executed plans to reintroduce employees to the workplace as vaccine rates increase and COVID-19 cases decrease. Although, in light of SiC crystals priorthe recent increase in infections due to evolving viral variants, the Company has not yet returned to pre-pandemic workforce levels in its workplace and is experiencing stabilization of employee attendance in its operations and distribution facilities and throughout its supply chain. A segment of the Company’s corporate staff continues working a blend of remote and in-person work schedules and management is taking measures to facilitate the provision of vaccines to the Company’s employees in line with state and local guidelines. The Company also continues working with its customers and suppliers to minimize disruptions, including at times accelerating payments to key suppliers that are due by their terms in future periods. The Company expects to continue accelerating payments to its suppliers in some cases into Fiscal 2022.
The ultimate impact of COVID-19 on the Company’s 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. The Company cannot at this time predict the full impact of the COVID-19 pandemic, but the Company anticipates that the COVID-19 pandemic is likely to continue to impact its business, financial condition, results of operations and/or cash flows in the fiscal year ending June 30, 2022.
At the onset of the pandemic, the Company applied for and received the proceeds from a Paycheck Protection Program loan (a “PPP Loan”) pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), as administered by the U.S. Small Business Administration (the “SBA”). The Company’s PPP Loan in the principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, (its “Lender”), a nationally licensed lender under the SBA, pursuant to a promissory note issued by the Company on June 15, 2020. In accordance with applicable provisions of the CARES Act, effective June 23, 2021, the Company’s PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000 and the related accrued and unpaid interest. The full amount of the gain in connection with the extinguishment of the underlying debt, including the forgiveness of accrued and unpaid interest, was recognized by the Company in the fiscal year ended June 30, 2021.
The Company took advantage of available COVID-19 related payroll tax credits for certain wages and paid leave provided by us during the pandemic. A portion of these eligible tax credits are determined by qualified emergency paid sick and expanded family and medical leave wages pursuant to the Families First Coronavirus Response Act (“FFCRA”). In addition, the Consolidated Appropriations Act, 2021, provides that employers who received a PPP loan may also qualify for the Employee Retention Credit (the “ERC”). Previously, pursuant to the CARES Act, taxpayers that received a PPP loan were not eligible for the ERC and this change is retroactive to March 27, 2020. The Company believes that it qualifies for certain employer-related tax benefits pursuant to the ERC and expects to amend its applicable federal payroll tax returns for such benefit. Further, as permitted by the NC COVID-19 Relief Act, the Company expects to receive an incremental tax credit towards its contributions to the North Carolina Unemployment Insurance Fund. Accordingly, the Company will recognize any payroll tax credits related to these federal and state legislative actions in the period such benefits are received.
Paycheck Protection Program Loan
On June 18, 2020, the Company received the proceeds from its PPP Loan. The loan in the principal amount of $965,000 was disbursed by the Lender pursuant to a promissory note issued by the Company (the “Promissory Note”) on June 15, 2020. During the period of time that the principal under the Promissory Note was outstanding, the Company accounted for the Promissory Note as debt within the accompanying consolidated financial statements.
Pursuant to its terms, the Promissory Note was scheduled to mature on June 18, 2022. However, on June 14, 2021, in accordance with applicable provisions of the CARES Act the Company filed its PPP Loan forgiveness application with the Lender for forgiveness of the full amount of the PPP Loan proceeds and the related accrued and unpaid interest. Effective June 23, 2021, the Company’s PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of $965,000 and the related accrued and unpaid interest. Accordingly, the full amount of the gain in connection with the extinguishment of this debt was recognized in the fiscal year ended June 30, 2021.
In accordance with the terms of the Promissory Note, during the period of time the principal of the PPP Loan was outstanding, interest was accrued by the Company at a fixed rate of 1% per annum. In connection with the Company’s PPP Loan forgiveness, the SBA also approved forgiveness of accrued interest amounts that would have been otherwise payable by the Company to the Lender. Accordingly, the benefit from the forgiveness of the inception to-date interest expense in the amount of approximately $9,000 was recognized and included within the gain on extinguishment of debt in the consolidated statement of operations for the fiscal year ended June 30, 2019 were2021.
For financial reporting purposes, during the period the principal of the PPP Loan was outstanding, the classification of the current maturity of long-term debt assumed there would have been no principal forgiveness. In accordance with the terms of the Promissory Note, as amended by the Paycheck Protection Program Flexibility Act, principal repayment for the full outstanding principal amount of the PPP Loan was assumed to have been spread in equal monthly installments over the period from October 1, 2021 through the maturity date of the Promissory Note.
The Company did not provide any collateral or guarantees for the PPP Loan, nor did the Company pay any facility charge to the Lender when it obtained the PPP Loan. The Promissory Note provided for customary events of default, which did not occur during the period of time the PPP Loan was outstanding, including, among others, those relating to failure to make payment and breaches of representations.
Line of Credit
Effective July 7, 2021, the Company obtained from JPMorgan Chase Bank, N.A. (“JPMorgan Chase”) a $5.00 million cash collateralized line of credit facility (the “JPMorgan Chase Credit Facility”). The JPMorgan Chase Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions and certain additional indebtedness for borrowed money, installment obligations, and obligations under capital and operating leases. The JPMorgan Chase Credit Facility is secured by a cash deposit in the amount of $5.05 million held by JPMorgan Chase as collateral for the line of credit facility.
Each advance accrues interest at a rate equal to JPMorgan Chase’s monthly 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 without penalty at any time.
The JPMorgan Chase Credit Facility is evidenced by a credit agreement between JPMorgan Chase and the Company (the “JPMorgan Chase Credit Agreement”), dated as of July 12, 2021, 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 (the “JPMorgan Chase Line of Credit Note”) in which the Company promises to pay on or before July 31, 2022, 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, and changes in control.
In connection with the JPMorgan Chase Credit Facility, the Company 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. The Company also agreed to maintain its primary banking depository and disbursement relationship with JPMorgan Chase.
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 the indebtedness, liabilities, and obligations of the Company to JPMorgan Chase or would result from the extension of credit by JPMorgan Chase to the Company.
On July 12, 2021, upon its execution, the Company did not request any advances pursuant to the terms and conditions of the Supply Agreement prior to the effective date of its amendment as of June 22, 2018.JPMorgan Chase Credit Facility.
On July 13, 2018,Prior to obtaining the JPMorgan Chase Credit Facility, the Company and its
wholly-ownedwholly owned subsidiary, charlesandcolvard.com, LLC (collectively, the “Borrowers”),
obtainedhad a $5.00 million asset-based revolving credit facility (the “White Oak Credit Facility”) from White Oak Commercial Finance, LLC (“White Oak”)
. , which was terminated by the Company in accordance with its terms as of July 9, 2021. The effective date of the White Oak Credit Facility was July 13, 2018, and it was scheduled to mature on July 13, 2021.
The White Oak Credit Facility may be usedwas available for general corporate and working capital purposes, including permitted acquisitions. The White Oak Credit Facility, which matures on July 13, 2021, isacquisitions and was guaranteed by Charles & Colvard Direct, LLC, a wholly-ownedwholly owned subsidiary of the Company (the “Guarantor”). Under the terms of the White Oak Credit Facility, the Borrowers mustwere required to maintain at least $500,000 in excess availability at all times. The White Oak Credit Facility containscontained no other financial covenants.
Advances under the White Oak Credit Facility arewere limited to a borrowing base, which iswas computed by applying specified advance rates to the value of the Borrowers’ eligible accounts receivable and inventory, plus the value of precious metal jewelry components, less reserves. The inclusion of inventory and precious metal jewelry components in the borrowing base was subject to the completion of an inventory appraisal, which was completed subsequent to the execution of the White Oak Credit Facility. Eligible inventory iswould have been further limited to 60% of the net borrowing base, while precious metal jewelry components arewere limited to $500,000.
Advances may beAvailable advances could have been in the form of either revolving or non-revolving. Non-revolving advances arewere limited to $1.00 million in aggregate principal amount outstanding and mustwould have been required to be repaid on each January 15 (which may becould have been effected by conversion to revolving advances, absent an event of default)default, which did not occur during the term of the White Oak Credit Facility). There arewere no other mandatory prepayments or line reductions. The Company may electwas able to prepay any advances in whole or in part at any time without penalty. In addition, the White Oak Credit Facility may becould have been terminated by the Company at any time, subject to a $100,000 fee in the first year of the term of the White Oak Credit Facility, a $50,000 fee in the second year, and no fee thereafter. In connection with the execution of the White Oak Credit Facility, the Company will incurincurred a non-refundable origination fee in the total amount of $125,000 that iswas due and payable to White Oak in three installments. The first installment in the amount of $41,667 was paid upon execution of the White Oak Credit Facility on July 13, 2018, and the second installment in the amount of $41,667 was paid on July 15, 2019. The2019, and the third and final installment in the amount of $41,666 will be due and payablewas paid on July 13, 2020, or the date of termination, whichever is sooner.August 14, 2020.
During the first year of the term of the White Oak Credit Facility, any revolving advances will accruewould have accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and any non-revolving advances will accruewould have accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins will reducewould have been reduced upon the Company’s achievement of a specified fixed charge coverage ratio.ratio during the period of any outstanding advances. However, any advances arewere in all cases subject to a minimum interest rate of 5.50%. Interest is and interest would have been calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default, accrueswhich again did not occur during the term of the White Oak Credit Facility, would have accrued interest at a rate 2% in excess of the rate that would have been otherwise applicable.
The White Oak Credit Facility iswas secured by a lien on substantially all assets of the Borrowers, each of which iswas jointly and severally liable for all obligations thereunder. White Oak’s security interest in certain SiC materials iswas subordinate to Cree’s security interest in such materials pursuant to the Company’s Supply Agreement and an Intercreditor Agreement by and among the Borrowers and the Guarantor with White Oak. In addition, White Oak’s security interest in certain tangible personal property of the Company iswas subordinate to its landlord’s security interest in such tangible personal property.
The White Oak Credit Facility iswas evidenced by a credit agreement, dated as of July 13, 2018 (the “Credit Agreement”), a security agreement, dated as of July 13, 2018 (the “Security Agreement”), and customary ancillary documents. The Credit Agreement, Security Agreement, and ancillary documents containcontained customary covenants, representations, fees, and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, liens, loans, investments, mergers, acquisitions, divestitures, and affiliate transactions.
Events of default under the White Oak Credit Facility include,included, without limitation, a change in control, an event of default under other indebtedness of the Borrowers or Guarantor in excess of $250,000, a material adverse change in the business of the Borrowers or Guarantor or in their ability to perform their obligations under the White Oak Credit Facility, and other defined circumstances that White Oak believeswould have believed may impairhave impaired the prospect of repayment. If an event of default occurs,had occurred, White Oak iswould have been entitled to take enforcement action, including acceleration of any amounts that would have been due under the White Oak Credit Facility, and foreclosureto foreclose upon collateral.
The White Oak Credit Facility containsalso contained other customary terms, that includeincluded indemnity, collateral monitoring fee, minimum interest charge, expense reimbursement, yield protection, and certain confidentiality provisions.
As of June 30, 2019, theThe Company had not borrowed against the White Oak Credit Facility.
Prior to obtainingFacility as of July 9, 2021, the date upon which the White Oak Credit Facility was terminated by the Company and its wholly owned subsidiaries, Charles & Colvard Direct, LLC and Moissanite.com, LLC (now charlesandcolvard.com, LLC), had a $10.00 million asset-based revolving credit facility from Wells Fargo Bank, National Association. This asset-based revolving credit facility (the “Wells Fargo Credit Facility”) was available for general corporate and working capital purposes, including transaction fees and expenses incurred in connection therewith, and the issuance of letters of credit up to a $1.00 million sublimit. The effective date of the Wells Fargo Credit Facility was June 25, 2014, and it was scheduled to mature on June 25, 2017. Effective June 22, 2017, the Wells Fargo Credit Facility was amended to, among other things, extend the maturity date to June 25, 2018, the date upon which it matured in accordance with its terms.
Any advances would have accrued interest at a rate equal to either (i) Wells Fargo’s three-month LIBOR rate plus 2.00%, or (ii) Wells Fargo’s Prime Rate plus 1%, each calculated on an actual/360 basis and would have been payable monthly in arrears. Principal outstanding during an event of default, which did not occur during the term of the Wells Fargo Credit Facility, would have accrued interest at a rate of 3% in excess of the above rate.
The Company had not borrowed against the Wells Fargo Credit Facility as of June 25, 2018, the date upon which the Wells Fargo Credit Facility matured and was terminated in accordance with its terms.
11.12. | SHAREHOLDERS’ EQUITY AND STOCK-BASED COMPENSATION |
Common Stock
The Company is authorized to issue 50,000,000 shares of common stock, no par value. As of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, it had 28,027,569, 21,705,17329,913,095 and 21,580,10228,949,410 shares of common stock outstanding, respectively. Holders of the Company’s common stock are entitled to one vote for each share held.
Preferred Stock
The Board of Directors is authorized, without further shareholder approval, to issue up to 10,000,000 shares of preferred stock, no par value. The preferred stock may be issued from time to time in one or more series. No shares of preferred stock had been issued as of June 30, 2019.2021.
Dividends
The Company has paid no cash dividends during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017.2020.
Shelf Registration Statement
The Company has an effective shelf registration statement on Form S-3 on file with the SECU.S. Securities and Exchange Commission (the “SEC”) which allows it 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 approximately $13.99 million remainsall is available
after giving effect to. However, the Company may offer and sell no more than one-third of its public float (which is the aggregate market value of the Company’s
June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option, as described belowoutstanding common stock held by non-affiliates) in any 12-month period. . The Company’s ability to issue equity securities under its effective shelf registration statement is subject to market conditions.conditions, which may be in turn, subject to, among other things, the potential disruption and volatility caused by ongoing effects of the COVID-19 pandemic.
On June 11, 2019, the Company completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the public of $1.60 per share, pursuant to its
then effective shelf registration statement on Form S-3. Net proceeds from the offering were approximately $9.06 million, net of the underwriting discount and fees and expenses in the amount of approximately $941,000. Pursuant to the terms of the underwriting agreement entered in connection with this offering, the underwriters were granted a 30-day option to buy up to an additional 937,500 shares of the Company’s common stock to cover over-allotments.
Pursuant to the partial exercise of the underwriters’ over-allotment option,Accordingly, on July 3, 2019, the Company
issued an additional 630,500 shares of its common stock at a price of $1.60 per share for net proceeds of approximately
$930,000,$932,000, net of the underwriting discount and fees and expenses of approximately
$82,000$77,000. After giving effect to the partial exercise of the over-allotment option, the Company sold an aggregate of 6,880,500 shares of its common stock at a price of $1.60 per share with total gross proceeds of approximately $11.01 million, before deducting the total underwriting discount and fees and expenses of approximately $1.02 million.
Equity Compensation Plans
2018 Equity Incentive Plan
On November 21, 2018, the shareholders of the Company approved the adoption of the Charles & Colvard, Ltd. 2018 Equity Incentive Plan, (the “2018 Plan”). The 2018 Plan will expire by its terms on September 20, 2028.
The 2018 Plan provides for the grant of equity-based awards to selected employees, directors, and consultants of the Company and its affiliates. The aggregate number of shares of the Company’s common stock that could be issued pursuant to awards granted under the 2018 Plan are not to exceed the sum of 3,300,000 plus the number of shares of common stock underlying any award granted under any stock incentive plan maintained by the Company prior to the 2018 Plan (each, a “2018 Prior Plan”) that expires, terminates or is canceled or forfeited under the terms of the 2018 Prior Plans. Stock options granted to employees under the 2018 Plan generally vest over four years and have terms of up to 10 years. The vesting schedules and terms of stock options granted to independent contractors vary depending on the specific grant, but the terms are no longer than 10 years. Stock option awards granted to members of the Board of Directors generally vest at the end of one year from the date of the grant. The vesting schedules of restricted stock awards granted to employees or independent contractors vary depending on the specific grant but are generally four years or less. Only stock options and restricted stock have been granted under the 2018 Plan. As of June 30, 2019,2021 and 2020, there were 285,0251,151,935 and 790,407 stock options outstanding under the 2018 Plan.Plan, respectively.
2008 Stock Incentive Plan
In May 2008, the shareholders of the Company approved the adoption of the Charles & Colvard, Ltd. 2008 Stock Incentive Plan, as amended on March 31, 2015 and approved by the shareholders of the Company on May 20, 2015 and further amended on March 15, 2016 and approved by the shareholders of the Company on May 18, 2016 (the “2008 Plan”). The 2008 Plan expired (with respect to future grants) on May 26, 2018.
The 2008 Plan authorized the Company to grant stock options, stock appreciation rights, restricted stock, and other equity awards to selected employees, directors, and independent contractors. The aggregate number of shares of the Company’s common stock that could be issued pursuant to awards granted under the 2008 Plan were not to exceed the sum of 6,000,000 plus any shares of common stock subject to an award granted under any stock incentive plan maintained by the Company prior to the 2008 Plan (each, a “2008 Prior Plan”) that is forfeited, cancelled, terminated, expires, or lapses for any reason without the issuance of shares pursuant to the award, or shares subject to an award granted under a 2008 Prior Plan which shares are forfeited to, or repurchased or reacquired by, the Company. Stock options granted to employees under the 2008 Plan generally vest over four years and have terms of up to 10 years. The vesting schedules and terms of stock options granted to independent contractors vary depending on the specific grant, but the terms are no longer than 10 years. Stock option awards granted to members of the Board of Directors generally vest at the end of one year from the date of the grant. The vesting schedules of restricted stock awards granted to employees or independent contractors vary depending on the specific grant but are generally four years or less. Only stock options and restricted stock had been granted under the 2008 Plan. As of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, there were 2,238,613, 2,388,1691,083,351 and 2,377,2652,018,688 stock options outstanding under the 2008 Plan, respectively.
Stock-Based Compensation
The following table summarizes the components of the Company’s stock-based compensation included in net income (loss) for the periods presented:
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | |
| Employee stock options | | $ | 235,984 | | | $ | 142,096 | | | $ | 336,534 | |
| Restricted stock awards | | | 266,821 | | | | 93,537 | | | | 106,948 | |
| Totals | | $ | 502,805 | | | $ | 235,633 | | | $ | 443,482 | |
Due to the Company’s valuation allowance against deferred tax assets as discussed further in Note 12, “Income Taxes”, any income tax benefits associated with these grants and awards for the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the calendar year ended December 31, 2017 were fully reserved.
| | | Year Ended June 30, | |
| | | 2021 | | | 2020 | |
| Employee stock options | | $ | 234,947 | | | $ | 309,999 | |
| Restricted stock awards | | | 117,636 | | | | 149,539 | |
| Total | | $ | 352,583 | | | $ | 459,538 | |
No stock-based compensation was capitalized as a cost of inventory during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017.2020.
Stock Options
The following is a summary of the stock option activity for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017:2020:
| | | Shares | | | Weighted Average Exercise Price | | | Shares | | | Weighted Average Exercise Price | |
| Outstanding at December 31, 2016 | | 2,134,898 | | | $ | 1.99 | | |
| Outstanding at June 30, 2019 | | | | 2,523,638 | | | $ | 1.39 | |
| Granted | | 836,369 | | | $ | 0.94 | | | | 605,387 | | | $ | 0.95 | |
| Forfeited | | (103,000 | ) | | $ | 1.22 | | | | (125,005 | ) | | $ | 1.02 | |
| Expired | | | (491,002 | ) | | $ | 2.95 | | | | (194,925 | ) | | $ | 1.18 | |
| Outstanding at December 31, 2017 | | 2,377,265 | | | $ | 1.46 | | |
| Granted | | 216,157 | | | $ | 1.27 | | |
| Forfeited | | (173,750 | ) | | $ | 1.05 | | |
| Expired | | | (31,503 | ) | | $ | 2.17 | | |
| Outstanding at June 30, 2018 | | 2,388,169 | | | $ | 1.46 | | |
| Outstanding at June 30, 2020 | | | | 2,809,095 | | | $ | 1.19 | |
| Granted | | 285,025 | | | $ | 1.00 | | | | 438,533 | | | $ | 1.05 | |
| Exercised | | (52,500 | ) | | 1.21 | | | | (947,435 | ) | | | 0.95 | |
| Forfeited | | (30,000 | ) | | $ | 1.20 | | | | (7,000 | ) | | $ | 1.23 | |
| Expired | | | (67,056 | ) | | $ | 1.71 | | | | (57,907 | ) | | $ | 1.95 | |
| Outstanding at June 30, 2019 | | | 2,523,638 | | | $ | 1.41 | | |
| Outstanding at June 30, 2021 | | | | 2,235,286 | | | $ | 1.24 | |
The weighted average grant date fair value of stock options granted during the fiscal year ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 20172020 was $0.57, $0.68$0.54 and $0.53,$0.50, respectively. The total fair value of stock options that vested during the fiscal year ended June 30, 2019, the transition period ended June 30, 20182021 and the year calendar ended December 31, 20172020 was approximately $176,000, $232,000$650,000 and $400,000,$282,000, respectively.
The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option pricing model with the following weighted average assumptions for stock options granted during the periods presented:
| | | | Year Ended June 30, | |
| | | Year Ended June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | 2021 | | | 2020 | |
| Dividend yield | | 0.0 | % | | 0.0 | % | | 0.0 | % | | | 0.0 | % | | | 0.0 | % |
| Expected volatility | | 61.0 | % | | 62.8 | % | | 63.4 | % | | | 61.7 | % | | | 63.2 | % |
| Risk-free interest rate | | 3.09 | % | | 2.76 | % | | 1.90 | % | | | 0.36 | % | | | 0.82 | % |
| Expected lives (years) | | 5.5 | | | 5.4 | | | 5.5 | | | | 4.9 | | | | 5.2 | |
The following tables summarize information in connection with stock options outstanding at June 30, 2019:2021:
| Options Outstanding | | | Options Exercisable | | | Options Vested or Expected to Vest | |
Balance as of 6/30/2019 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | | | Balance as of 6/30/2019 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | | | Balance as of 6/30/2019 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | |
| 2,523,638 | | | | 6.95 | | | $ | 1.41 | | | | 2,053,613 | | | | 6.51 | | | $ | 1.49 | | | | 2,460,292 | | | | 6.91 | | | $ | 1.42 | |
| Options Outstanding | | | Options Exercisable | | | Options Vested or Expected to Vest | |
Balance as of 6/30/2021 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | | | Balance as of 6/30/2021 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | | | Balance as of 6/30/2021 | | | Weighted Average Remaining Contractual Life (Years) | | | Weighted Average Exercise Price | |
| | 2,235,286 | | | | 6.47 | | | $ | 1.24 | | | | 1,696,003 | | | | 5.62 | | | $ | 1.31 | | | | 2,166,723 | | | | 6.39 | | | $ | 1.25 | |
As of June 30, 2019,2021, the unrecognized stock-based compensation expense related to unvested stock options was approximately $167,000,$192,000, which is expected to be recognized over a weighted average period of approximately 1819 months.
The aggregate intrinsic value of stock options outstanding,
exercisable, and vested or expected to vest at June 30,
20192021 was approximately
$1.36$3.77 million. These amounts are before applicable income taxes and represent the closing market price of the Company’s common stock at June 30,
2019,2021, less the grant price, multiplied by the number of stock options that had a grant price that is less than the closing market price. These amounts represent the amounts that would have been received by the optionees had these stock options been exercised on those dates.
During the fiscal year ended June 30, 2019, theThe aggregate intrinsic value of stock options exercised
during the fiscal year ended June 30, 2021 was approximately
$51,000.$1.24 million. The total tax benefit associated with stock options exercised during the fiscal year ended June 30, 2021, was approximately $147,000. No stock options were exercised during the
transition periodfiscal year ended June 30,
2018 and the calendar year ended December 31, 2017.2020.
Restricted Stock
The following is a summary of the restricted stock activity for the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017:2020:
| | | Shares | | | Weighted Average Grant Date Fair Value | | | Shares | | | Weighted Average Grant Date Fair Value | |
| Unvested at December 31, 2016 | | 359,400 | | | $ | 0.91 | | |
| Unvested at June 30, 2019 | | | | 129,500 | | | $ | 1.08 | |
| Granted | | 420,000 | | | $ | 1.11 | | | | 325,000 | | | $ | 1.57 | |
| Vested | | (214,200 | ) | | $ | 0.92 | | | | (258,341 | ) | | $ | 1.07 | |
| Canceled | | | (209,783 | ) | | $ | 0.96 | | | | (33,659 | ) | | $ | 1.07 | |
| Unvested at December 31, 2017 | | 355,417 | | | $ | 1.11 | | |
| Unvested at June 30, 2020 | | | | 162,500 | | | $ | 1.57 | |
| Granted | | 264,000 | | | $ | 1.25 | | | | 178,750 | | | $ | 0.72 | |
| Vested | | (216,488 | ) | | $ | 1.11 | | |
| Canceled | | | (138,929 | ) | | $ | 1.11 | | | | (162,500 | ) | | $ | 1.57 | |
| Unvested at June 30, 2018 | | 264,000 | | | $ | 1.25 | | |
| Granted | | 129,500 | | | $ | 1.07 | | |
| Vested | | (154,396 | ) | | $ | 1.20 | | |
| Canceled | | | (109,604 | ) | | $ | 1.31 | | |
| Unvested at June 30, 2019 | | | 129,500 | | | $ | 1.08 | | |
| Unvested at June 30, 2021 | | | | 178,750 | | | $ | 0.72 | |
The unvested restricted shares as of June 30, 20192021 are all performance-based restricted shares that willare scheduled to vest, subject to achievement of the underlying performance goals, onin July 31, 2019.2021. As of June 30, 2019,2021, the estimated unrecognized stock-based compensation expense related to these unvested restricted shares subject to the achievement of performance goals was approximately $32,000,$11,000, all of which is expected to be recognized over a weighted average period of approximately one month.month.
The Tax Act, which was signed into law in December 2017, among other things lowered the U.S. corporate income tax rate from 35% to that of 21% effective January 1, 2018. Consequently, the Company wrote down its net deferred tax assets as of December 31, 2017 by approximately $519,000 to reflect the estimated impact of the Tax Act. Likewise, the Company recorded a corresponding net adjustment to its valuation allowance related to the re-measurement of certain net deferred tax assets using the lower U.S. corporate income tax.
In connection with filing its 2017 U.S. corporate income tax return in June 2018, the Company’s management completed its analysis of the income tax effects of the Tax Act and the effect on its existing corporate alternative minimum tax (“AMT”) deferred tax asset, including the nature, validity, and recoverability of its AMT-related deferred tax credit carryforwards. Upon completing this analysis, management determined that it was able to recognize the underlying tax benefit relating to the realization of the recoverable portion of its AMT-related deferred tax credit carryforwards, net of an expected sequestration reduction, in the amount of approximately $328,000. Accordingly, the Company recorded the expected AMT credit refund as a receivable, net of an anticipated sequestration reduction and such amount was included with other long-term assets in the accompanying Consolidated Balance Sheets as of June 30, 2018.
However, on January 14, 2019, the Internal Revenue Service (the “IRS”) announced that refund payments and refund offset transactions due to refundable minimum tax credits associated with the repeal of the corporate AMT as part of the Tax Act would not be subject to sequestration. Accordingly, following the IRS’s announcement that AMT credit refunds would not be subject to the government sequestration amount, in January 2019 the Company recognized the additional available underlying tax benefit in the amount of approximately $23,000 relating to the sequestered portion of its AMT credit. This amount was also included in other long-term assets in the accompanying Consolidated Balance Sheet as of June 30, 2019.
In May 2019, the Company received its first installment refund in the amount of approximately $80,000 from the IRS in accordance with the AMT refundability schedule as set forth in the Tax Act. The full refundable amount of the Company’s AMT credit carryover receivable will be refunded to the Company in scheduled installment amounts through the calendar year ending December 31, 2021.
The Company accounts for income taxes under the liability method. Under the liability method, deferred income taxes are recognized for the income tax consequences of “temporary differences” by applying enacted statutory income tax rates applicable to future years to differences between the financial statement carrying amounts and the income tax bases of existing assets and liabilities.
IncomeThe Company’s income tax net benefit (expense) for the periods presented comprises the following:
| | | | Year Ended June 30, | |
| | | Year Ended
June 30, 2019 | | | Six Months Ended June 30, 2018 | | | Year Ended December 31, 2017 | | | 2021 | | | 2020 | |
| Current: | | | | | | | | | | | | | | | |
| Federal | | $ | 23,149 | | | $ | 327,594 | | | $ | - | | | $ | - | | | $ | - | |
| State | | | (21,706 | ) | | | (9,534 | ) | | | (27,609 | ) | | | (18,409 | ) | | | (1,733 | ) |
| Total current benefit (expense) | | | 1,443 | | | | 318,060 | | | | (27,609 | ) | |
| Total current expense | | | | (18,409 | ) | | | (1,733 | ) |
| | | | | | | | | | |
| Deferred: | | | | | | | | | | | | | | | | | |
| Federal | | - | | | - | | | - | | | | 6,062,222 | | | | - | |
| State | | | - | | | | - | | | | - | | | | 288,608 | | | | - | |
| Total deferred benefit (expense) | | | - | | | | - | | | | - | | | | 6,350,830 | | | | - | |
| Income tax net benefit (expense) | | $ | 1,443 | | | $ | 318,060 | | | $ | (27,609 | ) | | $ | 6,332,421 | | | $ | (1,733 | ) |
Significant components of the Company’s noncurrent deferred income tax assets, net, as of the dates presented are as follows:
| | | June 30, | | | December 31, | | | June 30, | |
| | | 2019 | | | 2018 | | | 2017 | | | 2021 | | | 2020 | |
| Deferred tax assets: | | | | | | | |
| Reversals and accruals | | $ | 970,516 | | | $ | 668,813 | | | $ | 686,573 | | | $ | 454,846 | | | $ | 476,666 | |
| Prepaid expenses | | | (38,552 | ) | | | (38,944 | ) | | | (28,744 | ) | |
| Federal NOL carryforwards | | | 4,911,437 | | | | 5,540,016 | | | | 5,185,438 | | |
| Federal net operating loss (“NOL”) carryforwards | | | | 3,989,278 | | | | 4,980,513 | |
| State NOL carryforwards | | | 674,522 | | | | 714,588 | | | | 681,364 | | | | 585,563 | | | | 663,918 | |
| Hong Kong NOL carryforwards | | | 995,566 | | | | 995,566 | | | | 995,566 | | | | 995,566 | | | | 995,566 | |
| Federal benefit on state taxes under uncertain tax positions | | | 100,703 | | | | 96,144 | | | | 94,142 | | | | 2,073 | | | | 1,668 | |
| Stock-based compensation | | | 194,524 | | | | 412,148 | | | | 422,623 | | | | 149,047 | | | | 177,508 | |
| Section 263A adjustment | | | | 122,562 | | | | 215,416 | |
| Research tax credit | | | 83,315 | | | | 235,742 | | | | 434,637 | | | | - | | | | 252 | |
| Alternative minimum tax | | | - | | | | 23,149 | | | | 350,743 | | |
| Contributions carryforward | | | - | | | | 1,923 | | | | - | | | | - | | | | 7,184 | |
| Depreciation | | | (157,310 | ) | | | (159,100 | ) | | | (178,670 | ) | |
| Accrued rent | | | 88,923 | | | | 121,124 | | | | 138,178 | | |
| Inventory valuation reserve | | | | 1,605,871 | | | | 1,594,795 | |
| Operating lease liabilities | | | | 942,471 | | | | 185,422 | |
| Loss on impairment of long-lived assets | | | 32,985 | | | | 33,157 | | | | 33,864 | | | | - | | | | 32,749 | |
| Valuation allowance | | | (7,856,629 | ) | | | (8,644,326 | ) | | | (8,815,714 | ) | | | (1,452,296 | ) | | | (8,988,696 | ) |
| Total deferred income tax assets, net | | $ | - | | | $ | - | | | $ | - | | |
| Noncurrent deferred tax assets, net | | | | 7,394,981 | | | | 342,961 | |
Deferred tax liabilities: | | | | | | | | | |
| Prepaid expenses | | | | (44,890 | ) | | | (39,943 | ) |
| Depreciation | | | | (105,369 | ) | | | (172,010 | ) |
| Operating lease right-of-use assets | | | | (893,892 | ) | | | (131,008 | ) |
| Noncurrent deferred tax liabilities | | | | (1,044,151 | ) | | | (342,961 | ) |
| Total noncurrent deferred tax assets, net | | | $ | 6,350,830 | | | $ | - | |
The following are reconciliations between expected income taxes, computed at the applicable statutory federal income tax rate applied to pretax accounting loss, and the income tax net benefit (expense) for the periods presented:
| | | Year Ended June 30, 2019 | | Six Months Ended June 30, 2018 | | Year Ended December 31, 2017 | | | Year Ended June 30, | |
| | | | | | | | | | 2021 | | | 2020 | |
| Anticipated income tax (expense) benefit at statutory rate | | $ | (477,545 | ) | | $ | 334,716 | | | $ | 144,795 | | | $ | (1,360,452 | ) | | $ | 1,293,673 | |
| State income tax expense, net of federal tax effect | | | (42,334 | ) | | | 7,755 | | | | (54,083 | ) | |
| Federal income tax effect of change in tax rate | | | - | | | | - | | | | (3,729,007 | ) | |
| State income tax (expense) benefit, net of federal tax effect | | | | (84,288 | ) | | | 64,034 | |
| Income tax effect of uncertain tax positions | | | 17,494 | | | | 37,671 | | | | (17,946 | ) | | | (1,468 | ) | | | 17,508 | |
| Return to provision adjustments | | | 126 | | | | - | | | | 2,982 | | | | (45 | ) | | | 1 | |
| Stock-based compensation | | | (3,929 | ) | | | 9,855 | | | | (36,233 | ) | | | 38,197 | | | | (31,195 | ) |
| PPP Loan forgiveness | | | | 202,729 | | | | - | |
| Other changes in deferred income tax assets, net | | | (280,066 | ) | | | (243,325 | ) | | | (437 | ) | | | 1,348 | | | | (114,288 | ) |
| Decrease in valuation allowance | | | 787,697 | | | | 171,388 | | | | 3,662,320 | | |
| Decrease (Increase) in valuation allowance | | | | 7,536,400 | | | | (1,231,466 | ) |
| Income tax net benefit (expense) | | $ | 1,443 | | | $ | 318,060 | | | $ | (27,609 | ) | | $ | 6,332,421 | | | $ | (1,733 | ) |
The Company’s statutory tax rate as of the fiscal year ended June 30, 2019 is 22.16% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.16%, net of the federal benefit. The Company’s statutory tax rate as of June 30,
2018 was 22.13%2021 is 22.24% and consisted of the federal income tax rate of 21% and a blended state income tax rate of
1.13%1.24%, net of the federal benefit. The Company’s statutory tax rate as of
December 31, 2017the fiscal year ended June 30, 2020 was
23.25%22.11% and consisted of the federal income tax rate of 21% and a blended state income tax rate of
2.25%1.11%, net of the federal benefit.
As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of available deferred tax assets. As of the fiscal year ended June 30, 2019, June 30, 20182020, the Company did not recognize an income tax benefit for any of its deferred tax assets, primarily related to net operating loss carryforwards and December 31, 2017, the Company’s inventory valuation reserves, because 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.
However, as of June 30, 2021, cumulative positive taxable income over the last three tax years had been generated in the U.S., as compared to the negative evidence of cumulative losses in previous years. The Company’s management also determined that its 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 therefore,assumptions, would be sufficient to result in full utilization of the Company maintainedCompany’s federal net operating loss carryforwards and certain of the deferred tax assets prior to any statutory expiration. As a result, the Company’s management determined that sufficient positive evidence exists as of June 30, 2021, to conclude that it is more likely than not deferred tax assets of approximately $6.35 million are realizable, and it reduced the Company’s valuation allowance accordingly. The reduction of the valuation allowances against these deferred tax assets was the main driver of the income tax benefit during the fiscal year ended June 30, 2021 of approximately $6.33 million. A valuation allowance remains against certain deferred tax assets primarily relating to state net operating loss carryforwards from the Company’s e-commerce subsidiary due to the timing uncertainty of when it will generate positive taxable income to utilize the associated deferred tax assets. In addition, as detailed below, a valuation allowance also remains against itscertain deferred tax assets.
80assets relating to operating loss carryforwards relating to the Company’s dormant subsidiary located in Hong Kong.
As of June 30,
2019, June 30, 2018 and December 31, 2017,2021, all of the
Company had approximately $102,000, $313,000 and $884,000, respectively, ofCompany’s remaining federal income tax credits
that expire between 2020had expired or been utilized, and
2021 and all of which cantherefore, are not available to be carried forward to offset future income taxes. As of June 30,
2019, June 30, 20182021 and
December 31, 2017,2020, the Company
also had federal tax net operating loss carryforwards of approximately
$23.39 million, $26.28$19.00 million and
$24.59$23.72 million, respectively, expiring between
20302034 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
$20.20 million, $20.24$19.87 million and
$20.22$20.12 million, respectively, expiring between 2023 and
2033;2035; and various other state tax net operating loss carryforwards expiring between
20212023 and
2034,2040, which can be used to offset against future state taxable income.
As of each of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, there was approximately $6.03 million in net operating loss carryforwards in Hong Kong. In accordance with the Hong Kong tax code, these amounts can be carried forward indefinitely to offset future taxable income in Hong Kong. The Company’s deferred tax assets in Hong Kong were fully reserved with a valuation allowance of $996,000 as of each of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, and had been fully reserved in all prior fiscal periods due to the uncertainty of future taxable income in this jurisdiction to utilize the deferred tax assets. Charles & Colvard (HK) Ltd., the Company’s Hong Kong subsidiary, which was re-activatedentered into dormancy as of September 30, 2020, following its re-activation in December 2017, but2017. Charles & Colvard (HK) Ltd. previously became dormant in the second quarter of 2009 and has had no operating activity during the fiscal year ended June 30, 2019, the transition period ended June 30, 2018 and the calendar year ended December 31, 2017, previously ceased operations during 2008 and became a dormant entity during 2009.since 2008. If the Company uses any portion of its deferred tax assets in future periods, the valuation allowance would need to be reversed and may impact the Company’s future operating results.
Pursuant to provisions of the CARES Act, existing AMT credit carryforwards were eligible for acceleration and refundable AMT credits were to be completely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, during the fiscal year ended June 30, 2020, the Company elected to have its AMT credit in the amount of approximately $270,000 refunded and filed a refund claim with the IRS for the remaining AMT tax credit. Consequently, the full amount of the Company’s AMT credit refund was refunded by the IRS during the fiscal year ended June 30, 2021.
The Company continues to monitor future developments and interpretations of the CARES Act and other federal and state legislative actions for any material impacts on its future results of operations, financial position, and liquidity.
Uncertain Tax Positions
The gross liability for income taxes associated with uncertain tax positions at June 30,
2019,2021 and June 30,
2018 and December 31, 2017,2020, was approximately
$512,000, $525,000$10,000 and
$560,000,$8,000, respectively.
These amounts are shown net of approximately $19,000, $54,000 and $98,000, respectively, recorded as a direct reduction to the associated deferred tax asset. The gross liability, if recognized, would favorably affect the Company’s effective tax rate.
The Company’s policy for recording interest and penalties associated with tax audits is to record such items as a component of the provision for income taxes. The Company accrued approximately $22,000, $10,000 and $28,000$2,000 of interest and penalties associated with uncertain tax positions for each of the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017, respectively.2020. Including the interest and penalties recorded for uncertain tax positions, there is a total of approximately $225,000, $203,000$7,000 and $193,000$5,000 of interest and penalties included in the accrued income tax liability for uncertain tax positions as of June 30, 2019, June 30, 20182021 and December 31, 2017,2020, respectively. To the extent interest and penalties are not ultimately incurred with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.
In all significant federal and state jurisdictions where it is required to file income tax returns, the Company has analyzed filing positions for all tax years in which the statute of limitations is open. The only periods subject to examination by the major tax jurisdictions where the Company does business are the tax years ended December 31, 20142016 through June 30, 2018.2020. The Company does not believe that the outcome of any examination will have a material impact on its consolidated financial statements and does not expect settlement on any uncertain tax positions within the next 12 months. Beginning with the transition period ended June 30, 2018, the Company’s tax year conforms with its fiscal accounting period year ending on June 30 of each year.
The following table summarizes the activity related to the Company’s gross liability for uncertain tax positions for the period from December 31, 2016 through June 30, 2019:
Balance at December 31, 2016 | | $ | 532,764 | |
| Increases related to prior calendar year tax positions | | | 27,609 | |
Balance at December 31, 2017 | | | 560,373 | |
| Decreases related to prior calendar year tax positions | | | (35,670 | ) |
Balance at June 30, 2018 | | | 524,703 | |
| Decreases related to prior transition period tax positions | | | (12,936 | ) |
Balance at June 30, 2019 | | $ | 511,767 | |
13.14. | MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK |
At times, a portion of the Company’s accounts receivable will be due from customers that have individual balances of 10% or more of the Company’s total gross accounts receivable.
The following is a summary of customers that represent greater than or equal to 10% of total gross accounts receivable as of the dates presented:
| | | June 30, | | | December 31, | | | June 30, | |
| | | 2019 | | | 2018 | | | 2017 | | | 2021 | | | 2020 | |
| Customer A | | 25 | % | | 23 | % | | * | % | | | 30 | % | | | 26 | % |
| Customer B | | 15 | % | | ** | % | | **
| % | | | 22 | % | | | 14 | % |
| Customer C | | 13 | % | | 10 | % | | 18 | % | | | 14 | % | | | 13 | % |
| Customer D | | ***
| % | | ***
| % | | 12 | % | |
* Customer A did not have individual balances that represented 10% or more of total gross accounts receivable as of December 31, 2017.** Customer B did not have individual balances that represented 10% or more of total gross accounts receivable as of June 30, 2018 and December 31, 2017.
*** Customer D did not have individual balances that represented 10% or more of total gross accounts receivable as of June 30, 2019 and 2018.
A significant portion of sales is derived from certain customer relationships. The following is a summary of customers that represent greater than or equal to 10% of total net sales for the periods presented:
|
| Year Ended June 30, 2019 |
|
| Six Months Ended June 30, 2018 |
|
| Year Ended December 31, 2017 |
|
| Customer A | | | 14 | % | | | 12 | % | | | 21 | % |
| Customer C | | | 10 | % | | | 12 | % | | | * | % |
* Customer C did not have net sales that represented 10% or more of total net sales for the calendar year ended December 31, 2017.
| | | Year Ended June 30, | |
| | | 2021 | | | 2020 | |
| Customer A | | | 13 | % | | | 12 | % |
| Customer B | | | 12 | % | | | 13 | % |
The Company records its sales returns allowance at the corporate level based on several factors including historical sales return activity and specific allowances for known customer returns.
14.15. | EMPLOYEE BENEFIT PLAN |
All full-time employees who meet certain length of service requirements are eligible to participate in and receive benefits from the Company’s 401(k) Plan. This plan provides for matching contributions by the Company in such amounts as the Board of Directors may annually determine, as well as a 401(k) option under which eligible participants may defer a portion of their salaries. The Company contributed a total of $67,000, $44,000$72,000 and $64,000$82,000 to thisits employee benefit defined contribution plan during the fiscal yearyears ended June 30, 2019, the transition period ended June 30, 20182021 and the calendar year ended December 31, 2017,2020, respectively.
On July 3, 2019,12, 2021, the Company issued an aggregateobtained a cash collateralized $5.00 million line of 630,500 shares of its common stock atcredit facility with JPMorgan Chase Bank, N.A. See Note 11, “Debt”, for a price of $1.60 per share pursuant to the partial exercise of the underwriters’ over-allotment option received in connection with the Company’s recently completed public offering. The Company received net proceeds of approximately $930,000, net of the underwriting discount and fees and expenses, from the partial exercise of the over-allotment option. A more detailed description of the Company’s underwritten public offering pursuant to its shelf registration statement on Form S-3 is included in Note 11, “Shareholders’ Equity and Stock-Based Compensation”.credit facility.
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
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 June 30, 2019.2021. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or 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 June 30, 2019,2021, 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 have not experienced any material impact to our internal control over financial reporting even though a segment of our corporate headquarters employees continue working a hybrid of remote and in-person schedules due to the COVID-19 pandemic. We are continually monitoring and assessing the impact of COVID-19 on our internal control over financial reporting to minimize the impact on its design and operating effectiveness. 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 June 30, 2019,2021, we made no changes to our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, that we believe materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system was designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Our internal control over financial reporting includes those policies and procedures that:
| (i)(i) | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; |
| (ii)(ii) | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and |
| (iii)(iii) | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. |
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to the reliability of financial reporting and the preparation of financial statements.
In making the assessment of internal control over financial reporting, our management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission, (“COSO”)or COSO, in Internal Control-Integrated Framework (2013). Based on that assessment and those criteria, management determined that our internal control over financial reporting was effective as of June 30, 2019.2021.
None.
| Item 9C. | Disclosure Regarding Foreign Jurisdictions that Prevent Inspections |
Not applicable.
PART III
| Item 10. | Directors, Executive Officers and Corporate Governance |
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
| Item 14. | Principal Accounting Fees and Services |
The information called for in Items 10 through 14 is incorporated by reference from our definitive Proxy Statement relating to our 20192021 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the end of the fiscal year ended June 30, 2019.2021.
PART IV
| Item 15. | Exhibits, Financial Statement Schedules |
(a)(1) and (2). The consolidated financial statements and report of our independent registered public accounting firm are filed as part of this report (see “Index to Financial Statements,” at Part II, Item 8). The financial statement schedules are not included in this Item as they are either not applicable or the information is otherwise included in the consolidated financial statements or the notes to the consolidated financial statements.
(a)(3). The following exhibits have been or are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:
Exhibit No. | Description |
| |
| Asset Purchase Agreement, effective March 4, 2016, by and among Yanbal USA, Inc., Charles & Colvard, Ltd., and Charles & Colvard Direct, LLC (incorporated herein by reference to Exhibit 2.1 to our Current Report on Form 8-K, as filed with the SEC on March 8, 2016)
|
| |
| List of Schedules Omitted from Asset Purchase Agreement included as Exhibit 2.1 above (incorporated herein by reference to Exhibit 2.2 to our Current Report on Form 8-K, as filed with the SEC on March 8, 2016)
|
| | |
| Restated Articles of Incorporation of Charles & Colvard, Ltd. (incorporated herein by reference to Exhibit 3.1 to our Annual Report on Form 10-K for the year ended December 31, 2004) |
| | |
| Bylaws of Charles & Colvard, Ltd., as amended and restated, effective May 19, 2011 (incorporated herein by reference to Exhibit 3.1 to our Current Report on Form 8-K, as filed with the SEC on May 24, 2011) |
| | |
| Specimen Certificate of Common Stock (incorporated herein by reference to Exhibit 4.1 to our Annual Report on Form 10-K for the year ended December 31, 1998) |
| | |
| 4.2 | Description of Common Stock++ |
| |
| Exclusive Supply Agreement, dated as of December 12, 2014, by and among Charles & Colvard, Ltd., Cree, Inc. and, solely for purposes of Section 6(c) of the Exclusive Supply Agreement, Charles & Colvard Direct, LLC and moissanite.com, LLC (incorporated herein by reference to Exhibit 10.110.4 to our CurrentQuarterly Report on Form 8-K,10-Q for the quarter ended December 31, 2020, as filed with the SEC on December 16, 2014)February 4, 2021)** |
| | |
| First Amendment to Exclusive Supply Agreement, dated as of June 22, 2018, by and between Charles & Colvard, Ltd. and Cree, Inc. (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on June 27, 2018)* |
| | |
| Second Amendment to Exclusive Supply Agreement, effective as of June 30, 2020, by and between Charles & Colvard, Ltd. and Cree, Inc. (incorporated herein by reference to Exhibit 10.3 to our Annual Report on Form 10-K for the fiscal year ended June 30, 2020, as filed with the SEC on September 4, 2020)** |
| |
| Credit Agreement, dated as of July 12, 2021, by and among Charles & Colvard, Ltd., and JPMorgan Chase Bank, N.A. (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on July 13, 2021) |
| |
| Line of Credit Note, dated as of July 12, 2021, by and among Charles & Colvard, Ltd., and JPMorgan Chase Bank, N.A. (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on July 13, 2021) |
| |
| Credit Agreement, dated as of July 13, 2018, by and among Charles & Colvard, Ltd., charlesandcolvard.com, LLC, Charles & Colvard Direct, LLC, and White Oak Commercial Finance, LLC (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on July 17, 2018) |
| | |
| Security Agreement, dated as of July 13, 2018, by and among Charles & Colvard, Ltd., charlesandcolvard.com, LLC, Charles & Colvard Direct, LLC, and White Oak Commercial Finance, LLC (incorporated herein by reference to Exhibit 10.4 to our Transition Report on Form 10-KT for the transition period ended June 30, 2018) |
| |
| Intercreditor Agreement, dated as of July 13, 2018, by and among Charles & Colvard, Ltd., charlesandcolvard.com, LLC, Charles & Colvard Direct, LLC, Cree, Inc., and White Oak Commercial Finance, LLC (incorporated herein by reference to Exhibit 10.5 to our Transition Report on Form 10-KT for the transition period ended June 30, 2018) |
| Credit and Security Agreement, dated as of June 25, 2014, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, moissanite.com, LLC, and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on June 30, 2014)
|
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| First Amendment to Credit and Security Agreement, dated as of September 16, 2014, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2014)
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| Second Amendment to Credit and Security Agreement, dated as of December 12, 2014, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.3 to our Current Report on Form 8-K, as filed with the SEC on December 16, 2014)
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| ThirdFirst Amendment to Credit and Security Agreement, and Other Loan Documents, dated as of September 23, 2016,June 15, 2020, by and among Charles & Colvard, Ltd., charlesandcolvard.com, LLC, Charles & Colvard Direct, LLC, Moissanite.com,and White Oak Commercial Finance, LLC to be known as charlesandcolvard.com, LLC, and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.110.7 to our QuarterlyAnnual Report on Form 10-Q10-K for fiscal year ended June 30, 2020, as filed with the quarter endedSEC on September 30, 2016)4, 2020)
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| Fourth Amendment to Credit and Security Agreement,Promissory Note, dated as of June 22, 2017,15, 2020, by and amongbetween Charles & Colvard, Ltd., Charles & Colvard Direct,and Newtek Small Business Finance, LLC charlesandcolvard.com, LLC (formerly known as Moissanite.com, LLC) and Wells Fargo Bank, National Association (incorporated(incorporated herein by reference to Exhibit 10.110.8 to our CurrentAnnual Report on Form 8-K,10-K for fiscal year ended June 30, 2020, as filed with the SEC on June 26, 2017)September 4, 2020)
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| Fifth Amendment to Credit and Security Agreement, dated as of April 3, 2018, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, charlesandcolvard.com, LLC (formerly known as Moissanite.com, LLC) and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.11 to our Transition Report on Form 10-KT for the transition period ended June 30, 2018)
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| Intercreditor Agreement, dated as of December 12, 2014, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, Cree, Inc., and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on December 16, 2014)
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| Lease Agreement, dated December 9, 2013, between Charles & Colvard, Ltd. and Southport Business Park Limited Partnership (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on December 12, 2013)Partnership** ++ |
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| First Amendment to Lease, dated December 23, 2013, between Charles & Colvard, Ltd. and Southport Business Park Limited Partnership (incorporated herein by reference to Exhibit 10.20 to our Annual Report on Form 10-K for the year ended December 31, 2013) |
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| Second Amendment to Lease, dated April 15, 2014, between Charles & Colvard, Ltd. and Southport Business Park Limited Partnership (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014) |
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| Third Amendment to Lease Agreement, dated January 29, 2021, between Charles & Colvard, Ltd. and SBP Office Owner, L.P., successor to Southport Business Park Limited Partnership (incorporated herein by reference to Exhibit 10.5 to our Quarterly Report on Form 10-Q for the quarter ended December 31, 2020, as filed with the SEC on February 4, 2021) |
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| Board Compensation Program, effective October 1, 2017 (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2017)+ |
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| Charles & Colvard, Ltd. 2008 Stock Incentive Plan, as amended (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on May 20, 2016)+ |
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| Form of Employee Incentive Stock Option Agreement under the Charles & Colvard, Ltd. 2008 Stock Incentive Plan (incorporated herein by reference to Exhibit 10.116 to our Current Report on Form 8-K, as filed with the SEC on June 2, 2008)+ |
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| Form of Employee Nonqualified Stock Option Agreement under the Charles & Colvard, Ltd. 2008 Stock Incentive Plan (incorporated herein by reference to Exhibit 10.118 to our Current Report on Form 8-K, as filed with the SEC on June 2, 2008)+ |
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| Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018)+ |
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| Form of Restricted Stock Award Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
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| Form of Employee Incentive Stock Option Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.3 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
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| Form of Employee Nonqualified Stock Option Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.4 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
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| Form of Non-Employee Director Nonqualified Stock Option Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.5 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
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| Form of Independent Contractor Nonqualified Stock Option Agreement under the Charles & Colvard, Ltd. 2018 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.6 to our Current Report on Form 8-K, as filed with the SEC on November 9, 2018) |
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| Charles & Colvard, Ltd. 2018 Senior Management Equity Incentive Program, effective January 1, 2018 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on February 1, 2018)+
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| Charles & Colvard, Ltd. Fiscal 2019 Q1-Q2 Senior Management Equity Incentive Program, effective July 1, 2018 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on May 29, 2018)+ |
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| Charles & Colvard, Ltd. Fiscal 2019 Q3-Q4 Senior Management Equity Incentive Program, effective January 1, 2019 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on February 13, 2019)+ |
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| Charles & Colvard, Ltd. Fiscal 2020 Senior Management Equity Incentive Program, effective July 1, 2019 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on July 11, 2019)+ |
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| Charles & Colvard, Ltd. Fiscal 2021 Senior Management Equity Incentive Program, effective July 1, 2020 (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on August 4, 2020)+ |
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| Employment Agreement, dated December 1, 2015, by and between Charles & Colvard, Ltd. and Suzanne Miglucci (incorporated herein by reference to Exhibit 10.2 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2015)+ |
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| Employment Agreement, dated May 23, 2017, by and between Charles & Colvard, Ltd. and Clint J. Pete (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on May 24, 2017)+ |
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| Employment Agreement, dated May 23, 2017, by and between Charles & Colvard, Ltd. and Don O’Connell (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on May 24, 2017)+ |
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| Amendment to 2015 Employment Agreement, dated April 9, 2020, by and between Charles & Colvard, Ltd. and Suzanne Miglucci (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on April 9, 2020)+ |
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| Amendment to 2017 Employment Agreement, dated April 9, 2020, by and between Charles & Colvard, Ltd. and Clint J. Pete (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on April 9, 2020)+ |
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| Amendment to 2017 Employment Agreement, dated April 9, 2020, by and between Charles & Colvard, Ltd. and Don O’Connell (incorporated herein by reference to Exhibit 10.3 to our Current Report on Form 8-K, as filed with the SEC on April 9, 2020)+ |
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| Separation of Employment Agreement, dated May 28, 2020, by and between Charles & Colvard, Ltd. and Suzanne Miglucci (incorporated herein by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on May 29, 2020)+ |
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| Amended and Restated Employment Agreement, effective as of June 1, 2020, by and between Charles & Colvard, Ltd. and Don O’Connell (incorporated herein by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on May 29, 2020)+ |
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| Subsidiaries of Charles & Colvard, Ltd. (incorporated herein by reference to Exhibit 21.1 to our Transition Report on Form 10-KT for the transition period ended June 30, 2018)++ |
| Consent of BDO USA, LLP++ |
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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 | The following materials from Charles & Colvard, Ltd.’s Annual Report on Form 10-K for the fiscal year ended June 30, 20192021 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i)(i) Consolidated Balance Sheets; (ii)(ii) Consolidated Statements of Operations; (iii)(iii) Consolidated Statements of Shareholders’ Equity; (iv)(iv) Consolidated Statements of Cash Flows; and (v)(v) Notes to Consolidated Financial Statements. |
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| * | Asterisks located within the exhibit denote information which has been redacted pursuant to a request for confidential treatment filed with the SEC. |
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| ** | Asterisks located within the exhibit denote information which has been redacted pursuant to Item 601(b)(10)(iv) of Regulation S-K because it is both not material and would likely cause competitive harm to us if publicly disclosed. |
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| + | Denotes management contract or compensatory plan or arrangement. |
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| ++ | Denotes filed herewith. |
Pursuant to the requirements of Section 13 or 15(d) 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. |
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| | By: | /s/ Suzanne MiglucciDon O’Connell |
September 5, 20192, 2021 | | Suzanne MiglucciDon O’Connell
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| | | President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| | By: | /s/ Suzanne MiglucciDon O’Connell |
September 5, 20192, 2021 | | Suzanne MiglucciDon O’Connell
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| | | Director, President and Chief Executive Officer |
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| | By: | /s/ Clint J. Pete |
September 5, 20192, 2021 | | Clint J. Pete |
| | | Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer) |
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| | By: | /s/ Neal I. Goldman |
September 5, 20192, 2021 | | Neal I. Goldman |
| | | Chairman of the Board of Directors |
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| | By: | /s/ Anne M. Butler |
September 5, 20192, 2021 | | Anne M. Butler |
| | | Director |
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| By: | /s/ Benedetta Casamento |
September 5, 20192, 2021 | | Benedetta Casamento |
| | Director
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| By:
| /s/ Jaqui Lividini
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September 5, 2019
| | Jaqui Lividini
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| | | Director |
| | | |
| | By: | /s/ Ollin B. Sykes |
September 5, 20192, 2021 | | Ollin B. Sykes |
| | | Director |
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