Although the Company issued dividends in prior years, a dividend yield of zero was used due to the uncertainty of future dividend payments. 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. 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. The expected lives of the stock options issued insince 2014 and the first nine months of 2015 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. Stock options issued prior to 2014 were expensed using expected lives that represented the time until exercise or forfeiture using historical information.information.
The aggregate intrinsic value of stock options outstanding, exercisable, and vested or expected to vest at September 30, 2015 wasMarch 31, 2016 were each approximately $89,000, $30,000, and $83,000, respectively.$30,000. This amount is before applicable income taxes and represents the closing market price of the Company’s common stock at September 30, 2015March 31, 2016 less the grant price, multiplied by the number of stock options that had a grant price that is less than the closing market price. This amount represents the amount that would have been received by the optionees had these stock options been exercised on that date. During the three and nine months ended September 30, 2015, the aggregate intrinsic value ofMarch 31, 2016, no stock options exercised was approximately $0 and $167,000, respectively.were exercised.
Basic net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the periods. Diluted net 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 that are computed using the treasury stock method. Antidilutive stock awards consist of stock options and unvested restricted shares that would have been antidilutive in the application of the treasury stock method in accordance with the “Earnings Per Share” topic of the FASB Accounting Standards Codification.
The following table reconciles the differences between the basic and diluted earnings per share presentations:
Trade receivables potentially subject the Company to credit risk. The Company’s standard wholesale customer payment terms on trade receivables are generally between 30 and 90 days, though it may offer extended terms with specific customers and on significant orders from time to time. The Company believes its competitors and other vendors in the wholesale jewelry industry have also expanded their use of extended payment terms and, in aggregate, the Company believes that by expanding its use of extended payment terms, it has provided a competitive response in its market and that its net sales have been favorably impacted. The Company is unable to estimate the impact of this program on its net sales, but if it ceased providing extended payment terms in select instances, the Company believes it would not be competitive for some wholesale customers in the marketplace and that its net sales and profits would likely decrease. 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. The Company has not experienced any significant accounts receivable write-offs related to revenue arrangements with extended payment terms. TheHowever, the Company’s allowance for doubtful accounts includes approximately $815,000 related to one customer that has become past due on its payment arrangement.
At times, a portion of the Company’s accounts receivable will be due from customers that have individual balances in excess of 10% of the Company’s total net accounts receivable. The following is a summary of customers that represent greater than or equal to 10% of total net accounts receivable:
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 gross sales:sales from continuing operations:
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Statements expressing expectations regarding our future and projections relating to products, sales, revenues, and earnings are typical of such statements and are made under the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, representations, and contentions and are not historical facts and typically are identified by use of terms such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “continue,” and similar words, although some forward-looking statements are expressed differently.
All forward-looking statements are subject to the risks and uncertainties inherent in predicting the future. You should be aware that although the forward-looking statements included herein represent management’s current judgment and expectations, our actual results may differ materially from those projected, stated, or implied in these forward-looking statements as a result of many factors including, but not limited to, the following:
Forward-looking statements speak only as of the date they are made. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur except as required by the federal securities laws, and you are urged to review and consider disclosures that we make in the reports that we file with the Securities and Exchange Commission, or SEC, that discuss other factors relevant to our business.
The following discussion is designed to provide a better understanding of our unaudited condensed consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. This information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the condensed consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2014.2015. Historical results and percentage relationships among any amounts in the condensed consolidated financial statements are not necessarily indicative of trends in operating results for future periods.
We sell our loose moissanite jewels at wholesale to some of the largest distributors and manufacturers in the world, which mount them into fine jewelry to be sold at retail outlets and via the Internet. We also sell loose moissanite jewels and finished jewelry featuring moissanite at wholesale to retailers, TV shopping networks, and designers to be sold to end consumers and directly to consumers through our e-commerce sales channel Moissanite.com. Additionally, we sell fashionMoissanite.com and moissanite finished jewelry directly to consumers through our home party sales channel Charles & Colvard Direct.third-party marketplaces. We believe our continued and expanding use of multiple sales channels to the jewelry trade and the end consumer with branded finished jewelry featuring moissanite jewelry creates a more compelling consumer value proposition with the potential to drive increased demand.
We have and will continue to focus on our core business of manufacturing and distributing the loose moissanite jewel and finished jewelry featuring moissanite through wholesale sales channels, because this is currently the primary way we reach consumers. We believe there is opportunity to grow our wholesale business and to capture a larger share of the jewelry market as we execute our strategy to increase consumer awareness of moissanite.
Our wholesale finished jewelry business has expanded through select retailers and television shopping networks. We believe there is significant opportunity to further expand our wholesale finished jewelry business through e-commerce, television shopping, and other retailers. In September 2015, we shipped Forever Brilliant® moissanite jewelry for a 50-store test with a nationwide U.S. retailer. Based on the results of the test we were informed by the retailer that at this time they did not want to move forward with carrying moissanite in time for the upcoming holiday season. In addition, in October 2015 we shipped an expanded assortment of moissanite jewelrytheir stores. We continue to a regional U.S. retailer,work with which we have had a limited assortment of moissanite jewelry over the previous twelve months.
The execution of our strategy to grow our company, 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/or net income due to the challenging business environment in which we operate and our investment in various initiatives to support our growth strategies. However, as we execute our growth strategy and messaging initiatives, we remain committed to our current priorities of generating positive cash flow and strengthening our financial position while both monetizing our existing inventory and manufacturing both our Forever Brilliant® and new Forever OneTMcreated moissanite loose jewels and finished jewelry featuring moissanite to 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, but we fully recognize the business and economic challenges that we face.
The following table sets forth certain consolidated statements of operations data for the three and nine months ended September 30, 2015March 31, 2016 and 2014:2015:
Moissanite.com25 and Lulu Avenue®, which increased 70% to $3.56 million and 358% to $4.07 million, respectively, compared to the corresponding period
Sales of loose jewels represented 44% and 47%85% of total consolidated net sales for the three and nine months ended September 30, 2015, respectively,March 31, 2016, compared to 51% and 54% of total consolidated net sales for the corresponding periodsperiod of the prior year. For the three months ended September 30, 2015,March 31, 2016, loose jewel sales were $2.87$9.64 million compared to $2.32$3.82 million for the corresponding period of the prior year, an increase of $543,000,$5.82 million, or 23%152%. The increase for the three months ended March 31, 2016 was primarily due to the sale of slow-moving inventory during the quarter and the increase in international sales as we serve distributors in the China and Hong Kong markets. We have been evaluating each of our current international wholesale distributors, and others, to determine the best long-term partner within these markets, as well as enforcing the collection from one customer with which we are in dispute. As a result, our sales in these markets may fluctuate significantly each reporting period.
Sales of finished jewelry represented 15% of total consolidated net sales for the three months ended March 31, 2016, compared to 46% of total consolidated net sales for the corresponding period of the prior year. For the ninethree months ended September 30, 2015, loose jewelMarch 31, 2016, finished jewelry sales were $10.45$1.75 million compared to $10.02$3.19 million for the corresponding period of the prior year, an increasea decrease of $439,000,$1.44 million, or 4%45%. The increases for the three and nine months ended September 30, 2015 wereThis decrease was primarily dueattributable to the launchlower sales through our wholesale distribution segment as we have transitioned our largest customer to larger purchases of our new Forever OneTM loose jewels and a focus to reduce inventory of slower moving Forever ClassicTM and other lower quality loose jewels through existing distribution channels.
Salesfewer purchases of finished jewelry represented 56% and 53% of total consolidated net sales for the three and nine months ended September 30, 2015, respectively, compared to 49% and 46% of total consolidated net sales for the corresponding periods of the prior year. For the three months ended September 30, 2015, finished jewelry sales were $3.65 million compared to $2.20 million for the corresponding period of the prior year, an increase of $1.45 million, or 66%. For the nine months ended September 30, 2015, finished jewelry sales were $11.92 million compared to $8.42 million for the corresponding period of the prior year, an increase of $3.50 million, or 42%. The increasejewelry. This decrease was offset in finished jewelry sales in the three and nine months ended September 30, 2015 was primarily due topart by the growth of our direct-to-consumer e-commerce and home party businesses,business which offset the decrease ofhad increased finished jewelry sales in our wholesale business.of 25% to $1.22 million.
United States, or U.S., net sales were 86% andaccounted for approximately 93% of total consolidated net sales for the three months ended March 31, 2016, compared to 91% of total consolidated net sales for the three and nine months ended September 30, 2015, respectively, compared to 77% and 89% of total consolidated net sales for the corresponding periodsperiod of the prior year. U.S. net sales increased $2.10to $10.64 million, or 60%66%, to $5.60 million forduring the three months ended September 30, 2015March 31, 2016 from the corresponding period of the prior year primarily as a result of an increase in U.S. finished jewelrythe sale of $6.77 million of slow-moving inventory to our largest domestic customer, and the increased sales throughof our direct-to-consumer businesses, Moissanite.com and Lulu Avenue®, and the launch of our new Forever OneTM loose jewels to limited distribution, primarily in the U.S. For the nine months ended September 30, 2015, U.S. net sales increased $3.84 million, or 23%, to $20.32 million compared to the corresponding period of the prior year primarily due to the increase in U.S. finished jewelry sales through our direct-to-consumer businesses, Moissanite.com and Lulu Avenue®.e-commerce business.
Our largest U.S. customer during the three and nine months ended September 30, 2015March 31, 2016 accounted for 11% and 26%, respectively,59% of total consolidated sales compared to 27% and 29%, respectively,28% during the corresponding periodssame period of 2014. Two2015. One other U.S. customerscustomer accounted for 13% and 11%20% of total consolidated sales during the ninethree months ended September 30, 2014,March 31, 2015, but did not account for a significant portion of our total consolidated sales induring the correspondingsame period of 2015.2016. We expect that we will remain dependent on our ability, and that of our largest customers, to maintain and enhance retail programs. A change in or loss of any of these customer or retailer relationships could have a material adverse effect on our results of operations.
International net sales accounted for approximately 14% and7% of total consolidated net sales for the three months ended March 31, 2016, compared to 9% of total consolidated net sales for the three and nine months ended September 30, 2015, compared to 23% and 11% of total consolidated net sales for the corresponding periodsperiod of the prior year. International net sales decreased $101,000, or 10%,increased 22% during the three months ended September 30, 2015,March 31, 2016, from the corresponding period of the prior year primarily as a result of a decreasewe serve distributors in loose jewel sales to our international wholesale customer base. International net sales increased $102,000, or 5%, during the nine months ended September 30, 2015, from the corresponding period of the prior year.China and Hong Kong markets. We believe the economic and market conditions that face our larger international customers have caused some fluctuation in our international net sales. As we attempt to expand our international markets, we will continue to evaluatebeen evaluating each of the existing distributors as well as potential new distributors,in these markets, and others, to determine the best long-term partnerspartner within these markets, as well as enforcing the collection from two customersone customer with which we are in dispute. As a result, of these conditions and our evaluation of long-term partners, our sales in these markets may continue to fluctuate significantly each reporting period.
We did not have an international customer account for more than 10% of total consolidated sales during the three and nine months ended September 30, 2015March 31, 2016 or 2014.2015. 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 three months ended September 30, 2015, in order,March 31, 2016 were located in Hong Kong, the United Kingdom, and India. Our top three international distributors by sales volume during the nine months ended September 30, 2015, in order, were located in Hong Kong,India, Hong Kong, and the United Kingdom.Taiwan.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the three and nine months ended September 30,March 31, 2016 and 2015 and 2014 are as follows:
| | | Three Months Ended September 30, | | | Change | | | Nine Months Ended September 30, | | | Change | | | Three Months Ended March 31, | | | Change | |
| | | 2015 | | | 2014 | | | Dollars | | | Percent | | | 2015 | | | 2014 | | | Dollars | | | Percent | | | 2016 | | | 2015 | | | Dollars | | | Percent | |
| Product line cost of goods sold | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loose jewels | | $ | 1,489,997 | | | $ | 1,424,318 | | | $ | 65,679 | | | | 5 | % | | $ | 6,773,455 | | | $ | 5,288,016 | | | $ | 1,485,439 | | | | 28 | % | | $ | 7,814,060 | | | $ | 2,221,174 | | | $ | 5,592,886 | | | | 252 | % |
| Finished jewelry | | | 1,826,738 | | | | 1,447,258 | | | | 379,480 | | | | 26 | % | | | 5,851,605 | | | | 5,832,871 | | | | 18,734 | | | | 0 | % | | | 765,107 | | | | 1,708,170 | | | | (943,063) | | | | -55 | % |
| Total product line cost of goods sold | | | 3,316,735 | | | | 2,871,576 | | | | 445,159 | | | | 16 | % | | | 12,625,060 | | | | 11,120,887 | | | | 1,504,173 | | | | 14 | % | | | 8,579,167 | | | | 3,929,344 | | | | 4,649,823 | | | | 118 | % |
| Non-product line cost of goods sold | | | 574,056 | | | | 397,227 | | | | 176,829 | | | | 45 | % | | | 2,571,171 | | | | 1,135,939 | | | | 1,435,232 | | | | 126 | % | | | 584,721 | | | | 499,279 | | | | 85,442 | | | | 17 | % |
| Total cost of goods sold | | $ | 3,890,791 | | | $ | 3,268,803 | | | $ | 621,988 | | | | 19 | % | | $ | 15,196,231 | | | $ | 12,256,826 | | | $ | 2,939,405 | | | | 24 | % | | $ | 9,163,888 | | | $ | 4,428,623 | | | $ | 4,735,265 | | | | 107 | % |
Total cost of goods sold was $3.89$9.16 million for the three months ended September 30, 2015March 31, 2016 compared to $3.27$4.43 million for the three months ended September 30, 2014,March 31, 2015, an increase of $622,000, or 19%. Total cost of goods sold was $15.20 million for the nine months ended September 30, 2015 compared to $12.26 million for the nine months ended September 30, 2014, an increase of $2.94$4.74 million, or 24%107%. Product line cost of goods sold is defined as product cost of goods sold in each of our wholesale distribution and direct-to-consumer e-commerce distribution and direct-to-consumer home party distribution operating segments 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 royalties on design of goods, costs of quality issues, damaged goods, and inventory write-offs.
The increase in cost of goods sold for the three months ended September 30, 2015March 31, 2016 compared to the correspondingsame period in 20142015 was primarily due to a $379,000$6.77 million sale of slow-moving loose gemstone inventory at low margins and an increase in finished jewelry product line cost of goods sold due to increased finished jewelry sales through our direct-to-consumer businesses, Moissanite.com and Lulu Avenue®, a net increase of $177,000 in non-product line cost of goods sold and a $66,000 increase in loose jewels product line cost of goods sold primarily due to increased loose jewel sales to our wholesale customers. The cost of goods sold for the three months ended September 30, 2015 also included the effect of a finished jewelry melt of slow moving and obsolete jewelry that we identified during the quarter, from which we recovered the cost of the metal and loose jewels, which was less than the carrying cost of the finished jewelry.$85,000, or 17%. The net increase in non-product line cost of goods sold comprises a $516,000 increase in other inventory adjustments, which includes $26,000 of royalties on fashion jewelry design work, a $293,000$264,000 increase in non-capitalized manufacturing and production control expenses primarily due to timing of receiving work in process into inventory and allocating overhead, and a $25,000$4,000 increase in freight expensesout due to increased sales through our direct-to-consumer businesses.volume. These increases are partiallywere offset in part by a $657,000$149,000 decrease in the change in inventory valuation allowances, including inventory obsolescence, shrinkage, recuts, repairs, and scrap reserves.
The increase in cost of goods sold for the nine months ended September 30, 2015 compared to the corresponding period in 2014 was primarily due to a $1.49 million increase in loose jewels product line cost of goods sold resulting from the sale of slow moving loose jewel inventory of less desirable quality at lower product margins to one customer and increased finished jewelry sales through our direct-to-consumer businesses, Moissanite.com and Lulu Avenue®,reserves, and a net increase in non-product line cost of goods sold of $1.44 million. The net increase in non-product line cost of goods sold comprises a $926,000 increase$33,000 decrease in other inventory adjustments, which includes $93,000 of royalties on fashion jewelry design work; a $530,000 increase in non-capitalized manufacturing and production control expenses; and a $91,000 increase in freight expenses due to increased sales through our direct-to-consumer businesses. These increases are partially offset by a $111,000 decrease in inventory valuation allowances, including inventory obsolescence, shrinkage, recuts, repairs, and scrap reserves.adjustments. See Note 3, “Segment Information and Geographic Data,” in the Notes to Condensed Consolidated Financial Statements for further discussion of non-product line cost of goods sold.
Sales and Marketing
Sales and marketing expenses for the three and nine months ended September 30,March 31, 2016 and 2015 and 2014 are as follows:
| | | Three Months Ended September 30, | | | Change | | | Nine Months Ended September 30, | | | Change | |
| | | 2015 | | | 2014 | | | Dollars | | | Percent | | | 2015 | | | 2014 | | | Dollars | | | Percent | |
| Sales and marketing | | $ | 3,008,840 | | | $ | 2,520,426 | | | $ | 488,414 | | | | 19 | % | | $ | 9,500,074 | | | $ | 6,886,651 | | | $ | 2,613,423 | | | | 38 | % |
| | | Three Months Ended March 31, | | | Change | |
| | | 2016 | | | 2015 | | | Dollars | | | Percent | |
| Sales and marketing | | $ | 1,528,585 | | | $ | 1,357,944 | | | $ | 170,641 | | | | 13 | % |
Sales and marketing expenses were $3.01$1.53 million for the three months ended September 30, 2015March 31, 2016 compared to $2.52$1.36 million for the three months ended September 30, 2014,March 31, 2015, an increase of $488,000,$171,000, or 19%. Sales and marketing expenses were $9.50 million for the nine months ended September 30, 2015 compared to $6.89 million for the nine months ended September 30, 2014, an increase of $2.61 million, or 38%13%.
The increase in sales and marketing expenses for the three months ended September 30, 2015March 31, 2016 compared to the correspondingsame period in 20142015 was primarily due to an increase of $417,000 in net compensation expenses; a $97,000$185,000 increase in office-related expenses; an $85,000advertising; a $35,000 increase in recruiting fees; a $23,000 increase in market research; and a $13,000 increase in professional services primarily related to operation of our sales platform and fulfillment services for our direct-to-consumer home party business; and a $4,000 increase in advertising expenses.public relations. These increases were partially offset by an $89,000a $45,000 decrease in travel expense due to fewer international sales trips andtrips; a $26,000$16,000 decrease in depreciation expense related to the Moissanite.com and Lulu Avenue®e-commerce websites’ direct sales platforms.platform; a $13,000 decrease in office-related expense; and an $11,000 decrease in compensation expenses.
The increase in advertising expenses for the three months ended March 31, 2016 compared to the same period in 2015 comprises a $155,000 increase in cooperative advertising and an increase in internet marketing of $34,000, offset in part by a $4,000 decrease in print media expenses to develop and promote brand awareness campaigns.
Compensation costs for the three months ended September 30, 2015March 31, 2016 compared to the correspondingsame period in 2014 increased2015 decreased primarily as a result of an increasea decrease in commissions of $345,000$139,000 for sales to specific wholesale customers under which commission plans of sales representatives are based and the increase in sales within our direct-to-consumer home party line of business;based. This decrease was partially offset by a $69,000$53,000 increase in salaries and related employee benefits; and a $9,000$38,000 increase in bonus expense, a $21,000 increase in stock-based compensation expense. These changes were partially offset byexpense, a $6,000 decrease in bonus expense.
The$10,000 increase in advertising expenses for the three months ended September 30, 2015 compared to the corresponding period in 2014 comprises an increase in internet marketing of $128,000 which is partially offset by a $56,000 decrease in cooperative advertising; a $52,000 decrease in agency and other media and awareness spending,relocation expense, and a decrease of $16,000 in print media expenses to develop and promote brand awareness campaigns. The decrease in cooperative advertising expenses resulted primarily from management’s decision to offer sales discounts to most of our international customers in lieu of cooperative advertising assistance.
The increase in sales and marketing expenses for the nine months ended September 30, 2015 compared to the corresponding period in 2014 was primarily due to an increase of $1.96 million in net compensation expenses; a $436,000 increase in office-related expenses; a $357,000 increase in professional services primarily related to the operation of our sales platform and fulfillment services for our direct-to-consumer home party business; and a $116,000 increase in advertising expenses. These increases were partially offset by a $153,000 decrease in travel expense due to fewer international sales trips and a $99,000 decrease in depreciation expense related to the Moissanite.com and Lulu Avenue® e-commerce websites’ direct sales platforms.
Compensation costs for the nine months ended September 30, 2015 compared to the corresponding period in 2014 increased primarily as a result of an increase in commissions of $1.41 million for sales to specific wholesale customers under which commission plans of sales representatives are based and the increase in sales within our direct-to-consumer home party line of business; a $319,000 increase in salaries and related employee benefits; and a $279,000$6,000 increase in severance expense related to personnel changes within the wholesale sales organization. These changes were partially offset by a $36,000 decrease in stock-based compensation expense and a $20,000 decrease in bonus expense.
The increase in advertising expenses for the nine months ended September 30, 2015 compared to the corresponding period in 2014 comprises an increase in internet marketing of $312,000, and an $87,000 increase in agency and other media and awareness spending, including $93,000 of increased samples expenses. These increases were partially offset by a $275,000 decrease in cooperative advertising and a decrease of $8,000 in print media expenses to develop and promote brand awareness campaigns. The decrease in cooperative advertising expenses resulted primarily from management’s decision to offer sales discounts to most of our international customers in lieu of cooperative advertising assistance, partially offset by the decision of our domestic distributors to not utilize the advertising credits we had accrued during 2014 within the allowable period that we reversed during the three months ended March 31, 2015.We expect our total sales and marketing expenses mayincrease as sales increase; however, this will be dependent on which overall companywide strategies and in which sales channels we may choose to make further investments to increase overall consumer awareness of mossanite and overall sales growth. Regardless of which future overall strategy is followed, we believe the overall rate of growth should slow and become a lower percentage of sales as expenses more variable in nature, such as advertising and commissions, may increase as part of our strategy to build sales; but fixed expenses remain relatively constant. While employee compensation costs may fluctuate from period to period as we continue to build a more efficient and productive sales organization, we expect that these costs will become more fixed in nature over time.
General and Administrative
General and administrative expenses for the three and nine months ended September 30,March 31, 2016 and 2015 and 2014 are as follows:
| | | Three Months Ended September 30, | | | Change | | | Nine Months Ended September 30, | | | Change | |
| | | 2015 | | | 2014 | | | Dollars | | | Percent | | | 2015 | | | 2014 | | | Dollars | | | Percent | |
| General and administrative | | $ | 1,574,903 | | | $ | 1,790,588 | | | $ | (215,685 | ) | | | -12 | % | | $ | 5,343,064 | | | $ | 5,543,269 | | | $ | (200,205 | ) | | | -4 | % |
| | | Three Months Ended March 31, | | | Change | |
| | | 2016 | | | 2015 | | | Dollars | | | Percent | |
| General and administrative | | $ | 1,442,695 | | | $ | 1,865,363 | | | $ | (422,668 | ) | | | -23 | % |
General and administrative expenses were $1.57$1.44 million for the three months ended September 30, 2015March 31, 2016 compared to $1.79$1.87 million for the three months ended September 30, 2014,March 31, 2015, a decrease of $216,000,$423,000, or 12%. General and administrative expenses were $5.34 million for the nine months ended September 30, 2015 compared to $5.54 million for the nine months ended September 30, 2014, a decrease of $200,000, or approximately 4%23%.
The decrease in general and administrative expenses for the three months ended September 30, 2015March 31, 2016 compared to the correspondingsame period in 20142015 was primarily due to a $205,000$184,000 decrease in compensation expenses; a $101,000 decrease in professional services; a $95,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; a $49,000 decrease in professional services; a $28,000$35,000 decrease in board compensation due to having fewer board members during the period;retainer fees; a $26,000$32,000 decrease in depreciation and amortization expense; and a $9,000 decrease in business and franchise taxes; a $25,000 decrease in travel expenses; and an $8,000 decrease for moving the corporate headquarters to its new leased space during 2014.taxes. These decreases were partially offset by a $79,000$30,000 increase in office-related expenses and a $3,000 increase in travel expense.
Compensation expenses decreased for the three months ended March 31, 2016 compared to the same period in 2015 primarily due to a decrease in severance expense of $335,000 associated with the new facility;departure of a $45,000former President and Chief Executive Officer and a decrease in stock-based compensation expense of $91,000, of which $55,000 was related to the transition of our President and Chief Executive Officer in the prior year period. These decreases were partially offset by an increase in compensation expenses;salaries and a $1,000related employee benefits in the aggregate of $207,000 and an increase in depreciation and amortization expense.bonus expense of $35,000.
Professional services decreased for the three months ended September 30, 2015March 31, 2016 compared to the correspondingsame period in 20142015 primarily due to a decrease of $70,000 in investor and public relations expenses and a decrease in legal fees of $22,000. These decreases were partially offset by$86,000, of which approximately $85,000 was related to the transition of our President and Chief Executive Officer in the prior year period; a $30,000 increase$17,000 decrease in audit and tax services primarily due to the timing of work performedperformed; and an increase of $13,000 in consulting and other professional services.
Compensation expenses increased for the three months September 30, 2015 compared to the corresponding period in 2014 primarily due to an increase in salaries and related employee benefits in the aggregatea decrease of $37,000 and an $8,000 increase in stock-based compensation expense.
The decrease in general and administrativepublic relations expenses for the nine months ended September 30, 2015 compared to the corresponding period in 2014 was primarily due to a $869,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; a $30,000 decrease in business and franchise taxes; a $22,000 decrease in other administrative expenses, primarily associated with the movethat are now included as part of the corporate headquarters to its new leased space during 2014; an $11,000 decrease in board compensation, and an $8,000 decrease in depreciation and amortization expense.marketing function. These decreases were partially offset by an increase in compensation expense of $488,000; a $194,000 increase in office-related expenses; a $46,000 increase in professional services, and a $12,000 increase in travel expense.
Compensation expenses increased for the nine months ended September 30, 2015 compared to the corresponding period in 2014 primarily due to an increase in severance expense of $335,000 associated with the departure of our former President and Chief Executive Officer; an increase in salaries and related employee benefits in the aggregate of $121,000, of which $11,000 was related to the transition of our President and Chief Executive Officer; an increase in stock-based compensation expense of $30,000, the majority of which was related to the transition of our President and Chief Executive Officer; and a $2,000 increase in bonus expense.
Professional services increased for the nine months ended September 30, 2015 compared to the corresponding period in 2014 primarily due to an increase in legal fees of $74,000, consisting of approximately $85,000 relating to the transition of our President and Chief Executive Officer, partially offset by lower fees for other corporate matters; an increase of $73,000$39,000 in consulting and other professional services of which approximately $18,000primarily related to the transition of our Presidenthuman resources and Chief Executive Officer;sales and a $21,000 increase in audit anduse tax services primarily due to timing of work performed. These increases were partially offset by a decrease of $122,000 in investor and public relations expenses.projects.
Research and Development
Research and development expenses for the three and nine months ended September 30,March 31, 2016 and 2015 and 2014 are as follows:
| | | Three Months Ended September 30, | | | Change | | | Nine Months Ended September 30, | | | Change | |
| | | 2015 | | | 2014 | | | Dollars | | | Percent | | | 2015 | | | 2014 | | | Dollars | | | Percent | |
| Research and development | | $ | 6,351 | | | $ | 3,863 | | | $ | 2,488 | | | | 64 | % | | $ | 15,455 | | | $ | 15,364 | | | $ | 91 | | | | 1 | % |
| | | Three Months Ended March 31, | | | Change | |
| | | 2016 | | | 2015 | | | Dollars | | | Percent | |
| Research and development | | $ | 1,868 | | | $ | 2,061 | | | $ | (193 | ) | | | -9 | % |
Research and development expenses were $6,000approximately $2,000 for the three months ended September 30, 2015March 31, 2016 compared to $4,000approximately $2,000 for the three months ended September 30, 2014, an increaseMarch 31, 2015, a decrease of approximately $2,000,less than $1,000, or 64%. Research and development expenses were $15,000 for the nine months ended September 30, 2015 compared to $15,000 for the nine months ended September 30, 2014, a slight increase of approximately 1%9%.
Research and development expenses for the three months ended September 30, 2015March 31, 2016 compared to the correspondingsame period in 2014 increased2015 were approximately the same due to an increase of $2,000 in compensation costs and office expenses for time and materials allocated by operations personnel to research and development activities.
Research and development expenses for the nine months ended September 30, 2015 compared to the corresponding period in 2014 remained consistent due to an increase of $7,000a $1,000 decrease in compensation costs and office expenses for time and materials allocated by operations personnel to research and development activities, and a $2,000 increase of materials specifically purchased for these activities,partially offset by a $9,000 decrease$1,000 increase in consulting professional services.purchases of materials for testing.
Interest Expense
Loss on Abandonment of Assets
Loss on abandonment of assetsInterest expense for the three and nine months ended September 30,March 31, 2016 and 2015 and 2014 areis as follows:
| | | Three Months Ended September 30, | | | Change | | | Nine Months Ended September 30, | | | Change | |
| | | 2015 | | | 2014 | | | Dollars | | | Percent | | | 2015 | | | 2014 | | | Dollars | | | Percent | |
| Loss on abandonment of assets | | $ | - | | | $ | - | | | $ | - | | | | - | % | | $ | - | | | $ | 2,201 | | | $ | (2,201 | ) | | | -100 | % |
| | | Three Months Ended March 31, | | | Change | |
| | | 2016 | | | 2015 | | | Dollars | | | Percent | |
| Interest expense | | $ | 1,507 | | | $ | 17 | | | $ | 1,490 | | | | 8,765 | % |
Loss on abandonment of assets
Interest expense was approximately $2,000 for the three months ended March 31, 2016 compared to approximately $0 for the ninethree months ended September 30,March 31, 2015, compared to $2,000 for the nine months ended September 30, 2014, a decreasean increase of approximately $2,000, or 100%8,765%.
ForThe increase in interest expense resulted primarily from the nine months ended September 30, 2014,interest charged on the balance of amounts due for late filings of compliance returns in various sales and use tax jurisdictions around the country. These interest charges were realized at the time of filing once we abandoned a trademark with remaining carrying costs of $2,000 after we determinedwere able to complete the trademark would no longer be utilized.registration and filing process, and to compile accurate information for future timely filings.
Provision for Income Taxes
We recognized an income tax net expense of approximately $3,000 for each of the three monthsthree-month periods ended September 30,March 31, 2016 and 2015 for estimated tax, penalties, and 2014. We recognized an incomeinterest associated with uncertain tax net expense of approximately $10,000 for the nine months ended September 30, 2015 compared to an income tax net expense of $4.05 million for the nine months ended September 30, 2014.positions.
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. Management had previously considered various strategic alternatives that would reduce its pre-tax operating losses, resulting in management determining that a valuation allowance was not necessary atAs of March 31, 2014. During the three months ended June 30, 2014,2016 and December 31, 2015, management determined that such strategic alternatives were no longer in our best interest. Accordingly, management concluded that thesufficient positive evidence was no longer sufficientcontinued to offset available negative evidence, primarily as a result of the pre-tax operating losses incurred during the six months ended June 30, 2014, and forecastedexist to continue through the remainder of 2014. As a result, management concluded thatconclude it was uncertain that we would have sufficient future taxable income to utilize itsour deferred tax assets, and therefore, we establishedmaintained a valuation allowance against our deferred tax assets resulting in a tax expense of $4.05 million for the nine months ended September 30, 2014. This valuation allowance remained as of September 30, 2015.assets.
For the three and nine months ended September 30, 2015, we recognized $3,000 and $10,000, respectively, of income tax expense for estimated tax, penalties, and interest associated with uncertain tax positions. During the three and nine months ended September 30, 2014, we also recognized approximately $3,000 and $9,000, respectively, of income tax expense for estimated tax, penalties, and interest associated with uncertain tax positions.
Liquidity and Capital Resources
We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of September 30, 2015,March 31, 2016, our principal sources of liquidity were cash and cash equivalents totaling $5.60$11.58 million, trade accounts receivable of $2.86$2.64 million, and current inventory of $12.81$10.45 million, as compared to cash and cash equivalents totaling $4.01$5.27 million, trade accounts receivable of $5.51$3.85 million, and current inventory of $13.32$10.74 million as of December 31, 2014.2015. As described more fully below, we also have access to a $10 million credit facility.
During the ninethree months ended September 30, 2015,March 31, 2016, our working capital decreasedincreased by approximately $1.40$6.13 million to $17.85$22.16 million from $19.25$16.03 million at December 31, 2014.2015. As described more fully below, the decreaseincrease in working capital at September 30, 2015March 31, 2016 is primarily attributable to a decrease in trade accounts receivable, a lower allocation of inventory to short-term, a net increase in accrued expenses and other liabilities, and an increase in trade accounts payable, offset in part by an increase in our cash and cash equivalents due to our increased cash from operations, an increasea decrease in trade accounts payable, and a net decrease in accrued expenses and other liabilities. These increases were partially offset by a decrease in trade accounts receivable, a decreased allocation of inventory to short-term, a decrease in prepaid expenses and other assets, and a decreasean increase in accrued cooperative advertising.
During the ninethree months ended September 30, 2015, $1.67March 31, 2016, $6.72 million of cash was provided by continuing operations and $745,000 of cash was used by discontinued operations. The primary drivers of positive cash flow were a decrease in inventory of $4.73$7.26 million, a decrease in trade accounts receivable of $3.13$1.34 million, and a net increasedecrease in accrued liabilitiesprepaid expenses of $232,000, and an increase in trade accounts payable of $11,000.$9,000. These factors were partially offset by a decrease in trade accounts payable of $1.31 million and our loss of $7.69 million$749,000 that included $1.68 million$359,000 of non-cash expenses, and an increasea decrease in prepaid expensesaccrued liabilities of $412,000.$189,000. Accounts receivable decreased primarily as a result of collection efforts during the first ninethree months of 20152016 on sales made in the third and fourth quarterquarters of 2014, and a significant reduction of2015. We did not offer any extended wholesale customer payment terms thatduring the three months ended March 31, 2016; however, we may offer these terms from time to time, thatwhich may not immediately increase liquidity as a result of current-period sales. 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 by offeringthrough our use of extended payment terms, under certain circumstances, we have provided a competitive response in our market and that our net sales have been favorably impacted. We are unable to estimate the impact of this program on our net sales, but if we ceased providing extended payment terms in select instances, we believe we would not be competitive for some wholesale customers in the marketplace and that our net sales and profits would likely decrease. Generally, we have not experienced any significant accounts receivable write-offs related to revenue arrangements with extended payment terms; however, we have increased our reserves for uncollectible accounts primarily due to one customer with extended terms and isare pursuing legal proceedings to collect on the outstanding balances. We do not believe the terms are a factor with this customer’s non-payment. Inventories decreased primarily as a result of sales, including a $6.77 million sale of slow-moving jewels to our largest customer, offset in part by the purchase of new raw material SiC crystals during the quarter pursuant to our new exclusive supply agreement, or the New Supply Agreement, with Cree, Inc., or Cree, which we entered into on December 12, 2014; purchases of jewelry castings, findings, and other jewelry components; and production of moissanite loose jewels. Prepaid expenses and other assets increaseddecreased primarily as a result of the timing of payment of insurance premiums,premium payments and other payments in advance of goods or services received. Accounts payable increaseddecreased primarily as a result of the timing of costs incurred but not yet paid as of September 30, 2015March 31, 2016 associated with inventory-related purchases and professional services incurred but not yet due under our vendors’ payment terms.
We manufactured approximately $4.54$1.79 million in loose jewels and $3.71$2.35 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 ninethree months ended September 30, 2015.March 31, 2016. We expect our purchases of precious metals and labor to increase as we increase our finished jewelry business. In addition, from the beginning of 2006 through the thirdfirst quarter of 2015,2016, the price of gold has increased significantly (approximately 110%132%), 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 during the periods when the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As of September 30, 2015, $21.19March 31, 2016, $14.56 million of our inventories were classified as long-term assets. Loose jewel sales and finished jewelry that we manufacture will utilize both the finished good loose jewels currently on-hand and, as we deplete certain shapes and sizes, our on-hand raw material SiC crystals of $6.65$5.58 million and new raw material that we are purchasing from Cree.
In connection with the prior exclusive supply agreement with Cree, or the Cree Exclusive Supply Agreement, which was set to expire in July 2015, we had committed to purchase from Cree a minimum of 50%, by dollar volume, of our raw material SiC crystal requirements. In February 2013, we entered into an amendment to a prior letter agreement with Cree, which provided a framework for our purchases of SiC crystals under the Cree Exclusive Supply Agreement. Pursuant to this amendment, we agreed to purchase at least $4.00 million of SiC crystals in an initial new order. After the initial new order, we agreed to issue non-cancellable, quarterly orders that must equal or exceed a set minimum order quantity. Our total purchase commitment under the amendment (as subsequently amended) until July 2015, including the initial new order, was dependent upon the grade of the material and ranged between approximately $7.64 million and approximately $18.56 million.
On December 12, 2014, we entered into the New Supply Agreement which superseded and replaced (with respect towith Cree, our long-time SiC raw materials ordered subsequent to the effective date of the New Supply Agreement) the Cree Exclusive Supply Agreement.supplier. Under the New 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 New Supply Agreement will expire on June 24, 2018, unless extended by the parties. We also have one option to unilaterally extend the term of the agreement for an additional two-year period, subject to certain conditions. Our total purchase commitment under the New Supply Agreement until June 2018 is dependent upon the size of the SiC material and ranges between approximately $29.6 million and approximately $31.5 million.
During the ninethree months ended September 30, 2015,March 31, 2016, we purchased approximately $4.95$1.91 million of SiC crystals from Cree. We expect to use existing cash and cash equivalents and other working capital, together with future cash expected to be provided by operating activities and, if necessary, our credit facility described below, to finance our purchase commitment under the New Supply Agreement.
We made no income tax payments during the ninethree months ended September 30, 2015.March 31, 2016. As of September 30, 2015,March 31, 2016, we had approximately $882,000 of remaining federal income tax credits, $533,000 of which expire between 2018 and 2021 and the balance without an expiration, which can be carried forward to offset future income taxes. As of September 30, 2015,March 31, 2016, we also had a federal tax net operating loss carryforward of approximately $12.21 million expiring between 2020 and 2034, which can be used to offset against future federal taxable income, a North Carolina tax net operating loss carryforward of approximately $14.32$18.05 million expiring between 2023 and 2029,2030, and various other state tax net operating loss carryforwards expiring between 2016 and 2034, which can be used to offset against future state taxable income.
On June 25, 2014, we and our wholly owned subsidiaries, Charles & Colvard Direct, LLC and Moissanite.com, LLC, collectively referred to as the Borrowers, obtained a $10,000,000 asset-based revolving credit facility, or the Credit Facility from Wells Fargo Bank, National Association, or Wells Fargo.Fargo, which is a $10,000,000 asset-based revolving credit facility. The Credit Facility will be used 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 $1,000,000 sublimit. The Credit Facility will mature on June 25, 2017.
The Credit Facility includes a $5,000,000 sublimit for advances that are supported by a 90% guaranty provided by the U.S. Export-Import Bank. Advances under the Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers’ eligible accounts and inventory, less reserves. Advances against inventory are further subject to an initial $3,000,000 maximum. We must maintain a minimum of $1,000,000 in excess availability at all times. There are no other financial covenants.
Each advance accrues interest at a rate equal to Wells Fargo’s 3-month LIBOR rate plus 2.50%, calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default accrues interest at a rate of 3% in excess of the above rate. Any advance may be prepaid in whole or in part at any time. In addition, the maximum line amount may be reduced by us in whole or part at any time, subject to a fee equal to 2% of any reduction in the first year after closing, 1% of any reduction in the second year after closing, and 0% thereafter. There are no mandatory prepayments or line reductions.
The Credit Facility is secured by a lien on substantially allassets of the Borrowers, each of which is jointly and severally liable for all obligations thereunder. Wells Fargo’s security interest in certain SiC materials is subordinate to Cree’s security interest in such materials pursuant to the New Supply Agreement and an Intercreditor Agreement with Wells Fargo.
The Credit Facility is evidenced by a credit and security agreement dated as of June 25, 2014 and amended as of September 16, 2014 and December 12, 2014, or the Credit Agreement, and customary ancillary documents. The Credit Agreement contains customary covenants, representations and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, contingent obligations, liens, loans, investments, mergers, acquisitions, divestitures, subsidiaries, affiliate transactions, and changes in control.
Events of default under the Credit Facility include, without limitation, (1) any impairment of the Export-Import Bank guaranty, unless the guaranteed advances are repaid within two business days, (2) an event of default under any other indebtedness of the Borrowers in excess of $200,000, and (3) a material adverse change in the ability of the Borrowers to perform their obligations under the Credit Agreement or in the Borrowers’ assets, liabilities, businesses or prospects, or other circumstances that Wells Fargo believes may impair the prospect of repayment. If an event of default occurs, Wells Fargo is entitled to take enforcement action, including acceleration of amounts due under the Credit Agreement and foreclosure upon collateral.
The Credit Agreement contains other customary terms, including indemnity, expense reimbursement, yield protection, and confidentiality provisions. Wells Fargo is permitted to assign the Credit Facility.
As of September 30, 2015,March 31, 2016, we had not borrowed against the Credit Facility.
We believe that our existing cash and cash equivalents and other working capital, together with future cash expected to be provided by operating activities, will be sufficient to meet our working capital and capital expenditure needs over the next 12 months. Our future capital requirements and the adequacy of available funds will depend on many factors, including our rate of sales growth; the expansion of our sales and marketing activities, including the operating capital needs of our wholly owned subsidiaries;activities; the timing and extent of raw materials and labor purchases in connection with loose jewel production to support our moissanite jewel business and precious metals and labor purchases in connection with jewelry production to support our finished jewelry business; the timing of capital expenditures; and risk factors described in more detail in “Risk Factors” in this report and in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014, and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2015. We obtained the Credit Facility to 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.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Not applicable.
| Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
We routinely review our internal control over financial reporting and from time to time make changes intended to enhance the effectiveness of our internal control over financial reporting. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an ongoing basis and will take action as appropriate. During the three months ended September 30, 2015,March 31, 2016, we made no changes to our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, that we believe materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
There are no material pending legal proceedings to which we are a party or to which any of our property is subject.
We discuss in our Annual Report on Form 10-K for the year ended December 31, 2014 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2015 various risks that may materially affect our business. Except as set forth below, there have been no material changes to such risks.
We may experience quality control challenges from timeOur failure to time that can result in lost revenue and harm to our brands and reputation. Part of our strategy for success is to establish Charles & Colvardmaintain compliance with reputable, high-quality, and sophisticated brands. The achievement of this goal depends in large part on our ability to provide customers with high-quality moissanite, finished jewelry featuring moissanite, and fashion finished jewelry. 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 soNASDAQ’s continued listing requirements could result in lost revenue, lost customers, significant warrantythe delisting of our common stock. Our common stock is currently listed on The NASDAQ Global Select Market. In order to maintain this listing, we must satisfy minimum financial and other expenses, and harm torequirements. In the Company’s reputation.
We maypast, we have received a notification letter from NASDAQ indicating that we were not be able to adequately protect our intellectual property, which could harmin compliance with listing requirements because the valueminimum bid price 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 had U.S. product and method patentscommon stock closed below $1.00 per share for moissanite jewels, which expired in August 2015, under which we believed30 consecutive business days. However, NASDAQ subsequently notified us that we had broad, exclusive rightsregained compliance with the minimum bid price requirement. If we fail to manufacture, use, and sell moissanite jewelssatisfy NASDAQ’s listing requirements in the U.S. We continuefuture, we expect to have these same patents in a number of foreign jurisdictions, most of which expire in 2016. We believe that the foreign patents create substantial technological barrierstake actions to our potential foreign competitors. However, our U.S. patent expirations could enable competitors and other businesses to duplicate and market a similar product and enter the U.S. marketplace. Without U.S. patent protection,regain compliance, but we must rely primarily on our branding strategy and the New Supply Agreement with Cree under which Cree supplies SiC crystals exclusively to us, as well as confidentiality procedures, to protect our proprietary rights in the U.S., which may or may not be sufficient. In addition, at the present time, we are dependent on Cree’s technology for the production of SiC crystals. There can beprovide no assurance that any patents issuedsuch 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 or licensed by or to us or Cree will provide any significant commercial protection, that we or Cree will have sufficient resources to protect our respective patentsobtain financing on acceptable terms, if at all; and proprietary rights, that any additional patents will be issuedmay result in the future,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 that any existing or future patents will be upheld by a court should we or Cree seek to enforce our respective rights against an infringer. At this point, we cannot reasonably estimate the impact these patent expirations will have on our future resultsall of operations.their investment.
Our former South Korean patent is no longer valid as a result of a ruling by the South Korean Patent Court, and there can be no assurance that we will not incur similar outcomes in other jurisdictions in the future. For example, on August 14, 2012, we learned that BetterThanDiamond.com requested that the Canadian Intellectual Property Office, or CIPO, conduct a re-examination of our Canadian Patent No. 2,230,262, or the ‘262 Patent, for manufacturing SiC gemstones based on claims of prior art. On November 3, 2012, the CIPO granted the re-examination request based on its finding that the information provided in the request raises “a substantial new question of patentability.” The U.S. Patent and Trademark Office, or USPTO, upheld in October 2012 all claims of our U.S. Patent No. 5,723,391 in a similar challenge by BetterThanDiamond.com, but there is no certainty of the same outcome with respect to the challenge of the ‘262 Patent. If the CIPO were to determine that some or all of the claims in the ‘262 Patent are invalid, our business, financial condition, and results of operations could be negatively impacted. In addition, the re-examination of the ‘262 Patent could result in substantial legal expenses and could divert our management’s time and attention away from our business operations. We believe that all of the claims of the ‘262 Patent are valid and enforceable, and we intend to vigorously defend the patents that protect our moissanite jewels and technology.
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 our foreign patents. Accordingly, existing and potential competitors may be able to develop products that are competitive with or superior to 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, and we use certain brand names for which we do not currently have proprietary rights. The success of our growth strategy depends on our continued ability to use our existing brand names in order to increase consumer awareness and further develop strong brands around our moissanite jewel 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.
Departure of President and Chief Executive Officer
On November 11, 2015, H. Marvin Beasley resigned as our President and Chief Executive Officer and as a member of our Board of Directors, or the Board, effective December 1, 2015. In connection with his resignation, we proposed a Transition Agreement with Mr. Beasley, or the Transition Agreement, which was approved by the Board and delivered to Mr. Beasley on November 11, 2015. The terms of the proposed Transition Agreement provide that Mr. Beasley may not execute and deliver the Transition Agreement until December 1, 2015.
Under the proposed Transition Agreement, Mr. Beasley is entitled to receive severance in an amount equal to the remainder of his current base annual salary not already paid prior to December 1, 2015 through March 17, 2016 (less applicable taxes and withholdings), payable in substantially equal installments on the same payroll schedule that was applicable to Mr. Beasley immediately prior to December 1, 2015, in exchange for a standard release of employment claims. We have also agreed as of December 1, 2015 to accelerate the vesting of 100,000 options previously granted to Mr. Beasley. Those options will be exercisable as set forth in the applicable option agreement. Furthermore, we have agreed that the restrictions on 100,000 shares of restricted stock previously granted to Mr. Beasley will lapse effective December 1, 2015. The proposed Transition Agreement also contains such confidentiality provisions and other terms and conditions as are usual and customary for agreements of this type. All of Mr. Beasley’s obligations under his employment agreement, dated March 17, 2015 regarding covenants not to compete, confidentiality, and proprietary information will continue.
Appointment of President and Chief Executive Officer
On November 11, 2015, the Board appointed Suzanne Miglucci, a current member of the Board, as our President and Chief Executive Officer effective as of December 1, 2015. While Ms. Miglucci will retain her position as a member of the Board, she relinquished her membership on our Compensation Committee as of November 11, 2015 and for the duration of her service as President and Chief Executive Officer as she is no longer an independent director under the NASDAQ Listing Rules.
Ms. Miglucci, age 55, served as Chief Marketing Officer of ChannelAdvisor Corporation, or ChannelAdvisor, a software and services solution provider, from June 2012 to November 2015. Prior to joining ChannelAdvisor, Ms. Miglucci served as Senior Director, Global Procurement Solution Marketing, at SAP, a market leader in enterprise application software, from November 2010 to March 2012. Prior to her time at SAP, Ms. Miglucci served as a Strategic Marketing Consultant for Miglucci on Marketing, LLC, a marketing consultant company, from January 2010 to November 2010. Ms. Miglucci has also held executive marketing positions at SciQuest, Inc., MicroMass Communications, and Arsenal Digital Solutions.
While serving as President and Chief Executive Officer, Ms. Miglucci will not receive compensation for her service as a member of the Board. Ms. Miglucci entered into an employment agreement with us, effective as of December 1, 2015, or the Employment Agreement, with a term of one year that renews automatically on an annual basis. Under the terms of the Employment Agreement, Ms. Miglucci will receive a signing bonus of $75,000 to be paid in December 2015 and an annual base salary of $335,000. Ms. Miglucci also will be entitled to receive such benefits as are made available to our other similarly-situated executive employees, including, but not limited to, life, medical, and disability insurance, as well as retirement benefits.
In addition, Ms. Miglucci will receive, on the effective date of the Employment Agreement, a stock option to purchase 300,000 shares of our common stock. The award will vest over a two-year period, with 50% of the option award vesting on the grant date and an additional 25% of the option award vesting on each of the following two anniversaries of the grant date provided Ms. Miglucci remains continuously employed with us through each anniversary.
Pursuant to the Employment Agreement, if Ms. Miglucci’s employment is terminated by us without cause (as defined in the Employment Agreement) Ms. Miglucci will continue to receive her base salary at the time of termination for a period of one year from such termination, or the Termination Compensation, so long as she complies with certain covenants in the Employment Agreement. If we experience a change of control (as defined in the Employment Agreement), Ms. Miglucci may voluntarily terminate her employment for good reason (as defined in the Employment Agreement) within six months after such change of control and be entitled to the Termination Compensation. During her employment with us and for a period of one year following termination of her employment, Ms. Miglucci is prohibited from competing with us or attempting to solicit our customers or employees.
The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:
Exhibit No. | | Description |
| 2.1 | | |
10.1 | | Board Compensation Program,Asset Purchase Agreement, effective January 1,March 4, 2016, by and among Yanbal USA, Inc., Charles & Colvard, Ltd., and Charles & Colvard Direct, LLC (incorporated herein by reference to Exhibit 10.12.1 to our Current Report on Form 8-K, as filed with the SEC on September 10, 2015)March 8, 2016) |
| | |
| 2.2 | 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) |
| |
| 10.1 | Charles & Colvard, Ltd. 2016 Senior Management Equity Incentive Program, effective January 1, 2016 (incorporated herein by reference to Exhibit 10.42 to our Annual Report on Form 10-K for the year ended December 31, 2015) |
| | |
| 10.2 | | First Amendment to Employment Agreement, effective as of December 1, 2015,dated March 8, 2016, by and between Charles & Colvard, Ltd. and Suzanne MiglucciSteve Larkin (incorporated herein by reference to Exhibit 10.46 to our Annual Report on Form 10-K for the year ended December 31, 2015) |
| | |
| 31.1 | | 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 |
| | | |
| 31.2 | | 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 |
| | | |
| 32.1 | | 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 |
| | | |
| 32.2 | | Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | | |
| 101 | | The following materials from Charles & Colvard, Ltd.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015March 31, 2016 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Cash Flows; and (iv) Notes to Condensed Consolidated Financial Statements. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | CHARLES & COLVARD, LTD. |
| | | |
| | By: | /s/ H. Marvin BeasleySuzanne T. Miglucci |
November 12, 2015April 29, 2016 | | H. Marvin BeasleySuzanne T. Miglucci |
| | | President and Chief Executive Officer |
| | | |
| | By: | /s/ Kyle Macemore |
November 12, 2015April 29, 2016 | | Kyle Macemore |
| | | Senior Vice President and Chief Financial Officer |
| | | (Principal Financial Officer and Chief Accounting Officer) |
Exhibit No. | | Description |
| 2.1 | | |
10.1 | | Board Compensation Program,Asset Purchase Agreement, effective January 1,March 4, 2016, by and among Yanbal USA, Inc., Charles & Colvard, Ltd., and Charles & Colvard Direct, LLC (incorporated herein by reference to Exhibit 10.12.1 to our Current Report on Form 8-K, as filed with the SEC on September 10,March 8, 2016) |
| |
| 2.2 | 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) |
| |
| 10.1 | Charles & Colvard, Ltd. 2016 Senior Management Equity Incentive Program, effective January 1, 2016 (incorporated herein by reference to Exhibit 10.42 to our Annual Report on Form 10-K for the year ended December 31, 2015) |
| | | |
| | First Amendment to Employment Agreement, effective as of December 1, 2015,dated March 8, 2016, by and between Charles & Colvard, Ltd. and Suzanne MiglucciSteve Larkin (incorporated herein by reference to Exhibit 10.46 to our Annual Report on Form 10-K for the year ended December 31, 2015) |
| | |
| | Certification by Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | | |
| | Certification by Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | | |
| | Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | | |
| | Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | | |
| 101 | | The following materials from Charles & Colvard, Ltd.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015March 31, 2016 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Cash Flows; and (iv) Notes to Condensed Consolidated Financial Statements. |
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