UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

(Mark One)
☒☒    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 20192020

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 classTrading Symbol(s)Name of each exchange on which registered
Common Stock, no par value per shareCTHRThe Nasdaq Stock Market LLC

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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   ☐     No   ☒

As of November 1, 2019,October 30, 2020, there were 28,981,91028,965,660 shares of the registrant’s common stock, no par value per share, outstanding.

CHARLES & COLVARD, LTD.

FORM 10-Q
For the Quarterly Period Ended September 30, 20192020

TABLE OF CONTENTS

  
Page
Number
PART I – FINANCIAL INFORMATION
Item 1.
Financial Statements
 
 1
 2
 
Condensed Consolidated Statements of Changes in Shareholders’ Equity (unaudited) for the three months ended September 30, 20192020 and 20182019
3
 4
 5
Item 2.
19
Item 3.
3031
Item 4.
3031
 
PART II – OTHER INFORMATION
Item 1.
3132
Item 1A.
3132
Item 6.
3235

3336

PART I – FINANCIAL INFORMATION

Item 1.
Financial Statements

CHARLES & COLVARD, LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS


 
September 30, 2019
(unaudited)
 June 30, 2019  
September 30, 2020
(unaudited)
  June 30, 2020 
ASSETS          
Current assets:          
Cash and cash equivalents $12,243,719  $12,465,483  
$
13,756,695
  
$
13,993,032
 
Restricted cash  356,191   541,062   
105,014
   
624,202
 
Accounts receivable, net  2,000,613   1,962,471   
1,625,515
   
670,718
 
Inventory, net  11,787,226   11,909,792   
8,975,998
   
7,443,257
 
Prepaid expenses and other assets  1,408,993   989,559   
1,260,322
   
1,177,860
 
Total current assets  27,796,742   27,868,367   
25,723,544
   
23,909,069
 
Long-term assets:                
Inventory, net  24,178,349   21,823,928   
20,748,762
   
23,190,702
 
Property and equipment, net  1,013,308   1,026,098   
969,635
   
999,061
 
Intangible assets, net  101,165   97,373   
180,722
   
170,151
 
Operating lease right-of-use assets  883,832   -   
475,113
   
584,143
 
Other assets  328,328   330,615   
50,109
   
51,461
 
Total long-term assets  26,504,982   23,278,014   
22,424,341
   
24,995,518
 
TOTAL ASSETS $54,301,724  $51,146,381  
$
48,147,885
  
$
48,904,587
 
        
       
LIABILITIES AND SHAREHOLDERS’ EQUITY        
       
Current liabilities:        
       
Accounts payable $4,563,460  $3,372,172 
$
2,582,538
  
$
3,748,235
 
Operating lease liabilities  609,988   - 
 
626,763
   
622,493
 
Current maturity of long-term debt
 
386,000
   
193,000
 
Accrued expenses and other liabilities  926,118   1,325,608 
 
1,496,755
   
1,922,332
 
Total current liabilities  6,099,566   4,697,780 
 
5,092,056
   
6,486,060
 
Long-term liabilities:        
       
Long-term debt
 
579,000
   
772,000
 
Noncurrent operating lease liabilities  632,038   - 
 
51,190
   
203,003
 
Deferred rent  -   236,745 
Accrued income taxes  498,917   492,832 
 
8,441
   
7,947
 
Total long-term liabilities  1,130,955   729,577 
 
638,631
   
982,950
 
Total liabilities  7,230,521   5,427,357 
 
5,730,687
   
7,469,010
 
Commitments and contingencies (Note 9)        







Shareholders’ equity:        







Common stock, no par value; 50,000,000 shares authorized; 28,981,910 and 28,027,569 shares issued and outstanding at September 30, 2019 and June 30, 2019, respectively  54,342,864   54,342,864 
Common stock, no par value; 50,000,000 shares authorized; 28,965,660 and 28,949,410 shares issued and outstanding at September 30, 2020 and June 30, 2020, respectively  
54,342,864



54,342,864
 
Additional paid-in capital  25,633,007   24,488,147   
25,987,520
   
25,880,165
 
Accumulated deficit  (32,904,668)  (33,111,987)  
(37,913,186
)
  
(38,787,452
)
Total shareholders’ equity  47,071,203   45,719,024   
42,417,198
   
41,435,577
 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $54,301,724  $51,146,381  
$
48,147,885
  
$
48,904,587
 

See Notes to Condensed Consolidated Financial Statements.

CHARLES & COLVARD, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

 Three Months Ended September 30,  Three Months Ended September 30, 
 2019  2018  2020 2019 
Net sales $7,608,421  $6,594,706  
$
7,926,293
  
$
7,608,421
 
Costs and expenses:            
Cost of goods sold 3,876,624  3,613,748  
4,196,055
  
3,876,624
 
Sales and marketing 2,229,591  1,641,125  
1,647,933
  
2,229,591
 
General and administrative  1,349,501   1,224,775   
1,208,035
   
1,349,501
 
Total costs and expenses  7,455,716   6,479,648   
7,052,023
   
7,455,716
 
Income from operations 152,705  115,058  
874,270
  
152,705
 
Other income (expense):            
Interest income 61,379  -  
3,459
  
61,379
 
Interest expense (142) (346) 
(2,439
)
 
(142
)
Loss on foreign currency exchange (538) (29)  
(530
)
  
(538
)
Other expense  -   (13)
Total other income (expense), net  60,699   (388)  
490
   
60,699
 
Income before income taxes 213,404  114,670  
874,760
  
213,404
 
Income tax expense  (6,085)  (4,767)  
(494
)
  
(6,085
)
Net Income $207,319  $109,903  
$
874,266
  
$
207,319
 
            
Net income per common share:            
Basic $0.01  $0.01  
$
0.03
  
$
0.01
 
Diluted $0.01  $0.01  
$
0.03
  
$
0.01
 
            
Weighted average number of shares used in computing net income per common share:            
Basic 28,563,688  21,454,977  
28,786,910
  
28,563,688
 
Diluted 29,222,936  21,658,516  
28,839,897
  
29,222,936
 

See Notes to Condensed Consolidated Financial Statements.

CHARLES & COLVARD, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(unaudited)

 Three Months Ended September 30, 2019  Three Months Ended September 30, 2020 
 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 June 30, 2019 28,027,569  $54,342,864  $24,488,147  $(33,111,987) $45,719,024 
Issuance of common stock, net of offering costs 630,500  -  932,480  -  932,480 
Balance at June 30, 2020
 
28,949,410
  
$
54,342,864
  
$
25,880,165
  
$
(38,787,452
)
 
$
41,435,577
 
Stock-based compensation -  -  212,380  -  212,380  
-
  
-
  
107,355
  
-
  
107,355
 
Issuance of restricted stock 325,000  -  -  -  -  
178,750
  
-
  
-
  
-
  
-
 
Retirement of restricted stock (1,159) -  -  -  -  
(162,500
)
 
-
  
-
  
-
  
-
 
Net income  -   -   -   207,319   207,319   
-
   
-
   
-
   
874,266
   
874,266
 
Balance at September 30, 2019  28,981,910  $54,342,864  $25,633,007  $(32,904,668) $47,071,203 
Balance at September 30, 2020
  
28,965,660
  
$
54,342,864
  
$
25,987,520
  
$
(37,913,186
)
 
$
42,417,198
 

 Three Months Ended September 30, 2018  Three Months Ended September 30, 2019 
 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 June 30, 2018 21,705,173  $54,243,816  $14,962,071  $(35,387,454) $33,818,433 
Balance at June 30, 2019
 
28,027,569
  
$
54,342,864
  
$
24,488,147
  
$
(33,111,987
)
 
$
45,719,024
 
Issuance of common stock, net of offering costs 
630,500
  
-
  
932,480
  
-
  
932,480
 
Stock-based compensation -  -  71,176  -  71,176  
-
  
-
  
212,380
  
-
  
212,380
 
Issuance of restricted stock 
325,000
  
-
  
-
  
-
  
-
 
Retirement of restricted stock (109,604) -  -  -  -  
(1,159
)
 
-
  
-
  
-
  
-
 
Stock option exercises 2,500  3,480  (1,229) -  2,251 
Net income  -   -   -   109,903   109,903   
-
   
-
   
-
   
207,319
   
207,319
 
Balance at September 30, 2018  21,598,069  $54,247,296  $15,032,018  $(35,277,551) $34,001,763 
Balance at September 30, 2019
  
28,981,910
  
$
54,342,864
  
$
25,633,007
  
$
(32,904,668
)
 
$
47,071,203
 

See Notes to Condensed Consolidated Financial Statements.

CHARLES & COLVARD, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

 Three Months Ended September 30,  Three Months Ended September 30, 
 2019  2018  2020  2019 
CASH FLOWS FROM OPERATING ACTIVITIES:            
Net income $207,319  $109,903  
$
874,266
  
$
207,319
 
Adjustments to reconcile net income to net cash used in operating activities:            
Depreciation and amortization 124,637  108,216  
132,456
  
124,637
 
Stock-based compensation 212,380  71,176  
107,355
  
212,380
 
Recovery of uncollectible accounts (28,000) (312)
(Recovery of) Provision for sales returns (31,000) 25,000 
Provision for inventory reserves 23,000  49,000 
Provision for (Recovery of) accounts receivable discounts 12,476  (2,936)
Provision for (Recovery of) uncollectible accounts 
32,514
  
(28,000
)
Provision for (Recovery of) sales returns 
96,000
  
(31,000
)
Inventory write-off 
80,000
  
23,000
 
Provision for accounts receivable discounts 
1,688
  
12,476
 
Changes in operating assets and liabilities:            
Accounts receivable 8,382  (342,076) 
(1,084,999
)
 
8,382
 
Inventory (2,254,855) (977,889) 
829,199
  
(2,254,855
)
Prepaid expenses and other assets, net (417,147) (70,494) 
27,920
  
(417,147
)
Accounts payable 1,191,288  (77,942) 
(1,165,697
)
 
1,048,990
 
Deferred rent -  (38,719)
Accrued income taxes 6,085  4,767  
494
  
6,085
 
Accrued expenses and other liabilities  (278,041)  168,861   
(573,120
)
  
(135,743
)
Net cash used in operating activities  (1,223,476)  (973,445)  
(641,924
)
  
(1,223,476
)
            
CASH FLOWS FROM INVESTING ACTIVITIES:            
Purchases of property and equipment (111,317) (164,099) 
(101,459
)
 
(111,317
)
Payments for intangible assets  (4,322)  (38,111)  
(12,142
)
  
(4,322
)
Net cash used in investing activities  (115,639)  (202,210)  
(113,601
)
  
(115,639
)
            
CASH FLOWS FROM FINANCING ACTIVITIES:            
Issuance of common stock, net of offering costs 932,480  -   
-
   
932,480
 
Proceeds from stock option exercises  -   2,251 
Net cash provided by financing activities  932,480   2,251   
-
   
932,480
 
            
NET DECREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH (406,635) (1,173,404) 
(755,525
)
 
(406,635
)
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, BEGINNING OF PERIOD  13,006,545   3,393,186   
14,617,234
   
13,006,545
 
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, END OF PERIOD $12,599,910  $2,219,782  
$
13,861,709
  
$
12,599,910
 
            
Supplemental disclosure of cash flow information:            
Cash paid during the period for interest $142  $346  
$
2,439
  
$
142
 
Cash paid during the period for income taxes $2,050  $4,748  
$
3,350
  
$
2,050
 
See Notes to Condensed Consolidated Financial Statements.
      

See Notes to Condensed Consolidated Financial Statements.

CHARLES & COLVARD, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

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™, our 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, retail, and other pure-play, exclusively e-commerce outlets.

2.BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation – The accompanying unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. However, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with U.S. GAAP have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of the Company’s management, the unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q include all normal and recurring adjustments necessary for the fair statement of the results for the interim periods presented. The results for the three months ended September 30, 20192020 are not necessarily indicative of the results to be expected for the fiscal year ending June 30, 2020.2021.

The condensed consolidated financial statements as of and for the three months ended September 30, 20192020 and 20182019 included in this Quarterly Report on Form 10-Q are unaudited. The balance sheet as of June 30, 20192020 is derived from the audited financial statements as of that date. The accompanying statements should be read in conjunction with the audited financial statements and related notes together with Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in Item 8 of the Company’s Annual Report on Form 10-K (the “2019“2020 Annual Report”) for the fiscal year ended June 30, 20192020 filed with the SEC on September 6, 2019.4, 2020.

The accompanying condensed consolidated financial statements as of and for the three months ended September 30, 20192020 and 2018,2019, and as of the fiscal year ended June 30, 2019,2020, include the accounts of the Company and its wholly owned subsidiaries charlesandcolvard.com, LLC; Charles & Colvard Direct, 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 three-month period ended September 30, 20192020 or 2018.2019. Charles & Colvard (HK) Ltd. previously became dormant in the second quarter of 2009 and has had no operating activity since 2008. All intercompany accounts have been eliminated.

Significant Accounting Policies – In the opinion of the Company’s management, except as discussed below, the Company’s significant accounting policies used for the three months ended September 30, 2019,2020, are consistent with those used for the fiscal year ended June 30, 2019.2020. Accordingly, please refer to Note 2 to the Consolidated Financial Statements in the 20192020 Annual Report for the Company’s significant accounting policies.

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 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 condensed consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions, and revenue recognition. Actual results could differ materially from those estimates.

Reclassifications – Certain amounts in the Company’s condensed consolidated financial statements for the quarter ended September 30, 2019 have been reclassified to conform to current presentation related to certain customer credit balances that were reclassified from accounts payable to accrued expenses and other liabilities in the amount of approximately $142,000. These reclassifications had no impact on the Company’s condensed consolidated financial position or condensed consolidated results of operations as of or for the quarterly periods ended September 30, 2020 and 2019.
5
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.

Restricted Cash – In accordance with cash management process requirements relating to the Company’s asset-based revolving credit facility from White Oak Commercial Finance, LLC (“White Oak”), there are access and usage restrictions on certain cash deposit balances for periods of up to two business days during which time such deposits are held by White Oak for the benefit of the Company. During the period these cash deposits are held by White Oak, such amounts are classified as restricted cash for reporting purposes on the Company’s condensed consolidated balance sheets. In the event that the Company has an outstanding balance on its revolving credit facility from White Oak, restricted cash balances held by White Oak would be applied to reduce such outstanding amounts.

The Company has full access to its cash balances without restriction following the period of time such cash is held by White Oak. For detailedadditional information regarding the Company’s asset-based revolving credit facility, see Note 10, “Line of Credit.“Debt.”

The reconciliation of cash, cash equivalents, and restricted cash, as presented on the Condensed Consolidated Statements of Cash Flows, consist of the following as of the dates presented:

 
September 30,
2019
  
June 30,
2019
  
September 30,
2020
 
June 30,
2020
 
Cash and cash equivalents $12,243,719  $12,465,483  
$
13,756,695
  
$
13,993,032
 
Restricted cash  356,191   541,062   
105,014
   
624,202
 
Total cash, cash equivalents, and restricted cash $12,599,910  $13,006,545  
$
13,861,709
  
$
14,617,234
 

Recently Adopted/Issued Accounting Pronouncements – Effective July 1, 2019,2020, the Company adopted the new lease accounting standard which requires virtually all leasesrelated to be recorded as right-of-use (“ROU”) assetsthe measurement and lease liabilitiesdisclosure of credit losses on the condensed consolidated balance sheet and provides guidance on the recognition of lease expense and income.financial instruments. The new guidance includes a current expected credit loss (“CECL”) model that requires an entity to estimate credit losses expected over the modified retrospective transition approach when applying the new standard tolife of an entity’s leases existingexposure or pool of exposures based on historical information, current conditions, and supportable forecasts at the date of initial application. The guidance further states that an entity’s date of initial application may be eithertime the effective date upon which it adopts the new standard or the beginning of the earliest comparative period presented in the financial statements during the period in which it adopts the new guidance. The Company used the date of initial application as the effective date,asset is recognized and as such, financial information and disclosures required under the new accounting standard will not be provided for dates and periods prior to July 1, 2019.
is measured at each reporting period. The new standard provides a numberguidance principally aligns the Company’s accounting for its trade accounts receivable with the economics of practical expedients for transitionextending credit and policy elections for ongoing accounting. The Company elected the “packageimproves its financial reporting by requiring timelier recording of practical expedients”, which permits the Company to not reassess its prior conclusions about lease identification, lease classification, and initial direct costs. The standard provides policy election options for recognition exemption for short-term leases and separation of lease and non-lease components. The Company elected the “short-term lease recognition” exemption and elected not to separate lease and non-lease components for all underlying asset classes. The Company determines lease and non-lease components based on observable information, including terms provided by the lessor.
related credit losses.
The adoption of the new accounting standard resulted in the recognition of ROU assets and lease liabilities of approximately $983,000 and $1.38 million, respectively, for operating leases as of July 1, 2019. Currently, the Company has no other material leases that qualify as finance, variable, or short-term leases. The adoption did not have a material impact on the Company’s condensed consolidated statementfinancial position or results of operations or condensed consolidated statement of cash flows.
Subsequent to the date of adoption,and the Company determines ifdid not record a contract is or contains a lease at inceptioncumulative-effect adjustment to retained earnings. The Company amended its allowance for credit losses policy, as set forth below, for the implementation of the agreement. Operating leases are recognized as ROU assets and the related obligations are recognized as current or noncurrent liabilities on the Company’s consolidated balance sheet. Leases with an initial lease term of one year or less are not recorded on the balance sheet.new accounting standard.

ROU assets,The Company records an allowance for credit losses, which representincludes a provision for expected losses based on historical write-offs, adjusted for current conditions as deemed necessary, and a specific reserve for accounts deemed at risk. The allowance is the Company’s right to use an underlying asset, and lease liabilities, which represent the Company’s obligation to make lease payments arising from the lease, are recognized based on the present valueestimate for accounts receivable as of the future lease payments overbalance sheet date that ultimately will not be collected. Any changes in the lease term atallowance are reflected in the commencement date. The ROU asset also includes any lease payments made at or beforeresults of operations in the commencement date and any initial direct costs incurred and excludes lease incentives. Certain ofperiod in which the Company’s leases contain renewal and/or termination options.change occurs. The Company recognizes renewal or termination options as part of its ROU assetswrites-off accounts receivable when it becomes probable, based upon customer facts and lease liabilities whencircumstances, that such amounts will not be collected.
Effective July 1, 2020, the Company hasalso adopted the unilateral right to renew or terminate and it is reasonably certain these options will be exercised. The Company determines the present value of lease payments based on the implicit rate, which may be explicitly stated in the lease if available or the Company’s estimated collateralized incremental borrowing rate based on the term of the lease. For operating leases, lease expense is recognized on a straight-line basis over the lease term.
Some leases could require the Company to pay non-lease components, which may include taxes, maintenance, insurance and certain other expenses applicable to the leased property, and are primarily considered variable costs. When applicable, such costs are expensed as incurred.
For additional information regarding the Company’snew accounting for lease arrangements, see Note 9, “Commitments and Contingencies.”

In August 2018, the Financial Accounting Standards Board issued additional guidancestandard in connection with accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. The updatednew 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.
In December 2019, the FASB issued guidance on simplifying the accounting for income taxes that is intended to reduce the complexity while maintaining or improving the usefulness of tax disclosure information in financial statements. The new guidance is effective for fiscal years beginning after December 15, 2019.2020. The Company is indoes not expect the process of conducting its analysis, but currently believes the effectimpact of the adoption of this new pronouncement is not expectedguidance 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 10, “Debt”, borrowings under the Company’s line of credit are based on a rate equal to the one-month LIBOR. As of September 30, 2020, 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 quarterly period ended September 30, 2020.

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 managementthe chief operating decision maker 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: its “Online Channels” segment, which consists of e-commerce outlets including charlesandcolvard.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” of this Quarterly Report on Form 10-Q and in the Notes to the Consolidated Financial Statements in the 20192020 Annual Report.

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. 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, leases, 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 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. Unallocated expenses remain in its Traditional segment.

Summary financial information by reportable segment is as follows:

  Three Months Ended September 30, 2020 
  
Online
Channels
  Traditional  Total 
Net sales
         
Finished jewelry 
$
3,623,462
  
$
711,876
  
$
4,335,338
 
Loose jewels  
841,833
   
2,749,122
   
3,590,955
 
Total 
$
4,465,295
  
$
3,460,998
  
$
7,926,293
 
             
Product line cost of goods sold
            
Finished jewelry 
$
1,333,383
  
$
420,906
  
$
1,754,289
 
Loose jewels  
312,689
   
1,431,233
   
1,743,922
 
Total 
$
1,646,072
  
$
1,852,139
  
$
3,498,211
 
             
Product line gross profit
            
Finished jewelry 
$
2,290,079
  
$
290,970
  
$
2,581,049
 
Loose jewels  
529,144
   
1,317,889
   
1,847,033
 
Total 
$
2,819,223
  
$
1,608,859
  
$
4,428,082
 
             
Operating income
 
$
774,665
  
$
99,605
  
$
874,270
 
             
Depreciation and amortization
 
$
54,352
  
$
78,103
  
$
132,456
 
             
Capital expenditures
 
$
59,250
  
$
42,209
  
$
101,459
 

  Three Months Ended September 30, 2019 
  
Online
Channels
  Traditional  Total 
Net sales
         
Finished jewelry 
$
2,977,348
  
$
880,647
  
$
3,857,995
 
Loose jewels  
728,282
   
3,022,144
   
3,750,426
 
Total 
$
3,705,630
  
$
3,902,791
  
$
7,608,421
 
             
Product line cost of goods sold
            
Finished jewelry 
$
1,212,873
  
$
490,037
  
$
1,702,910
 
Loose jewels  
265,194
   
1,534,258
   
1,799,452
 
Total 
$
1,478,067
  
$
2,024,295
  
$
3,502,362
 
             
Product line gross profit
            
Finished jewelry 
$
1,764,475
  
$
390,610
  
$
2,155,085
 
Loose jewels  
463,088
   
1,487,886
   
1,950,974
 
Total 
$
2,227,563
  
$
1,878,496
  
$
4,106,059
 
             
Operating income
 
$
45,665
  
$
107,040
  
$
152,705
 
             
Depreciation and amortization
 
$
49,250
  
$
75,387
  
$
124,637
 
             
Capital expenditures
 
$
73,725
  
$
37,592
  
$
111,317
 

  Three Months Ended September 30, 2018 
  
Online
Channels
  Traditional  Total 
Net sales         
Finished jewelry $2,115,940  $438,697  $2,554,637 
Loose Jewels  967,160   3,072,909   4,040,069 
Total $3,083,100  $3,511,606   6,594,706 
             
Product line cost of goods sold            
Finished jewelry $833,389  $222,649  $1,056,038 
Loose jewels  488,285   1,560,480   2,048,765 
Total $1,321,674  $1,783,129  $3,104,803 
             
Product line gross profit            
Finished jewelry $1,282,551  $216,048  $1,498,599 
Loose jewels  478,875   1,512,429   1,991,304 
Total $1,761,426  $1,728,477  $3,489,903 
             
Operating income $83,747  $31,311  $115,058 
             
Depreciation and amortization $28,076  $80,140  $108,216 
             
Capital expenditures $1,250  $162,849  $164,099 
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.

8
A reconciliation of the Company’s product line cost of goods sold to cost of goods sold as reported in the condensed consolidated financial statements is as follows:

 Three Months Ended September 30,  Three Months Ended September 30, 
 2019  2018  2020 2019 
Product line cost of goods sold $3,502,362  $3,104,803  
$
3,498,211
  
$
3,502,362
 
Non-capitalized manufacturing and production control expenses 389,877  346,604  
329,406
  
389,877
 
Freight out 131,119  99,119  
175,338
  
131,119
 
Inventory valuation allowances 23,000  49,000 
Inventory write-off
 
80,000
  
23,000
 
Other inventory adjustments  (169,734)  14,222   
113,100
   
(169,734
)
Cost of goods sold $3,876,624  $3,613,748  
$
4,196,055
  
$
3,876,624
 

The Company recognizes sales by geographic area based on the country in which the customer is based. Sales to international end consumers made through the Company’s transactional website, charlesandcolvard.com, are included in international sales for financial reporting purposes. During periods prior to the quarter ended December 31, 2018, sales to international end consumers made through charlesandcolvard.com were included in U.S. sales because during those prior periods products were shipped and invoiced to a U.S.-based intermediary that assumed all international shipping and credit risks. Currently, sales to international end consumers are made directly by the Company’s own transactional website. 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, as well as property and equipment, as of September 30, 20192020 and June 30, 2019,2020, are held and located in the United States.

The following presents net sales data by geographic area:

 Three Months Ended September 30, Three Months Ended September 30, 
 2019  2018 2020 2019 
Net sales:          
United States $6,763,876  $5,822,870  
$
7,499,720
  
$
6,763,876
 
International  844,545   771,836   
426,573
   
844,545
 
Total $7,608,421  $6,594,706  
$
7,926,293
  
$
7,608,421
 

4.FAIR VALUE MEASUREMENTS

Under 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, trade accounts receivable, and trade accounts payable. All financial instruments are reflected in the condensed consolidated 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. For the three months ended September 30, 20192020 and 2018,2019, no impairment was recorded.

9
TableSee Note 2, “Basis of Contents
Presentation and Significant Accounting Policies”, Recently Adopted/Issued Accounting Pronouncements, for further discussion related to credit risk within trade accounts receivable in accordance with the new accounting standard for the measurement and disclosure of credit losses on financial instruments.

5.INVENTORIES

The Company’s total inventories, net of reserves, consisted of the following as of the dates presented:

  
September 30,
2020
  
June 30,
2020
 
Finished jewelry:
      
Raw materials 
$
903,745
  
$
821,536
 
Work-in-process  
1,535,064
   
602,390
 
Finished goods  
6,565,932
   
6,019,985
 
Finished goods on consignment  
2,222,092
   
2,297,907
 
Total finished jewelry 
$
11,226,833
  
$
9,741,818
 
Loose jewels:
        
Raw materials 
$
2,314,759
  
$
3,526,399
 
Work-in-process  
10,212,689
   
10,453,586
 
Finished goods  
5,682,606
   
6,619,487
 
Finished goods on consignment  
205,675
   
204,635
 
Total loose jewels  
18,415,729
   
20,804,107
 
Total supplies inventory
  
82,198
   
88,034
 
Total inventory 
$
29,724,760
  
$
30,633,959
 

As of the dates presented, the Company’s total inventories, net of reserves, are classified as follows:

  
September 30,
2019
  
June 30,
2019
 
Raw materials $4,351,565  $4,450,478 
Work-in-process  12,266,806   10,871,823 
Finished goods  18,639,550   18,557,224 
Finished goods on consignment  2,963,009   2,086,084 
Supplies inventory  128,645   129,111 
Less: inventory reserves  (2,384,000)  (2,361,000)
Total $35,965,575  $33,733,720 
         
Short-term portion $11,787,226  $11,909,792 
Long-term portion  24,178,349   21,823,928 
Total $35,965,575  $33,733,720 
  
September 30,
2020
  
June 30,
2020
 
Short-term portion
 
$
8,975,998
  
$
7,443,257
 
Long-term portion
  
20,748,762
   
23,190,702
 
Total 
$
29,724,760
  
$
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 incurred; 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 September 30, 20192020 and June 30, 2019,2020, work-in-process inventories issued to active production jobs approximated $1.95$2.51 million and $1.23$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, and product obsolescence is 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 used 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.

10
The Company’s total inventories net of reserves, consisted ofare stated at the following as of the dates presented:

  
September 30,
2019
  
June 30,
2019
 
Finished jewelry:      
Raw materials $772,119  $643,797 
Work-in-process  1,089,875   487,680 
Finished goods  6,810,280   6,332,533 
Finished goods on consignment  2,700,443   1,867,549 
Total finished jewelry $11,372,717  $9,331,559 
Loose jewels:        
Raw materials $3,579,446  $3,806,681 
Work-in-process  11,176,931   10,384,143 
Finished goods  9,459,270   9,878,691 
Finished goods on consignment  248,566   203,535 
Total loose jewels  24,464,213   24,273,050 
Total supplies inventory  128,645   129,111 
Total inventory $35,965,575  $33,733,720 

Total net finished jewelry inventories at September 30, 2019 and June 30, 2019, including inventory on consignment net of reserves and finished jewelry featuring moissanite manufactured by the Company, were $11.37 million and $9.33 million, respectively. Total net loose jewel inventories at September 30, 2019 and June 30, 2019, including inventory on consignment net of reserves, were $24.46 million and $24.27 million, respectively.

As of September 30, 2019 and June 30, 2019, management established an obsolescence reserve of $1.82 million and $1.79 million, respectively. Typically, in the jewelry industry, slow-moving or discontinued lines are sold as closeouts or liquidated in sales channels. Regularly, management reviews the legacy loose jewel inventory for any lower of cost or net realizable value and obsolescence issues. Accordingly, as of September 30, 2019 and June 30, 2019, management identified certain finished jewelry that was obsolete due to damage and other factors that indicate the finished jewelry is unsaleable, and establishedon an obsolescence reserve of $67,000 and $19,000, respectively, for the carrying costs in excess of any estimated scrap values. Likewise, with respect to the Company’s loose jewels inventory, based on currentaverage cost basis. Each accounting period demand, and ongoing feedback from distribution customers on the value of some of these goods, management identified some of the remaining inventory of these lower quality goods that could not be sold at its current carrying value. Accordingly, during the three months ended September 30, 2019, based on quantity and volume changes, the Company maintained a lowerevaluates the valuation and classification of cost or net realizable value reserve on this remaining inventory of approximately $1.75 million as of September 30, 2019 from $1.77 million as of June 30, 2019.

As of September 30, 2019 and June 30, 2019 management established a rework reserveinventories including the need for recut and repairs of loose jewel inventories of $418,000 and $460,000, respectively.

As of September 30, 2019 and June 30, 2019 management established a shrinkage reserve of $144,000 and $112,000, respectively. The finished jewelry inventories at September 30, 2019 and June 30, 2019 include shrinkage reserves of $108,000 and $105,000, respectively. The loose jewel inventories at September 30, 2019 and June 30, 2019 include shrinkage reserves of $36,000 and $7,000, 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 $14,000 and $15,000 as of September 30, 2019 and June 30, 2019, 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 September 30, 2019 and June 30, 2019 include shrinkage reserves of $12,000 and $14,000, respectively. The loose jewel inventories on consignment at September 30, 2019 and June 30, 2019 include shrinkage reserves of $2,000 and $1,000, respectively.

The need forpotential adjustments to inventory-related reserves, and valuation allowances is evaluated on a period-by-period basis.which also include significant estimates by management. Changes to the Company’s inventory reserves and allowances are accounted for in the current accounting period in which a change in such reserves and allowances is observed and deemed appropriate, including changes in management’s estimates used in the process to determine such reserves and valuation allowances.

6.RETURNS ASSET AND REFUND LIABILITIES

In connection with its revenue recognition accounting policy, the Company provides for 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 September 30, 20192020 and June 30, 2019,2020, the Company’s refund liabilities balances were $715,000$800,000 and $746,000,$704,000, respectively, and are included as allowances for sales returns within accounts receivable, net, in the accompanying condensed consolidated balance sheets. As of September 30, 20192020 and June 30, 2019,2020, the Company’s returns asset balances were $308,000$319,000 and $279,000,$289,000, respectively, and are included within prepaid expenses and other assets in the accompanying condensed consolidated balance sheets.

7.ACCRUED EXPENSES AND OTHER LIABILITIES

Accrued expenses and other liabilities, current, consist of the following as of the dates presented:

 
September 30,
2019
  
June 30,
2019
  
September 30,
2020
 
June 30,
2020
 
Deferred revenue
 
$
414,525
  
$
794,740
 
Accrued compensation and related benefits $511,484  $760,324  
406,587
  
395,006
 
Accrued sales tax 190,933  286,864  
358,339
  
295,651
 
Deferred rent -  156,306 
Accrued severance
 
211,157
  
338,355
 
Accrued cooperative advertising 166,821  73,033  
106,146
  
89,517
 
Other  56,880   49,081   
1
   
9,063
 
Total accrued expenses and other liabilities $926,118  $1,325,608  
$
1,496,755
  
$
1,922,332
 

8.INCOME TAXES

As of June 30, 2018, the Company recognized its expected underlying tax benefit relating to the realization of the recoverable portion of its alternative minimum tax (“AMT”)-related deferred tax credit carryforwards, net of an expected sequestration reduction. 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 corporate AMT as part of the Tax Cuts and Jobs Act enacted in December 2017 (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 and recorded the sequestered portion of its AMT credit refund in the amount of approximately $23,000. The Company recorded this additional AMT credit refund as a receivable and such amount is included in other long-term assets in the accompanying condensed consolidated balance sheets.

The Company recognized an income tax net expense for estimated tax, penalties, and interest associated with uncertain tax positions of approximately $6,000$500 and $5,000$6,100 for the three months ended September 30, 20192020 and 2018,2019, respectively.

As of each reporting date, the Company’s management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. As of September 30, 20192020 and June 30, 2019,2020, 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. Therefore, as set forth above, the Company continued to maintain a full valuation allowance against its deferred tax assets as of September 30, 20192020 and June 30, 2019.2020.

9.COMMITMENTS AND CONTINGENCIES

Lease Arrangements

On December 9, 2013, the Company entered into a Lease Agreement, as amended on December 23, 2013 and April 15, 2014 (the “Lease Agreement”), for its corporate headquarters, which occupies approximately 36,350 square feet of office, storage, and light manufacturing space and is classified as an operating lease for financial reporting purposes. The base term of the Lease Agreement expires on October 31, 20222021 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 two options to extend the lease term for a period of five years under each option. 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 options are exercised, the monthly minimum rent for each of the extended terms will be adjusted to the then prevailing fair market rate.

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. These improvements and other lease related incentives offered by the landlord totaled approximately $623,000, of which approximately $393,000 was unamortized as of July 1, 2019, the effective date upon which the Company adopted the newcurrent lease accounting standard as described in more detail in Note 2, “Basis of Presentation and Significant Accounting Policies.”standard.

The Company has no other material operating leases and is not party to leases that would qualify for classification as a finance lease, variable lease or short-term lease.
As of September 30, 2019,2020, the Company’s balance sheet classifications of its leases are as follows:
Operating Leases:      
Noncurrent operating lease ROU assets $883,832  
$
475,113
 
      
Current operating lease liabilities $609,988  
$
626,763
 
Noncurrent operating lease liabilities  632,038   
51,190
 
Total operating lease liabilities $1,242,026  
$
677,953
 

The Company’s total operating lease cost for the three months ended September 30, 2020 and 2019 was approximately $137,000. The Company’s total rent expense for the three month-period ended September 30, 2018 was $134,000.
$131,000 and $137,000, respectively.
As of September 30, 2019,2020, the Company’s estimated incremental borrowing rate used and assumed discount rate with respect to operating leases was 7.14% and the remaining operating lease term was 2.081.08 years.

As of September 30, 2019,2020, the Company’s remaining future payments under operating leases for each fiscal year ending June 30 are as follows:

2020 $469,699 
2021 642,997  
$
482,615
 
2022  219,723   
219,723
 
Total lease payments 1,332,419  
702,338
 
Less: imputed interest  90,393   
24,385
 
Present value of lease payments 1,242,026  
677,953
 
Less: current lease obligations  609,988   
626,763
 
Total long-term lease obligations $632,038  
$
51,190
 

The Company makes cash payments for amounts included in the measurement of its lease liabilities. During the three months ended September 30, 2020 and 2019, cash paid for operating leases was approximately $170,000 and $164,000, respectively, and, except for the ROU assets recorded upon adoption of the current lease accounting standard as of July 1, 2019, there were no new ROU assets obtained in exchange for new operating lease liabilities.
Lease Disclosures for the fiscal year ended June 30, 2019, as reported
The Company recognized rent expense on a straight-line basis, having given consideration to the rent holidays and escalations, the lease signing and moving allowance paid to the Company, and the rent abatement.
The Company’s total rent expense for operating leases was approximately $528,000 for the fiscal year ended June 30, 2019. The Company also had future minimum payments as of June 30, 2019 under its operating leases for each fiscal year ending June 30 that were as follows:
2020 $625,788 
2021  642,997 
2022  219,723 
Total $1,488,508 

Purchase Commitments

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, 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) 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) 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) 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, (i) 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 $41.49$36.60 remains to be purchased as of September 30, 2019.2020. 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.

During the three months ended September 30, 2019,2020, the Company purchased approximately $2.49 million ofdid not purchase SiC crystals from Cree pursuant to the terms of the Supply Agreement, as amended. During the three months ended September 30, 2018,2019, the Company purchased approximately $2.11$2.49 million of SiC crystals from Cree.

COVID-19 Update

The global outbreak of the coronavirus disease 2019, or 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 economies, disrupted global supply chains, resulted in significant travel and transport restrictions, including mandated closures and orders to “shelter-in-place” and quarantine restrictions, and created significant disruption of the financial markets. Certain jurisdictions have begun re-opening only to return to restrictions due to increases in new COVID-19 cases. Even in the absence of legal restrictions, businesses and individuals may voluntarily continue to limit in-person interactions and practice social distancing, and such behaviors may continue beyond the formal end of the pandemic. The level and nature of the disruption caused by COVID-19 is unpredictable, may be cyclical and long-lasting and may vary from location to location. The Company’s management has taken measures to protect the health and safety of the Company’s employees, work with its customers and suppliers to minimize disruptions, reduce the Company’s expenses, and support its community in addressing the challenges posed by this ongoing COVID-19 pandemic. The pandemic continues to present unprecedented business challenges, and the Company has experienced impacts on its business related to the COVID-19 pandemic, primarily in increased coronavirus-related costs, delays in supplier deliveries, impacts of travel restrictions, access to some locations, the effects on net revenue related to reduced demand and store closures, and the impacts of remote work and adjusted work schedules.

Despite these challenges, the Company’s efforts, especially with regard to product fulfillment and supply chain, helped to partially mitigate the disruptions caused by the COVID-19 pandemic on the Company’s operations in the first quarter of its fiscal year ending June 30, 2021, or Fiscal 2021. However, the ultimate impact of the COVID-19 pandemic on the Company’s operations and financial performance in Fiscal 2021, and future periods, including management’s ability to execute its business plan and strategic initiatives in the expected timeframe, remains uncertain and will depend on future developments, including the duration and spread of the COVID-19 pandemic and related actions taken by the U.S. Government, state and local government officials, and international governments to prevent and manage disease spread, all of which are uncertain and cannot be predicted. The long-term impacts of the COVID-19 pandemic on global consumer buying behaviors, which impacts demand for the Company’s products and services, are also difficult to predict.

10.DEBT

Paycheck Protection Program Loan

The Company received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the U.S. Small Business Administration (the “SBA”). The loan in the principal amount of $965,000 (the “PPP Loan”) was disbursed by Newtek Small Business Finance, LLC, (the “Lender”), a nationally licensed lender under the SBA, on June 18, 2020 pursuant to a promissory note issued by the Company (the “Promissory Note”) on June 15, 2020. The Company accounted for the Promissory Note as debt within the accompanying consolidated financial statements.

The Promissory Note matures June 18, 2022 and may be extended with the consent of the Lender under the provisions of the CARES Act. The Promissory Note bears interest at a fixed rate of 1% per annum. Pursuant to the terms of the Promissory Note, monthly principal and interest payments in the amount of approximately $41,000 will commence on April 1, 2021. For financial reporting purposes, as of September 30, 2020, the classification of the current maturity of long-term debt assumes there will be no principal forgiveness, as allowed under certain conditions by the agreement,  and principal repayment for the full outstanding principal amount of the PPP Loan is assumed to be spread in equal monthly installments over the period from April 1, 2021 through the maturity date of the Promissory Note.

As of the dates presented, the Company’s total long-term debt is classified as follows:

  
September 30,
2020
  
June 30,
2020
 
Current maturity of long-term debt
 
$
386,000
  
$
193,000
 
Long-term debt, net
  
579,000
   
772,000
 
Total long-term debt 
$
965,000
  
$
965,000
 

10.LINE OF CREDIT
Line of Credit

On July 13, 2018, the Company and its wholly-owned subsidiary, charlesandcolvard.com, LLC (collectively, the “Borrowers”), obtained a $5.00 million asset-based revolving credit facility (the “White Oak Credit Facility”) from White Oak. The White Oak Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions. The White Oak Credit Facility, which matures on July 13, 2021, is guaranteed by Charles & Colvard Direct, LLC, a wholly-owned subsidiary of the Company. Under the terms of the White Oak Credit Facility, the Borrowers must maintain at least $500,000 in excess availability at all times. The White Oak Credit Facility contains no other financial covenants.

Advances under the White Oak Credit Facility may be either revolving or non-revolving. During the first year of the term of the White Oak Credit Facility, revolving advances accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and non-revolving advances accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins will reduce upon the Company’s achievement of a specified fixed charge coverage ratio. However, advances are in all cases subject to a minimum interest rate of 5.50%. Interest is calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default accrues interest at a rate 2% in excess of the rate otherwise applicable.

As of September 30, 2019,2020, the Company had not borrowed against the White Oak Credit Facility.

11.SHAREHOLDERS’ EQUITY AND STOCK-BASED COMPENSATION

Shelf Registration Statement

The Company has an effective shelf registration statement on Form S-3 on file with 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 remains available after giving effect to the Company’s June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option, as described below. The Company’s ability to issue equity securities under its effective shelf registration statement is subject to market conditions.

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 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, 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 $932,000, net of the underwriting discount and fees and expenses of approximately $76,000. 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.

Stock-Based Compensation

The following table summarizes the components of the Company’s stock-based compensation included in net income for the periods presented:

 Three Months Ended September 30, Three Months Ended September 30, 
 2019  2018 2020 2019 
Employee stock options $63,876  $58,172  
$
91,040
  
$
63,876
 
Restricted stock awards  148,504   13,004   
16,315
   
148,504
 
Totals $212,380  $71,176  
$
107,355
  
$
212,380
 

No stock-based compensation was capitalized as a cost of inventory during the three months ended September 30, 20192020 or 2018.2019.

Stock Options – The following is a summary of the stock option activity for the three months ended September 30, 2019:2020:

 Shares  
Weighted
Average
Exercise Price
  Shares 
Weighted
Average
Exercise Price
 
Outstanding, June 30, 2019 2,523,638  $1.41 
Outstanding, June 30, 2020
 
2,809,095
  
$
1.19
 
Granted 70,000  $1.33  
90,000
  
$
0.73
 
Expired  (15,600) $0.46   
(56,000
)
 
$
1.90
 
Outstanding, September 30, 2019  2,578,038  $1.41 
Outstanding, September 30, 2020
  
2,843,095
  
$
1.16
 

The total fair value of stock options that vested during the three months ended September 30, 20192020 was approximately $26,132.$490,000.

The following table summarizes information about stock options outstanding at September 30, 2019:2020:

Options OutstandingOptions Outstanding  Options Exercisable  Options Vested or Expected to Vest Options Outstanding Options Exercisable Options Vested or Expected to Vest 
Balance
as of
9/30/2019
  
Weighted
Average
Remaining
Contractual
Life
(Years)
  
Weighted
Average
Exercise
Price
  
Balance
as of
9/30/2019
  
Weighted
Average
Remaining
Contractual
Life
(Years)
  
Weighted
Average
Exercise
Price
  
Balance
as of
9/30/2019
  
Weighted
Average
Remaining
Contractual
Life
(Years)
  
Weighted
Average
Exercise
Price
 
Balance
as of
9/30/2020
Balance
as of
9/30/2020
 
Weighted
Average
Remaining
Contractual
Life
(Years)
 
Weighted
Average
Exercise
Price
 
Balance
as of
9/30/2020
 
Weighted
Average
Remaining
Contractual
Life
(Years)
 
Weighted
Average
Exercise
Price
 
Balance
as of
9/30/2020
 
Weighted
Average
Remaining
Contractual
Life
(Years)
 
Weighted
Average
Exercise
Price
 

2,578,038  6.82  $1.41  2,081,763  6.35  $1.49  2,497,408  6.75  $1.42  
2,843,095
  
5.94
  
$
1.16
  
2,381,458
  
5.29
  
$
1.19
  
2,772,524
  
5.86
  
$
1.17
 

As of September 30, 2019,2020, the unrecognized stock-based compensation expense related to unvested stock options was approximately $146,000,$135,000, which is expected to be recognized over a weighted average period of approximately 2321 months.

The aggregate intrinsic value of stock options outstanding, exercisable, and vested or expected to vest at September 30, 20192020 was approximately $1.09 million.$115,000.  This amount is before applicable income taxes and represents the closing market price of the Company’s common stock at JuneSeptember 30, 20192020 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. No stock options were exercised during the three months ended September 30, 2020 and 2019. During the three months ended September 30, 2018, the aggregate intrinsic value of stock options exercised was approximately $300.

Restricted Stock – The following is a summary of the restricted stock activity for the three months ended September 30, 2019:2020:

  Shares  
Weighted
Average
Grant Date
Fair Value
 
Unvested, June 30, 2019  129,500  $1.07 
Granted  325,000  $1.57 
Vested  (128,341) $1.07 
Canceled  (1,159) $1.07 
Unvested, September 30, 2019  325,000  $1.57 
  Shares  
Weighted
Average
Grant Date
Fair Value
 
Unvested, June 30, 2020
  
162,500
  
$
1.57
 
Granted  
178,750
  
$
0.72
 
Canceled  
(162,500
)
 
$
1.57
 
Unvested, September 30, 2020
  
178,750
  
$
0.72
 

The unvested restricted shares as of September 30, 20192020 are all performance-based restricted shares that are scheduled to vest, subject to achievement of the underlying performance goals, in July 2020.2021. As of September 30, 2019,2020, the estimated unrecognized stock-based compensation expense related to unvested restricted shares subject to achievement of performance goals was approximately $420,000,$112,000, all of which is expected to be recognized over a weighted average period of approximately nineten months.

Dividends –

The Company has paid no cash dividends during the current fiscal year through September 30, 2019.2020.

12.NET INCOME PER COMMON SHARE

Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the periods. Diluted net income 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.

The following table reconciles the differences between the basic and diluted net income per share presentations:

  Three Months Ended September 30, 
  2019  2018 
Numerator:      
Net income $207,319  $109,903 
         
Denominator:        
Weighted average common shares outstanding:        
Basic  28,563,688   21,454,977 
Effect of dilutive securities  659,248   203,539 
Diluted  29,222,936   21,658,516 
         
Net income per common share:        
Basic $0.01  $0.01 
Diluted $0.01  $0.01 
  Three Months Ended September 30, 
  2020  2019 
Numerator:
      
Net income 
$
874,266
  
$
207,319
 
         
Denominator:
        
Weighted average common shares outstanding:        
Basic  
28,786,910
   
28,563,688
 
Effect of dilutive securities  
52,987
   
659,248
 
Diluted  
28,839,897
   
29,222,936
 
         
Net income per common share:
        
Basic 
$
0.03
  
$
0.01
 
Diluted 
$
0.03
  
$
0.01
 

For the three months ended September 30, 20192020 and 2018,2019, stock options to purchase approximately 1.992.79 million and 2.231.99 million shares, respectively, were excluded from the computation of diluted net income per common share because the exercise price of the stock options was greater than the average market price of the common shares.shares or the effect of inclusion of such amounts would be anti-dilutive to net income per common share. Approximately 179,000 and 325,000 shares of unvested restricted stock are excluded from the computation of diluted net income per common share as of September 30, 2020 and 2019, respectively, because the shares are performance-based and the underlying conditions have not been met as of the periods presented and the effects of the inclusion of such shares would be anti-dilutive to net income per common share.

13.MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarilyprincipally of cash on deposit and cash equivalents and restricted cashheld with one bank and trade accounts receivable. At times, cash and cash equivalents balances may exceed the Federal Deposit Insurance Corporation (the “FDIC”(“FDIC”) insurable limits of $250,000 per depositor at each financial institution.limits. The Company’s money market fund investment account (recognized as cash and cash equivalents) is invested with what the Company believes to be a high-quality issuer. The Company has never experienced any losses related to these balances. There were no non-interest-bearingNon-interest-bearing amounts on deposit in excess of FDIC insurable limits at September 30, 2019.2020 and June 30, 2020 approximated $2.77 million and $2.01 million, respectively. Interest-bearing amounts on deposit in excess of FDIC insurable limits at September 30, 20192020 and June 30, 2020 approximated $11.87 million.$10.64 million and $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.

For additional information regarding the Company’s measurement and disclosure of credit losses on financial assets, including trade accounts receivable, see Note 4, “Fair Value Measurements.”

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 10% or more of total gross accounts receivable as of the dates presented:


 
September 30,
2019
  
June 30,
2019
  
September 30,
2020
 
June 30,
2020
 
Customer A 20% 25% 
26
%
 
26
%
Customer B 19% 13% 
17
%
 
14
%
Customer C *% 15% 
11
%
 
13
%
Customer D
 
11
%
 
*
%

* Customer C did not have individual balances that represented 10% or more of total gross accounts receivable as of September 30, 2019.
* Customer D did not have individual balances that represented 10% or more of total gross accounts receivable as of June 30, 2020.

A significant portion of sales is derived from certain customer relationships. The following is a summary of customers that represent 10% or more of total net sales for the periods presented:


 Three Months Ended September 30, 

 2019
 2018 
Customer A  13%  14%
Customer B  14%  **%
Customer D  *%  10%

* Customer D did not have net sales that represented 10% or more of total net sales for the three months ended September 30, 2019.
** Customer B did not have net sales that represented 10% or more of total net sales for the three months ended September 30, 2018.
 Three Months Ended September 30, 
 2020 2019 
Customer B
  
14
%
13%
Customer A
  
*
%
14
%

* Customer A did not have net sales that represented 10% or more of total net sales for the three months ended September 30, 2020.

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Statements expressing expectations regarding our future and projections relating to products, sales, revenues, and earnings are typical of such statements and are made under the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, representations, and contentions and are not historical facts and typically are identified by use of terms such as “may,” “will,” “should,” “could,” “expect,” “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:

Our future financial performance depends upon increased consumer acceptance, growth of sales of our products, and operational execution of our strategic initiatives.
The execution of our business plans could significantly impact our liquidity.
We face intense competition in the worldwide gemstone and jewelry industry.
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.
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.
We are currently dependent on a limited number of distributor and retail partners in our Traditional segment for the sale of our products.
Our business and our results of operations could be materially adversely affected as a result of general economic and market conditions.
We are subject to certain risks due to our international operations, distribution channels and vendors.
We depend on an exclusive supply agreement, or the Supply Agreement, with Cree, Inc., or Cree, for substantially all of our silicon carbide, or SiC, crystals, the raw materials we use to produce moissanite jewels; if our supply of high-quality SiC crystals is interrupted, our business may be materially harmed.
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.
Our failure to maintain compliance with The Nasdaq Stock Market’s continued listing requirements could result in the delisting of our common stock.
We may experience quality control challenges from time to time that can result in lost revenue and harm to our brands and reputation.
Seasonality of our business may adversely affect our net sales and operating income.
Our operations could be disrupted by natural disasters.
Sales of moissanite jewelry could be dependent upon the pricing of precious metals, which is beyond our control.
Our current customers may potentially perceive us as a competitor in the finished jewelry business.
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.
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 and 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.
Negative or inaccurate information on social media could adversely affect our brand and reputation.
If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer.
Governmental regulation and oversight might adversely impact our operations.

1.Our business, 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.The execution of our business plans could significantly impact our liquidity;

4.Our business and our results of operations could be materially adversely affected as a result of general and economic conditions;

5.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;

6.We face intense competition in the worldwide gemstone and jewelry industry;

7.We are subject to certain risks due to our international operations, distribution channels and vendors;

8.Our business and our results of operations could be materially adversely affected as a result of our inability to fulfill orders on a timely basis;

9.We are currently dependent on a limited number of distributor and retail partners in our Traditional segment for the sale of our products;

10.We 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;

11.Our failure to maintain compliance with The Nasdaq Stock Market’s continued listing requirements could result in the delisting of our common stock;

12.We may experience quality control challenges from time to time that can result in lost revenue and harm to our brands and reputation;

13.Seasonality of our business may adversely affect our net sales and operating income;

14.Our operations could be disrupted by natural disasters;

15.Our loan, pursuant to the Paycheck Protection Program, or the PPP Loan, under the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, as administered by the U.S. Small Business Administration, or the SBA, may not be forgiven or may subject us to challenges and investigations regarding qualification for the loan;

16.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;

17.Negative or inaccurate information on social media could adversely impact our brand and reputation;

18.Sales of moissanite and lab grown diamond jewelry could be dependent upon the pricing of precious metals, which is beyond our control;

19.Our current customers may potentially perceive us as a competitor in the finished jewelry business;

20.We depend  on an exclusive supply agreement, or the Supply Agreement, with Cree, Inc., or Cree, for substantially all of our silicon carbide, or SiC, crystals, the raw materials we use to produce moissanite jewels; if our supply of high-quality SiC crystals is interrupted, our business may be materially harmed;

21.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;

Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our company.

22.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 and operations;

23.If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer;

24.Governmental regulation and oversight might adversely impact our operations; and

25.Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our company.

Forward-looking statements speak only as of the date they are made. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur except as required by the federal securities laws, and you are urged to review and consider disclosures that we make in the reports that we file with the Securities and Exchange Commission, or SEC, that discuss other factors relevant to our business.

The following discussion is designed to provide a better understanding of our unaudited condensed consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. This information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019,2020, or the 20192020 Annual Report. Historical results and percentage relationships related to any amounts in the condensed consolidated financial statements are not necessarily indicative of trends in operating results for future periods.

Overview

Our Mission

At Charles & Colvard, Ltd., 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, markets is a globally recognized lab created gemstone company specializing in fine jewelry. We manufacture, market, and distributesdistribute Charles & Colvard Created Moissanite® (which we refer to as moissanite or moissanite jewels) and on September 14, 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 cut, polish, and symmetry. All of our Caydia™ lab grown diamonds are set with responsibly sourced 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 we believe offers an ideal combination of quality and value. We 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

COVID-19 Update

The global outbreak of the coronavirus disease 2019, we successfully completed an underwritten public offeringor 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 economies, disrupted global supply chains, resulted in significant travel and transport restrictions, including mandated closures and orders to “shelter-in-place” and quarantine restrictions, and created significant disruption of 6,250,000 sharesthe financial markets. Certain jurisdictions have begun re-opening only to return to restrictions due to increases in new COVID-19 cases. Even in the absence of legal restrictions, businesses and individuals may voluntarily continue to limit in-person interactions and practice social distancing, and such behaviors may continue beyond the formal end of the pandemic. The level and nature of the disruption caused by COVID-19 is unpredictable, may be cyclical and long-lasting and may vary from location to location. We have taken measures to protect the health and safety of our common stock, which, together with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July 2019, resulted in total gross proceeds of approximately $11.01 million, before deducting the underwriting discount 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 the Charles & Colvard global brand awarenessemployees, work with our target consumercustomers and further developsuppliers to minimize disruptions, reduce our global omni-channel sales strategy with a primary focusexpenses, and support our community in addressing the challenges posed by this ongoing COVID-19 pandemic. The pandemic continues to present unprecedented business challenges, and we have experienced impacts on top line growth.our business related to the COVID-19 pandemic, primarily in increased coronavirus-related costs, delays in supplier deliveries, impacts of travel restrictions, access to some locations, the effects to net revenue related to reduced demand and store closures, and the impacts of remote work and adjusted work schedules.

20
The Year Ahead

Our focus for theour fiscal year ending June 30, 2020,2021, or Fiscal 2021. In addition, strong net sales performance in our Online Channels segment and an overall reduction in costs and expenses resulting from cost-savings initiatives implemented by us have helped to offset the impacts of the COVID-19 pandemic on our financial results in our first quarter. However, the ultimate impact of the COVID-19 pandemic on our operations and financial performance in Fiscal 2021, and future periods, including our ability to execute our business plan and strategic initiatives in the expected timeframe, remains uncertain and will depend on future developments, including the duration and spread of the COVID-19 pandemic and related actions taken by the U.S. Government, state and local government officials, and international governments to prevent and manage disease spread, all of which are uncertain and cannot be predicted. The long-term impacts of the COVID-19 pandemic on global consumer buying behaviors, which impacts demand for our products and services, are also difficult to predict.

For additional risks to the Company related to the COVID-19 pandemic, see “Part II, Item 1A. Risk Factors”, contained in our 2020 Annual Report.

Fiscal 2021 Financial Trends

Currently, the full extent of the impact of the COVID-19 pandemic on our operational and financial performance remains uncertain and continues to depend on many factors outside of our control, including, without limitation, the timing, extent, trajectory and duration of the pandemic, the development and availability of effective treatments and vaccines, the imposition of protective public safety measures, and the impact of the pandemic on the global economy and demand for consumer products. We expect the COVID-19 pandemic will continue to have an adverse impact on our business, results of operations, financial condition, and liquidity during Fiscal 2021.

As we manage through these challenging times, our strategic focus for Fiscal 2021 is centered on the expansion of Charles & Colvard’s brand on a global scale. Asscale and to increase the size of our business through top-line disciplined growth by leveraging existing resources. We believe that lab-created gemstones, including our own lab grown diamond product line, Caydia™, which we introduced in September 2020, are now being embraced by emerging generations, wegenerations. We also believe that our ability to establishelevate our own lab-created gemstones - including both moissanite jewels and lab grown diamonds - and the Charles & Colvard brand directly with consumers is key to our future success and ability to fuel our growth. We willintend to elevate the Charles & Colvard name by making it synonymous with quality, value, and price. We plan to execute on our key strategies with a continuedan ongoing commitment to spending judiciously and generating sustainable earnings improvement.

As we head into Fiscal 2020, we are highly focused on increasing the reach of our brand – both domestically and internationally – and we plan to expand our digital marketing initiatives on a global scale. Over the past two years, we have been directing our digital advertising spend to convert consumers whom we believed were already familiar with the Charles & Colvard brand or to customers for whom we had evidence were searching for the term moissanite. Therefore, in order to garner the attention of consumers not yet familiar with our brand but interested in the ethical appeal of lab-created gemstones or a value-priced bridal option that competes well with diamond, we believe that we need to invest more resources and pay more attention to the new and hopefully soon-to-be-converted Charles & Colvard customer. We believe that work is done through awareness strategies such as mobile social ads, influencer marketing programs, and strategic paid media placements.

As we head into Fiscal 2020 and immediately into the calendar year-end holiday season, our timing is critical to drive awareness and proliferate our brand. With the financial resources of our recent capital raise, we believe that we will now have the ability to expand our domestic footprint while building a digital presence in emerging international regions.

Our key strategies for Fiscal 2020 are as follows:

Expansion of Brand Awareness. We plan to utilize digital advertising channels and other marketing strategies such as influencer marketing programs involving brand advocates to drive messaging to larger markets by way of large social media followings, and Over-the-Top, or OTT, advertising platforms that include subscription video-on-demand, or SVOD, services like Netflix and Hulu. Through these channels, we believe that we will find new and compelling ways to engage the target consumer that is not yet familiar with our brand. We plan to expand our brand footprint on 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 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, we expect cross-border trade promotions to 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.

Product Evolution. We believe being responsive to customer preferences has played a pivotal role in the rise 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 plan to 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 intend to 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,discuss our key strategies for Fiscal 2021 in Part II, Item 7, “Management’s Discussion and in practice, to have a business model that helps us be socially accountable to our stakeholders. During the fiscal year ended June 30, 2019, or Fiscal 2019, we elevated our useAnalysis of recycled precious metals in approximately 95%Financial Condition and Results of all the finished jewelry we sourced. Going forward, we are working toward utilizing only recycled precious metalsOperations”, contained 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 intend to continue supporting 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.

Fiscal 2020 – First Quarter Highlights

In the three months ended September 30, 2019, we began activating funds raised in our June 2019 underwritten public offering with the intent of expanding our brand’s awareness with consumers. We are investing these funds toward what we call top-of-funnel digital marketing strategies such as social media advertising campaigns, programmatic media programs, and influencer marketing engagements. Through these digital marketing channels, we believe that we will accelerate the momentum in our Online Channels segment by engaging new targeted consumers that are not yet familiar with our brand. We believe as these new consumers embark on their customer journey with Charles & Colvard, there will be a natural time lag between their first exposure with our brand and conversion to a purchasing customer. Accordingly, we believe these initial investments during the first quarter of Fiscal 2020 will begin to be realized during the fiscal quarter ending December 31, 2019 and particularly during the upcoming calendar year-end holiday season. In addition to our expanding digital marketing efforts, we also delivered new product offerings in preparation for the year-end holiday season including precious metal options such as platinum and tantalum – a scratch-resistant metal used in jewelry that will not tarnish and is also hypoallergenic – along with new shapes and cuts of moissanite gemstones and new lines of colored gemstones, such as lab-created sapphires and rubies. Finally, in our Traditional segment, we expanded our in-store footprint with a key brick-and-mortar retail strategic partner and bolstered our distribution network with calendar year-end holiday-ready product availability.

Our own e-commerce website, charlesandcolvard.com, delivered a 31% revenue increase over the year-ago quarter and has grown to represent more than 50% of all Online Channels segment sales. In addition, our marketplaces business continued to see significant growth in its net sales volume above the year-ago quarter. Combined with the remaining Online Channels segment customers, our Online Channels segment net sales grew 20% compared with the comparable quarter of Fiscal 2019. Online Channels represented 49% of all revenue in the first quarter of Fiscal 2020. Finished jewelry sales represented more than half of our total sales in the first quarter of Fiscal 2020, growing 51% over the year-ago quarter.Annual Report.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which we prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of these condensed 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, actual results of operations may materially differ. We have disclosed our critical accounting policies and estimates in our 20192020 Annual Report, and that disclosure should be read in conjunction with this Quarterly Report on Form 10-Q. Except as set forth below, there have been no significant changes in our critical accounting policies and estimates during the first quarterthree months of Fiscal 2020.2021.

For a discussion regarding our adoption of the new lease accounting standard related to the measurement and disclosure of credit losses on financial instruments, see Note 2 to our condensedcondensed consolidated financial statements in Item 1, “Financial Statements”, of this Quarterly Report on Form 10-Q.

10-Q.
22
Results of Operations

The following table sets forth certain consolidated statements of operations data for the three months ended September 30, 20192020 and 2018:2019:

 Three Months Ended September 30,  Three Months Ended September 30, 
 2019  2018  2020 2019 
Net sales $7,608,421  $6,594,706  
$
7,926,293
  
$
7,608,421
 
Costs and expenses:            
Cost of goods sold 3,876,624  3,613,748  
4,196,055
  
3,876,624
 
Sales and marketing 2,229,591  1,641,125  
1,647,933
  
2,229,591
 
General and administrative  1,349,501   1,224,775   
1,208,035
   
1,349,501
 
Total costs and expenses  7,455,716   6,479,648   
7,052,023
   
7,455,716
 
Income from operations 152,705  115,058  
874,270
  
152,705
 
Other income (expense):            
Interest income 61,379  -  
3,459
  
61,379
 
Interest expense (142) (346) 
(2,439
)
 
(142
)
Loss on foreign currency exchange (538) (29)  
(530
)
  
(538
)
Other expense  -   (13)
Total other income (expense), net  60,699   (388)  
490
   
60,669
 
Income before income taxes 213,404  114,670  
874,760
  
213,404
 
Income tax expense  (6,085)  (4,767)  
(494
)
  
(6,085
)
Net income $207,319  $109,903  
$
874,266
  
$
207,319
 

Consolidated Net Sales

Consolidated net sales for the three months ended September 30, 20192020 and 20182019 comprise the following:

 
Three Months Ended
September 30,
  Change  
Three Months Ended
September 30,
 Change 
 2019  2018  Dollars  Percent  2020 2019 Dollars Percent 
Finished jewelry $3,857,995  $2,554,637  $1,303,358  51% 
$
4,335,338
  
$
3,857,995
  
$
477,343
  
12
%
Loose jewels  3,750,426   4,040,069   (289,643) -7%  
3,590,955
   
3,750,426
   
(159,471
)
 
-4
%
Total consolidated net sales $7,608,421  $6,594,706  $1,013,715   15% 
$
7,926,293
  
$
7,608,421
  
$
317,872
  
4
%

Consolidated net sales were $7.93 million for the three months ended September 30, 2020 compared to $7.61 million for the three months ended September 30, 2019, compared to $6.59 million for the three months ended September 30, 2018, an increase of approximately $1.01 million,$318,000, or 15%4%. The increase in consolidated netCOVID-19 pandemic has continued to negatively affect the U.S. and global economies and has had a significant adverse impact on our worldwide sales forand results of operations during the three months ended September 30, 2019 wasperiod since the initial outbreak of the underlying coronavirus. Net sales through our cross-border trade, or CBT, platform were flat compared with the prior year fiscal quarter, which we believe is also due primarily to increased consumer awareness and strongthe strength of worldwide demand for our moissanite gemstones and jewelry resultingproducts in higher finished jewelry product net sales and contributed to strong loose jewel net sales duringspite of the three months ended September 30, 2019 in our Online Channels.COVID-19 pandemic.

Sales of finished jewelry represented 51%55% of total consolidated net sales for the three months ended September 30, 2019,2020, compared to 39%51% of total consolidated net sales for the corresponding period of the prior year. For the three months ended September 30, 2019,2020, finished jewelry sales were $3.86$4.34 million compared to $2.55$3.86 million for the corresponding period of the prior year, an increase of approximately $1.30 million,$477,000, or 51%12%. This increase in finished jewelry sales was due primarily to higher finished jewelry sales of Forever One™ and Moissanite by Charles & Colvard® in our Online Channels segment, as well as in our Traditional segment.which increased $646,000, or 22%, from the prior year fiscal quarter.

Sales of loose jewels represented 49%45% of total consolidated net sales for the three months ended September 30, 2019,2020, compared to 61%49% of total consolidated net sales for the corresponding period of the prior year. For the three months ended September 30, 2019,2020, loose jewel sales were $3.75$3.59 million compared to $4.04$3.75 million for the corresponding period of the prior year, a decrease of approximately $290,000,$159,000, or 7%4%. The decrease for the three months ended September 30, 20192020 was primarily due to a lower levels of loose jewel sales principally through the international distribution network in our Traditional segment. This decrease of loose jewel sales in our Traditional segment was partially offset by an increase of loose jewel sales in our Online Channels segment, and principally throughwhich increased $114,000, or 16%, from the international distribution network in our Traditional segment.prior year fiscal quarter.

U.S. net sales accounted for approximately 89%95% of total consolidated net sales for the three-month period ended September 30, 2019,2020, compared with 88%89% for the three-month period ended September 30, 2018.2019. U.S. net sales increased to $6.76$7.50 million, or 16%11%, in the three months ended September 30, 20192020 compared to $5.82$6.76 million in the comparable quarter of 20182019 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 three months ended September 30, 20192020 accounted for 14% of total consolidated net sales. This same customer was our second largest U.S. customer during the three months ended September 30, 2019 and accounted for 13% of total consolidated net sales during the period then ended. Our second largest U.S. customer during the three-month period ended September 30, 2019 accounted for 13% of total consolidated net sales. This same customer was our largest U.S. customer during the three months ended September 30, 2018 and accounted for 14% of total consolidated net sales during the period then ended. Our second largest U.S. customer during the three months ended September 30, 2018 accounted for 10% of total consolidated net sales during the period then ended. Other than our U.S. customers noted above during the three-month periods ended September 30, 20192020 and 2018,2019, we had no other customers with sales that represented 10% or more of total consolidated net sales for the periods then ended. We expect that we, along with our customers, will remain dependent on our ability to maintain and enhance our customer-related programs. A change in or loss of any of these customer or retailer relationships could have a material adverse effect on our results of operations.

International net sales accounted for approximately 5% and 11% of total consolidated net sales forduring the three-month periodquarters ended September 30, 2020 and 2019, compared with 12% for the three months ended September 30, 2018. As a percentage ofrespectively. International net sales international sales decreased to $427,000, or 49%, during the first quarter of Fiscal 20202021 compared to $845,000 in the correspondingfirst quarter of the prior fiscal year as a result ofended June 30, 2020, or Fiscal 2020. International sales decreased due to lower demand in our international distributor market, which was partially offset by growth in our direct-to-consumer presence internationally. However, our international net sales volume increased to $845,000, or 9%, in the three months ended September 30, 2019 compared to $772,000 in the same quarter of 2018 primarily as a result of ongoing increased demand and increasedinternationally 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 these markets and the potential adverse impacteffects of rising tariffs and political unrest in the Hong Kong market,ongoing global economic conditions, we continue to evaluate these and other potential distributors in these international markets to determine the best long-term partners. Additionally, we anticipate the need to further develop our direct-to-consumer presence, which would require marketing and e-commerce investments to drive expected growth in these regions. As a result, and in light of the ongoing worldwide pandemic and international trade challenges, we expect our sales in these markets mayto 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 three months ended September 30, 20192020 or 2018.2019. A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers.

Costs and Expenses

Cost of Goods Sold

Our total cost of goods sold for the three months ended September 30, 20192020 and 20182019 are as follows:

 
Three Months Ended
September 30,
  Change 
Three Months Ended
September 30,
 Change 
 2019  2018  Dollars  Percent 2020 2019 Dollars Percent 
Product line cost of goods sold:                    
Finished jewelry $1,702,910  $1,056,038  $646,872  61% 
$
1,754,289
  
$
1,702,910
  
$
51,379
  
3
%
Loose jewels  1,799,452   2,048,765   (249,313) -12%  
1,743,922
   
1,799,452
   
(55,530
)
 
-3
%
Total product line cost of goods sold 3,502,362  3,104,803  397,559  13% 
3,498,211
  
3,502,362
  
4,151
  
0
%
Non-product line cost of goods sold  374,262   508,945   (134,683) -26%  
697,844
   
374,262
   
323,582
  
86
%
Total cost of goods sold $3,876,624  $3,613,748  $262,876   7% 
$
4,196,055
  
$
3,876,624
  
$
319,431
  
8
%

Total cost of goods sold was $4.20 million for the three months ended September 30, 2020 compared to $3.88 million for the three months ended September 30, 2019, compared to $3.61 million for the three months ended September 30, 2018, an increase of approximately $263,000,$319,000, or 7%8%. 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, leases,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 increase in total cost of goods sold for the three months ended September 30, 20192020 compared to the same period in 20182019 was primarily due to increased sales of finished jewelry during the three months ended September 30, 2019,2020, which reflect higher material and labor costs resulting from increased sales of higher margin finished jewelry.costs. Our finished jewelry products cost more to produce due to higher material and labor costs when compared to cost of goods sold in the same period of 2018 during which period we sold a higher levelproduction of loose jewels.

The net decreaseincrease in non-product line cost of goods sold for the three months ended September 30, 2020, comprises a favorable $184,000an unfavorable $283,000 change in other inventory adjustments principally relating to adverse changes in production standard cost variances duringcompared to the three months ended September 30, 2018 that were not repeated2019. The net increase in the three-month period ended September 30, 2019 and a $26,000 favorablenon-product line cost of goods sold was also related to an approximate $57,000 change in inventory valuation allowancesadjustments primarily related to an increaseadverse changes in obsolescence reserves as well as an approximate $44,000 increase in freight out from increased shipments resulting from Online Channels segment sales growth during the three monthsquarter ended September 30, 2018.2020. These decreasesincreases in non-product line cost of goods sold were offset in part by a $43,000 increasean approximate $60,000 decrease in non-capitalized manufacturing and production control expenses principally due to the timing of when work-in-process is received into inventory and overhead costs are allocated and by an approximate $32,000 increase in freight out during the three months ended September 30, 2019 from increased shipments resulting from Online Channels segment sales growth. allocated.

Sales and Marketing

Sales and marketing expenses for the three months ended September 30, 20192020 and 20182019 are as follows:

  
Three Months Ended
September 30,
  Change 
  2019  2018  Dollars  Percent 
Sales and marketing $2,229,591  $1,641,125  $588,466   36%
 
Three Months Ended
September 30,
 Change 
 2020 2019 Dollars Percent 
Sales and marketing
 
$
1,647,933
  
$
2,229,591
  
$
(581,658
)
  
-26
%

Sales and marketing expenses were $1.65 million for the three months ended September 30, 2020 compared to $2.23 million for the three months ended September 30, 2019, compared to $1.64 million for the three months ended September 30, 2018, an increasea decrease of approximately $588,000,$582,000, or 36%26%.

The increasedecrease in sales and marketing expenses for the three months ended September 30, 20192020 compared to the same period in 20182019 was primarily due to a $395,000 increase$401,000 decrease in compensation expenses; a $136,000 decrease in advertising and digital marketing expenses reflecting the activation of funds from our underwritten public offering that we are deploying to expand brand awareness;expenses; a $62,000 increase$58,000 decrease in professional services principally comprising non-recurring consulting services for cybersecurity and merchandising imaging;imaging in the prior year period; a $45,000$6,000 decrease in travel expenses as a result of COVID-19 cost-control measures; and a $3,000 decrease in general office-related expenses. These decreases were partially offset by an $18,000 increase in software-related costs incurred primarily in connection with new software-related agreements associated with upgraded operating systems; and a $44,000$4,000 increase in other miscellaneous advertising and digital marketing expenses.

The decrease in compensation expenses;expenses for the three months ended September 30, 2020 compared to the same period in 2019 was primarily due to a $25,000 increase$319,000 decrease in general office-related expenses, which are principallysalaries, commissions, and related to higher credit card transaction fees from increased sales levels;employee benefits in the aggregate reflecting our June 2020 management reorganization and workforce reduction; a $46,000 decrease in bonus expense; and a $22,000 increase$38,000 decrease in depreciation and amortization relating to capitalized costs associated with the systems upgrade for our transactional website, charlesandcolvard.com.employee stock-based compensation expense. These increasesdecreases were partially offset by a $5,000 decrease$2,000 increase in travel expenses.employee-related severance costs.

The increasedecrease in advertising and digital marketing expenses for the three months ended September 30, 20192020 compared to the same period in 20182019 comprises a $202,000 increase$118,000 decrease in cooperative advertising; $43,000 decrease in Internet marketing; a $118,000 increase in cooperative advertising; a $57,000 increase in promotion-related expenses; a $17,000 increase in outside agency fees; and a $1,000 increasean $8,000 decrease in print media expenses.

The increase in compensation expenses for the three months ended September 30, 2019 compared to the same period in 2018 was primarily due to a $32,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $17,000 increase in employee stock-based compensation expense; and a $1,000 increase in bonus expense. These increasesdecreases were partially offset by a $6,000 decrease$23,000 increase in employee-related severance costs.promotion-related expenses and a $10,000 increase in outside agency fees.

General and Administrative

General and administrative expenses for the three months ended September 30, 20192020 and 20182019 are as follows:

  
Three Months Ended
September 30,
  Change 
  2019  2018  Dollars  Percent 
General and administrative $1,349,501  $1,224,775  $124,726   10%
 
Three Months Ended
September 30,
 Change 
 2020 2019 Dollars Percent 
General and administrative
 
$
1,208,035
  
$
1,349,501
  
$
(141,466
)
  
-10
%

General and administrative expenses were $1.21 million for the three months ended September 30, 2020 compared to $1.35 million for the three months ended September 30, 2019, compared to $1.22 million for the three months ended September 30, 2018, an increasea decrease of approximately $125,000,$141,000, or 10%.

The increasedecrease in general and administrative expenses for the three months ended September 30, 20192020 compared to the same period in 20182019 was primarily due to a $169,000 increase$129,000 decrease in professional services; a $115,000 decrease in compensation expensesexpenses; and a $58,000 increase$9,000 decrease in professional services.Board retainer fees as a result of the resignation of a former Director in September 2019. These increasesdecreases were partially offset by a $28,000 decrease$61,000 increase in bad debt expense associated with our allowance for doubtful accounts reserve policy; a $22,000 decrease$17,000 increase in insurance expenses, principally related to the changehigher renewal premiums; an $8,000 increase in timingtravel expense; a $5,000 increase in bank charges as a result of issuing annual meeting and shareholder communications;transaction fees associated with increased online transactions; a $15,000 decrease$4,000 increase in business taxes and licenses; a $13,000 decrease$2,000 increase in bank charges, which in the prior year quarter included a one-time fee associated with the execution of our $5.00 million asset-based revolving credit facility from White Oak Commercial Finance, LLC, or White Oak; a $9,000 decrease in an employee benefit health and welfare related expense due to the timing of the reconciliation with our provider; a $3,000 decrease in travelequipment-related rental expense; a $3,000 decrease in insurance expenses; a $2,000 decreaseincrease in depreciation and amortization expense; a $1,000 decrease in equipment-related rental expense; and a $6,000$13,000 net decreaseincrease in miscellaneous other general and administrative expenses.

The increase in compensation
25
Professional services expenses decreased for the three months ended September 30, 20192020 compared to the same period in 2018 comprises a $102,000 increase in employee stock-based compensation expense; a $44,000 increase in salaries and related employee benefits in the aggregate; and a $23,000 increase in bonus expense.

Professional services increased for the three months ended September 30, 2019 compared to the same period in 2018 primarily due to a $51,000 increase in accounting and tax services related to higher annual audit and tax fees, as well as fees associated with domestic and international tax consulting services; a $36,000 increasean $86,000 decrease in legal fees resulting from non-recurring non-capitalized fees incurred in connection with our underwritten public offering and corporate governance matters; andmatters in the prior year; a $5,000 increase$33,000 decrease in investor relations fees. These increases were partially offset byaccounting services also principally related to non-recurring fees associated with our underwritten public offering in the prior year; a $34,000$7,000 decrease in consulting and other professional services.services; and a $3,000 decrease in investor relations fees.

The decrease in compensation expenses for the three months ended September 30, 2020 compared to the same period in 2019 comprises a $55,000 decrease in salaries and related employee benefits in the aggregate resulting from our June 2020 management reorganization and workforce reduction; a $33,000 decrease in employee stock-based compensation expense; and a $27,000 decrease in bonus expense.

The net increase in miscellaneous other general and administrative expenses for the three months ended September 30, 2020 compared to the same period in 2019 comprises a $10,000 increase in software maintenance agreement-related expenses and a $3,000 net increase in office-related and other miscellaneous general and administrative expenses.

Loss on Foreign Currency Exchange

Loss on foreign currency exchange related to foreign sales transacted in functional currencies other than the U.S. dollar for the three months ended September 30, 20192020 and 20182019 are as follows:

  
Three Months Ended
September 30,
  Change 
  2019  2018  Dollars  Percent 
Loss on foreign currency exchange $538  $29  $509   *%

* Not Meaningful
 
Three Months Ended
September 30,
 Change 
 2020 2019 Dollars  Percent 
Loss on foreign currency exchange
 
$
530
  
$
538
  
$
(8
)
  
-1
%

During the three months ended September 30, 2019 and 2018,2020, we had international sales transactions denominated in currencies other than U.S.the U.S dollar currencies that resulted in foreign currency exchange net losses as stated above.losses. The increasedecrease in these losses reflects the increasedlower level of international sales during the three months ended September 30, 20192020 compared with the same period in the prior year.year, which was partially offset by favorable changes in foreign currency fluctuation during the first quarter of Fiscal 2021 compared with the first quarter of Fiscal 2020.

Interest Income

Interest income for the three months ended September 30, 20192020 and 20182019 is as follows:

  
Three Months Ended
September 30,
  Change 
  2019  2018  Dollars  Percent 
Interest income $61,379  $-  $61,379   100%
 
Three Months Ended
September 30,
 Change 
 2020 2019 Dollars  Percent 
Interest income
 
$
3,459
  
$
61,379
  
$
(57,290
)
  
-94
%

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, have beenalong with excess operating cash, are deposited into and maintained in an interest-bearing account with a federally-insured commercial bank. Accordingly, during the three months ended September 30, 2020 and 2019, we earned interest from cash on deposit in this interest-bearing account. We had no such interest-bearing amounts on depositThe decrease in earned interest reflects adverse changes in interest rate fluctuations during the three months ended September 30, 2018.first quarter of Fiscal 2021 compared with the first quarter of Fiscal 2020.

Provision for Income Taxes

We recognized income tax net expensesexpense of approximately $6,100$500 and $4,800$6,100 for the three months ended September 30, 20192020 and 2018,2019, respectively. Income tax provisions in these periods primarily relate to estimated tax, penalties, and interest associated with uncertain tax 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. Beginning in 2014, management determined that negative evidence outweighed the positive evidence and established a full valuation allowance against our deferred tax assets. We maintained a full valuation allowance against our deferred taxes as of September 30, 20192020 and June 30, 2019.2020.

Liquidity and Capital Resources

While some areas of the world and parts of the U.S. are lifting social and business restrictions following the worldwide lockdowns related to the COVID-19 pandemic, other geographical regions of the world and some sections of the U.S. are beginning to see a rise in COVID-19 infection levels. Accordingly, the world continues to adapt to the ongoing COVID-19 pandemic and its effects on global economics and business operations. The impact of the COVID-19 pandemic continues to place unprecedented pressures on global and U.S. businesses including our own. The ongoing spread of COVID-19 continues to lead to business disruption and volatility in the global capital markets, which, depending on future developments and control of the underlying virus, could further adversely impact our capital resources and liquidity in the future. We requireremain 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 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.

Under the CARES Act and the Promissory Note, loan forgiveness is available, subject to certain conditions, for the sum of documented payroll costs, covered rent payments, and covered utilities during the 24-week period beginning on the date of first disbursement of the PPP Loan. For purposes of the CARES Act, payroll costs exclude cash compensation of an individual employee in excess of $100,000, prorated annually. Not more than 40% of the forgiven amount can be attributable to fundnon-payroll costs. Although we currently believe that our operating expensesuse of the PPP Loan will meet the conditions for forgiveness of the PPP Loan, we cannot assure our future adherence to the forgiveness criteria and working capital requirements, including outlaysthat the PPP Loan will be forgiven, in whole or in part.

The CARES Act provides that existing AMT credit carryforwards are now eligible for capital expenditures. Asacceleration and refundable AMT credits are 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 the AMT tax completely refunded and filed a refund claim for the remaining AMT tax credit. The full amount of the remaining balance of our AMT credit refund in the amount of approximately $272,000 was refunded by the Internal Revenue Service in October 2020. Accordingly, the full amount of our AMT credit refund has been classified as current as of September 30, 2019, our principal sources of liquidity were cash, cash equivalents, and restricted cash totaling $12.60 million, trade accounts receivable, net, of $2.00 million, and net current inventory of $11.79 million, as compared to cash, cash equivalents, and restricted cash totaling $13.01 million, trade accounts receivable, net, of $1.96 million, and net current inventory of $11.91 million as of June 30, 2019. As described more fully below, we also have access to our $5.00 million asset-based revolving credit facility with White Oak, or the White Oak Credit Facility.2020.

We also intend to take advantage of COVID-19 related tax credits for required paid leave provided by us. 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. Under FFCRA, we have provided employees with paid federal sick and expanded family and medical leave benefits for which we may be reimbursed by the government through payroll tax credits. Qualifying wages for tax credit purposes under FFCRA are those paid to an employee who takes leave under FFCRA for a qualifying reason, up to the applicable per diem and aggregate payment caps. Applicable tax credits also extend to the employer’s share of amounts paid or incurred to maintain a group health plan.

Finally, as permitted by the NC COVID-19 Relief Act, we will receive a tax credit towards our contributions to the North Carolina Unemployment Insurance Fund, which will also serve to further enhance future cash flow.

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 which 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 to our June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option, described below.below. 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.conditions, which are in turn, subject to the disruption and volatility being caused by the ongoing 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. However, 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. We plan to maintain these reduced advertising and digital marketing expenditure levels for the foreseeable future.

As discussed above, on June 18, 2020 we received a PPP Loan in the principal amount of $965,000 from the Lender pursuant to a Promissory Note dated June 15, 2020. The Promissory Note matures June 18, 2022 and may be extended with the consent of the Lender under the provisions of the CARES Act. The Promissory Note bears interest at a fixed rate of 1% per annum. Pursuant to the terms of the Promissory Note, monthly principal and interest payments in the amount of approximately $41,000 will commence on April 1, 2021. For financial reporting purposes as of September 30, 2020, the classification of the current maturity of this long-term debt assumes there will be no principal forgiveness and principal repayment for the full outstanding principal amount of the PPP Loan will be spread in equal monthly installments over the period from April 1, 2021 through the maturity date of the Promissory Note.

We did not provide any collateral or guarantees for the PPP Loan, nor did we pay any facility charge to obtain the PPP Loan. The Promissory Note provides for customary events of default, including, among others, those relating to failure to make payment and breaches of representations. We may prepay the principal of the PPP Loan at any time without incurring any prepayment charges.

Operating Activities and Cash Flows

We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of September 30, 2020, our principal sources of liquidity were cash, cash equivalents and restricted cash totaling $13.86 million, trade accounts receivable of $1.63 million, and net current inventory of $8.98 million, as compared to cash and cash equivalents totaling $14.62 million, trade accounts receivable of $671,000, and net current inventory of $7.44 million as of June 30, 2020. As described more fully herein, we also have long-term debt in the amount of $965,000, of which $386,000 is classified as its current maturity as of September 30, 2020, and access to a $5.00 million asset-based revolving credit facility with White Oak, or the White Oak Credit Facility.

During the three months ended September 30, 2019,2020, our working capital decreasedincreased by approximately $1.47$3.2 million to $21.70$20.63 million from $23.17$17.42 million at June 30, 2019.2020. As described more fully below, the decreaseincrease in working capital at September 30, 20192020 is primarily attributable to a an increase in our allocation of inventory from long-term to short-term, decrease in our accounts payable, an increase in our accounts receivable, a decrease in our accrued expenses and other liabilities, and an increase in our prepaid expenses and other assets. These factors were offset partially by a decrease in our cash, cash equivalents, and restricted cash resulting from cash used in our operations, an increase in accounts payable, an increase in short-term operating lease liabilities due to the adoptioncurrent maturity of the new accounting standard, and a decrease in our allocation of inventory from long-term to short-term. These factors were offset partially by an increase in prepaid expenses and other assets, a decrease in accrued expenses and other liabilitiesdebt, and an increase in accounts receivable.our short-term operating lease liabilities.

During the three months ended September 30, 2019,2020, approximately $1.22 million$642,000 of cash was used by our operations. The primary drivers of our use of cash were a decrease in accounts payable of $1.17 million; an increase in inventoryaccounts receivable of $2.25 million to meet expected requirements for the upcoming calendar year-end holiday season; an increase in prepaid expenses and other assets of $417,000;$1.08 million; and a decrease in accrued expenses and other liabilities of $272,000.$573,000. These factors were offset partially by the favorable effect of net income in the amount of $207,000, an increase$874,000; a decrease in accounts payableinventory of $1.19 million;$829,000; and a decrease in accounts receivableprepaid expenses and other assets of $8,000.$28,000. In addition, the net effect of the changes in combined non-cash items totaling $313,000$450,000 also favorably impacted net cash used in operating activities during the three months ended September 30, 2019.2020.

Accounts receivable increased principally due to the increased level of sales during the three months ended September 30, 20192020 as compared with the sales during the period leading up to June 30, 2019. We did not offer any2020. As a result of the COVID-19 pandemic, we offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers during the three months ended September 30, 2019; however, we may offerfirst fiscal quarter of Fiscal 2021 and second half of Fiscal 2020. Because of the ongoing impact of the pandemic on the global economy, the extension of these terms from time to time, which may not immediately increase liquidity as a result of ongoing current-period sales. Wesales, which we expect to continue to be pressured due to the effects of the ongoing COVID-19 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 would likely decrease.be adversely impacted.

We manufactured approximately $2.89$2.21 million in finished jewelry and $3.33$1.68 million in loose jewels, which includes the cost of the loose jewels and the purchase of precious metals and labor in connection with jewelry production, during the three months ended September 30, 2019.2020. We expect our purchases of precious metals and labor to increase as we increase our finished jewelry business. In addition, the price of gold has increased significantly over the past decade, and more significantly over the past several months, 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 September 30, 20192020 and June 30, 2019, $24.182020, $20.75 million and $21.82$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 $3.58$2.31 million 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 September 30, 2019, 81% of the total inventory was New Material, while 19% was Legacy Material, as compared to percentages of total inventory of 79% of New Material and 21% of Legacy Material at June 30, 2019. We are actively selling Legacy Material jewelry through our omni-channel strategy in such outlets as third-party online marketplaces, drop-ship retailers, and pure-play retailers. A more detailed description of our inventories is included in Note 5 to our condensedcondensed consolidated financial statements in Part I, Item 1, “Financial Statements”, of this Quarterly Report on Form 10-Q10-Q.

As of September 30, 2020, we had approximately $309 of remaining federal income tax credits that expire in 2021 and can be carried forward to offset future income taxes. As of September 30, 2020, we also had a federal tax net operating loss carryforward of approximately $23.72 million expiring between 2022 and 2037, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $20.12 million expiring between 2023 and 2033; and various other state tax net operating loss carryforwards expiring between 2021 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 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 $41.49$36.60 million remains to be purchased as of September 30, 2019.2020.

During the three months ended September 30, 2019,2020, in accordance with the terms of the Supply Agreement, as amended, we purchased approximately $2.49 millionmade no purchases 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 and, if necessary, our White Oak Credit Facility, to finance our purchase commitment under the Supply Agreement, as amended.amended.

29
As of September 30, 2019, we had approximately $102,000 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 September 30, 2019, we also had a federal tax net operating loss carryforward of approximately $23.39 million 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 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

On July 13, 2018, we and our wholly-owned subsidiary, charlesandcolvard.com, LLC, collectively referred to as the Borrowers, obtained the $5.00 million asset-based revolving White Oak Credit Facility. The White Oak Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions. The White Oak Credit Facility, which matures on July 13, 2021, is guaranteed by Charles & Colvard Direct, LLC, another of our wholly-owned subsidiaries. Under the terms of the White Oak Credit Facility, the Borrowers must maintain at least $500,000 in excess borrowing availability at all times. The White Oak Credit Facility contains no other financial covenants.

Advances under the White Oak Credit Facility may be either revolving or non-revolving. During the first year of the term of the White Oak Credit Facility, revolving advances accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and non-revolving advances accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins will reduce upon our achievement of a specified fixed charge coverage ratio. However, advances are in all cases subject to a minimum interest rate of 5.50%. Interest is calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default accrues interest at a rate 2% in excess of the rate otherwise applicable.

As of September 30, 2019,2020, we had not borrowed against the White Oak Credit Facility. As a result of our diminished borrowing base as of September 30, 2020, which is tied to our accounts receivable, our ability to draw down funds from the White Oak Credit Facility is currently restricted.

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 access to federal government economic relief programs pursuant to the CARES Act, including our existing PPP Loan and the available conditional forgiveness of the PPP Loan in whole or in part, access to available federal and state tax-related considerations, 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, including the ongoing spread of 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 diamonds 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 this Quarterly Report on Form 10-Q and in Part I, Item 1A of our 20192020 Annual Report. on Form 10-K. Currently, we have the White Oak Credit Facility through its expiration on July 13, 2021, that 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.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.

30
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 despite the fact that our corporate employees are working remotely 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 September 30, 2019,2020, 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, with the exceptionreporting.

PART II – OTHER INFORMATION

Item 1.
Legal Proceedings

There are no material pending legal proceedings to which we are a party or to which any of our property is subject.

Item 1A.
Risk Factors

We discuss in our Annual Report on Form 10-K for the fiscal year ended June 30, 20192020 and our Quarterly Report on Form 10-Q for the quarter September 30, 2020 various risks that may materially affect our business. There have been no material changes to such risks.risks, except as set forth below.

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 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 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 developing and promoting the Charles & Colvard brands, such as Forever OneTM, Moissanite by Charles & Colvard®, and Caydia™, all of which are used in finished jewelry featuring moissanite and lab grown diamonds, resulting in increased 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 grown diamond industry;

The 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;

The 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® to the retail jewelry trade;


•
The continued willingness of distributors, retailers, and others in our distribution channels to purchase loose Forever OneTM, 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 high-quality workmanship; and

Our continued ability and the ability of retail jewelers to effectively market and sell finished jewelry featuring moissanite to consumers.

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 from 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 remaining (which expires in 2021). However, we have certain trademarks and pending trademark applications that support our moissanite branding strategy. Additionally, we have certain issued and 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. 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.

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 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 2006 through 2020, 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.

Item 6.
Exhibits

The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:

Exhibit No.
Description
 
10.1
Charles & Colvard, Ltd. Fiscal 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)
  
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 quarterquarterly period ended September 30, 20192020 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 Changes in Shareholders’ Equity; (iv) Condensed Consolidated Statements of Cash Flows;Flow; and (v) Notes to Condensed Consolidated Financial Statements.

SIGNATURESSIGNATURES

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/ Suzanne MiglucciDon O’Connell
November 7, 20195, 2020
 Suzanne Miglucci
Don O’Connell
  
President and Chief Executive Officer
   
 
By:
/s/ Clint J. Pete
November 7, 20195, 2020
 
Clint J. Pete
  
Chief Financial Officer
  
(Principal Financial Officer and Chief Accounting Officer)


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