CHARLES & COLVARD, LTD. The following Management's Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, is intended to provide a better understanding of our consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. This information should be read in conjunction with Item 1A, "Risk Factors" and our consolidated financial statements and the notes thereto included in Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. Historical results and percentage relationships among any amounts in the consolidated financial statements are not necessarily indicative of trends in operating results for future periods.
Business Overview
Our Mission
At
About Charles & Colvard
Charles & Colvard, Ltd. , aNorth Carolina corporation founded in 1995 (which may be referred to as Charles & Colvard, we, us, or our) is a globally recognized fine jewelry company specializing in lab created gemstones. We manufacture, market, and distribute Charles & Colvard Created Moissanite® (which we refer to as moissanite or moissanite jewels) and inSeptember 2020 , we announced our expansion into the lab grown diamond market with the launch of Caydia®, an exclusive brand of premium lab grown diamonds. We offer gemstones and finished jewelry featuring our proprietary moissanite jewels and premium lab grown diamonds for sale in the worldwide fine jewelry market. Charles & Colvard is the original source of created moissanite, and in 2015, we debuted Forever One™, our premium moissanite gemstone brand. As an e-commerce and multi-channel destination for fine jewelry featuring lab grown gemstones, we believe that the addition of lab grown diamonds is a natural progression for the Charles & Colvard brand. We sell loose moissanite jewels, lab grown diamonds, and finished jewelry set with these gems through two operating segments: our Online Channels segment, which encompasses our digital properties components, comprised of our charlesandcolvard.com and moissaniteoutlet.com websites, e-commerce outlets, including marketplaces, drop-ship customers, and other pure-play, exclusively e-commerce customers; and our Traditional segment, which consists of domestic and international distributors and retail customers. We report segment information based on the "management" approach. This segment reporting approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of our operating and reportable segments. We operate in an e-commerce environment characterized by both complexity in global markets and ongoing economic uncertainties in theU.S. and internationally. Our strategy is to build a globally revered and accessible brand of gemstones and finished fine jewelry products set with moissanite and lab grown diamonds. We believe that our goods appeal to a wide consumer audience and leverage our advantage of being the original and leading worldwide source of moissanite and purveyor of premium lab grown diamonds. We believe a direct relationship with consumers is an important component to this strategy, which entails delivering tailored educational content, engaging in interactive dialogue with our audience, and positioning our brand to meet the demands of today's discerning consumer. A significant component of our strategy in this environment is to focus on our core products, improving the quality and predictability of the delivery of our products and services, and placing those products quickly into the hands of ourU.S. and international customers at affordable prices. Moreover, recognizing today that our customers and vendors are resource constrained, we are endeavoring to develop and extend our portfolio of products in a disciplined manner with a focus on domestic markets close to our core capabilities, as well as growing our global marketplace sales. We continue to focus on affordability initiatives. We also expect to continue innovating and investing in lab created gemstone technologies to fulfill evolving product requirements for our customers and investing in our people so that we have the technical and production skills necessary to succeed without limiting our ability to build sound financial returns to our investors. 32 -------------------------------------------------------------------------------- Table of Contents We believe our expanding application of an omni-channel sales strategy across the fine jewelry trade and to the end consumer with accessible gemstones and value branded finished jewelry featuring Charles & Colvard Created Moissanite® and Caydia® lab grown diamonds positions our products at the many touchpoints where consumers are when they are making their buying decisions - thereby continuing to create greater exposure for our brand and increasing consumer demand.
COVID-19
InMarch 2020 , the novel strain of coronavirus, known as COVID-19, was declared a pandemic by theWorld Health Organization and declared a national emergency by theU.S. Government , and has continued to negatively affect theU.S. and global economies. In response to the pandemic, federal, state, county and local governments, and public health organizations and authorities around the world have implemented a variety of measures intended to control the spread of the virus including quarantines, "stay-at-home" orders, travel restrictions, school closures, business limitations and closures, social distancing, and hygiene requirements. While some of these measures have been lifted or eased in certain jurisdictions, other jurisdictions have seen increases in new COVID-19 cases, resulting in restrictions being reinstated or new restrictions being imposed. There continues to be considerable uncertainty regarding such measures and potential future measures. We have continued taking measures to protect the health and safety of our employees, including updating our return-to-work policies, as necessary, working with our customers and suppliers to minimize disruptions, and supporting our community in addressing the challenges posed by this ongoing global pandemic. During Fiscal 2021, we experienced impacts in our business related to COVID-19, primarily in continued increased coronavirus-related costs, interruptions in supplier deliveries, impacts of travel and delivery restrictions, site access and quarantine restrictions, and the impacts of remote work and adjusted work schedules. The COVID-19 pandemic continues to present business challenges and we expect these to continue into Fiscal 2022. We have executed plans to reintroduce employees to the workplace as vaccine rates increase and COVID-19 cases decrease. Although, in light of the recent increase in infections due to evolving viral variants, we have not yet returned to pre-pandemic workforce levels in our workplace, and we are experiencing stabilization of employee attendance in our operations and distribution facilities and throughout our supply chain. A segment of our corporate staff continues working a blend of remote and in-person work schedules and we are taking measures to facilitate the provision of vaccines to our employees in line with state and local guidelines. We also continue working with our customers and suppliers to minimize disruptions, including at times accelerating payments to key suppliers that are due by their terms in future periods. We expect to continue accelerating payments to our suppliers in some cases into Fiscal 2022. Although the COVID-19 pandemic did not have a significant adverse impact on our financial results in Fiscal 2021, the ultimate impact of COVID-19 on our operations and financial performance in future periods, including our ability to execute our strategic initiatives in the expected timeframes, remains uncertain and will depend on future pandemic related developments, including the duration of the pandemic, any potential subsequent waves of COVID-19 and its variant viral infections, the effectiveness, distribution and acceptance of COVID-19 vaccines, and related government actions to prevent and manage disease spread, all of which are uncertain and cannot be predicted. We cannot at this time predict the full impact of the COVID-19 pandemic, but we anticipate that the COVID-19 pandemic is likely to continue to impact our business, financial condition, results of operations and/or cash flows in the fiscal year endingJune 30, 2022 . At the onset of the pandemic, we successfully applied for and received the proceeds from a PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. Our PPP Loan in the principal amount of$965,000 was disbursed by our Lender pursuant to a Promissory Note issued by us onJune 15, 2020 . In accordance with applicable provisions of the CARES Act, effectiveJune 23, 2021 , our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of$965,000 . The full amount of the gain in connection with the extinguishment of the underlying debt, including the forgiveness of accrued and unpaid interest in the amount of approximately$9,000 , was recognized in the fiscal year endedJune 30, 2021 . We took advantage of available COVID-19 related payroll tax credits for certain wages and paid leave provided by us during the pandemic. A portion of these eligible tax credits are determined by qualified emergency paid sick and expanded family and medical leave wages pursuant to the Families First Coronavirus Response Act, or FFCRA, which had positive impact on our cash from operations in Fiscal 2021. In addition, the Consolidated Appropriations Act, 2021, provides that employerswho received a PPP loan may also qualify for the Employee Retention Credit (the "ERC"). Previously, pursuant to the CARES Act, taxpayers that received a PPP loan were not eligible for the ERC and this change is retroactive toMarch 27, 2020 . We believe that we qualify for certain employer-related tax benefits pursuant to the ERC and expect to amend our applicable federal payroll tax returns for such benefit. Further, as permitted by the NC COVID-19 Relief Act, we expect to receive an incremental tax credit towards our contributions to theNorth Carolina Unemployment Insurance Fund . Accordingly, we will recognize any payroll tax credits related to these federal and state legislative actions in the period such benefits are received. 33 -------------------------------------------------------------------------------- Table of Contents Currently, we are conducting business with certain modifications. In accordance with recentCenters for Disease Control and Prevention , orCDC , and theNorth Carolina Department of Health and Human Services , or the NCDHHS, guidelines related to maximizing protection from the spread and infection of the Delta variant of COVID-19, we are requiring all employees, contractors, and visitors to wear masks and practice physical distancing while onsite, regardless of vaccination status. We believe that our employees and contractors continue to play a critical role in our COVID-19 prevention and mitigation efforts for the Company as well as for our community at large. Recent modifications to our COVID-19 return-to-work policy include but are not limited to the following: all employees, contractors, and visitors are encouraged to clean and sanitize all work surfaces, including personal office or cubicle areas; office common areas will be cleaned nightly, and floors and carpets will be cleaned as necessary; and currently, we are not mandating that employees, contractors, and visitors receive the COVID-19 vaccine or that non-fully vaccinated individuals provide evidence of negative COVID-19 test results in order to enter our facilities. At this time, and until further notice, the following precautionary steps and procedures within our policy remain in place. Prior to entry to our facilities, all employees, contractors, and visitors (regardless of vaccination status) are required to comply with the following: complete a COVID-19 symptom screening questionnaire; properly wear a mask; take a thermal body temperature scan; and practice social distancing at all times within the facility, including designated common areas. We are supplying all employees, contractors, and visitors with face masks and latex gloves for their personal use, and we have established a designated quarantine room to isolate any employee, contractor, or visitorwho may be experiencing COVID-19-like symptoms while in our facilities. Given our office's square footage, we intend to continue to observe recommended governmental guidelines related to occupancy and capacity restrictions. Regardless of vaccination status, any employees, contractors, or visitors presenting with symptoms of COVID-19 orwho have tested positive for the COVID-19 virus may only return to our facilities once ten days have passed since symptoms of COVID-19 first appeared, at least 24 hours have passed with no fever (without the use of fever-reducing medications), and any other COVID-19 symptoms (i.e., loss of taste or smell) continue improving. Employees, contractors, or visitorswho may have been exposed to COVID-19, but remain asymptomatic, are able to return to work after receiving a negative COVID-19 test result three-to-five days following a known exposure or 14 days since the last contact with an individualwho was presumed to have or had COVID-19. Our current return-to-work policy is tentative and subject to change based on federal, state, or local governmental guidance as well as the evolution of the pandemic itself. Going forward, we plan to continue monitoring the development and progression of COVID-19 and its variant infections in our state and local geographical area. If we believe such policy changes are warranted, we intend to consider and plan to take appropriate actions at that time. As global andU.S economic activity continues evolving in response to the ongoing COVID-19 pandemic, the risk of constraints on our cash and working capital, including experiencing potential liquidity challenges, remains in the forefront of our working capital management practices. Despite our cost-saving efforts, many business and operating expenses have remained flat or continued to rise. Cash flow management will remain crucial for our business in the months ahead and we intend to monitor fluctuations in our revenues that could impact our ongoing cash flow from operations We continue to focus on being more nimble in managing our inventory levels given the uncertainty in the supply chain, which may also place further demands on working capital. Our outlook remains subject to the various risks and uncertainties in connection with the pandemic and is based on assumptions that management believes in good faith are reasonable, but which may be materially different from actual results. Currently, we believe there are multiple factors that could cause actual results to differ materially from the forward-looking statements in this Form 10-K, including our strategic goals for Fiscal 2022 set forth in Our Strategic Outlook, included in Part I, Item 1, "Business", of this Annual Report on Form 10-K. These factors include, but are not limited to: our ability to face the challenges posed by the COVID-19 pandemic and implementation of any such related response plans; fluctuations in COVID-19 cases in theU.S. and the extent that geography of outbreak primarily matches the regions in which we and our principal business partners operate; the resiliency and potential adverse impacts on our various consumer end-use markets; the potential negative impact of the COVID-19 pandemic on our ability to continue producing and supplying finished goods and related services at normal levels or at all; the duration, impact and severity of the impact of the COVID-19 pandemic on our operations, including the markets in which we do business, our suppliers, customers or other business partners as well as our employees; the economic impact of government responses to the pandemic; the performance of theU.S. economy, including the impact on the economy of the COVID-19 pandemic and governmental orders restricting activities imposed to prevent further outbreak of viral infections; and the resulting economic events beyond our control. 34 -------------------------------------------------------------------------------- Table of Contents We believe that our management has taken - and continues to take - swift and appropriate action designed to hedge against the overall impact that the pandemic may have on our business, to prepare for a potential recessionary environment, and to efficiently manage the business while maintaining adequate liquidity and maximum operating flexibility. We remain focused on three critical areas of wellbeing, including safeguarding the health and safety of our employees, streamlining operations while ensuring support of our brand and customers, and maintaining our financial strength and stability as we move forward into Fiscal 2022.
Highlights of the Fiscal Year Ended
During the fiscal year ended
• Expansion of Digital Presence. During Fiscal 2021, we remained focused on our
digital marketing advertising strategy that includes a high-conversion consumer
targeting plan coupled with lower marketing funnel activities. We believe that
the success we've seen targeting consumers with whom we have already engaged -
and
effective use of our digital advertising spend and provides a more immediate
return on our marketing investment. We believe this strategy is critical to our
top line growth as we move forward into Fiscal 2022. In addition, during Fiscal
2021, we expanded our presence on available social media channels such as
Instagram Live. In
product disposition channel that we believe complements our global positioning
and dominance in the moissanite gemstone market. Our website,
moissaniteoutlet.com, is an e-commerce shopping destination that caters to the
opportunistic and bargain-seeking consumer base for our moissanite products;
• Enhanced Customer Experience. This fiscal year we expanded our virtual
consultation services that we introduced last year, by adding additional expert
jewelry consultants to our team that provides us with broader availability to
make it easier for consumers to schedule personal consultive services. This is
a personal shopping concierge service where we offer a customized virtual
experience designed to simplify the ring buying process for our customers. This
customer support service offers deeper personalization and a more immersive
shopping experience for our consumers. We also launched our Macy's in-store
program in Fiscal 2021 to reach and service more customers
see, touch, and feel our products when shopping. As consumers are returning to
in-store shopping, we believe this is a critical component of our omnichannel
marketing strategy, which places our products where the customer is actually
shopping. Lastly, in September we upgraded the online shopping experience on
charlesandcolvard.com, our primary transactional website. These online
modifications provide new and improved functionality as well as a new look and
feel to our website. We believe that offering these ongoing enhanced customer
experiences, particularly those featuring virtual personal shopping
opportunities, are important for the growth of our brand. We also believe that
these options remain relevant and important to our customers when social
distancing practices are - and will likely remain - in place throughout the
• Product Development. In Fiscal 2021, we expanded our patented Signature
Collection of Forever One™ moissanite jewelry assortment to include emerald,
elongated cushion, and radiant cut gemstones. Previously, these gems and unique
cuts were not available in our Signature Collection line of products. In
diamonds and jewelry. We believe our premium lab grown diamonds provide us
access to serve a broader and completely new segment of the gemstone audience
and customer base that is predisposed to shopping for a real diamond.
Throughout Fiscal 2021, we continued to expand our Caydia® lab grown diamond
jewelry assortment with new styles as well as additional gemstone cuts.
Currently, our exclusive brand of Caydia® lab grown diamonds are available in
round, oval, cushion, emerald, and princess cuts; and
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• Disciplined Growth. We capitalized on the change in the global consumer
behavior and buying habits that developed during the past year as shoppers
turned to online shopping and e-commerce purchasing opportunities as the world
evolved and learned to live with the restrictions imposed by the COVID-19
pandemic. We achieved stability and improved technical access to our shopping
platforms, which resulted in a strong shopping foundation that supports our
omnichannel marketing strategy. We also developed and initiated a new strategic
relationship and business partnership with
includes a new
may be used for general corporate and working capital purposes. We believe this
new commercial banking and financial relationship provides a foundation for us
to solidify our strategic and financial objectives and is a basis for us to
expand our financial capabilities going forward.
As we move forward into Fiscal 2022, our strategic focus remains centered on the health and growth of our brand on a global scale. We will continue to execute on our key strategies with an ongoing commitment to measured spending and generating sustainable earnings improvement. Further, as we continue managing through these challenging and unprecedented times, we plan to remain highly focused on prudently developing the reach of our brand - both domestically and internationally - through select digital marketing initiatives that align with consumer engagement and demand. We continue to believe that our long-term mission will ultimately be accomplished through our ability to remain fluid and shift brand awareness strategies that are sensitive and responsive to these ever-changing times. Our MD&A generally discusses Fiscal 2021 and Fiscal 2020 items and year-to-year comparisons between Fiscal 2021 and Fiscal 2020. Discussions of Fiscal 2020 items and year-to-year comparisons between Fiscal 2020 and the fiscal year endedJune 30, 2019 , or Fiscal 2019, that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results or Operations" in our Annual Report on Form 10-K for the fiscal year endedJune 30, 2020 filed with theSEC onSeptember 4, 2020 .
Results of Operations
The following table sets forth certain consolidated statements of operations
data for the fiscal years ended
Year Ended June 30,
2021 2020
Net sales $ 39,235,839 $ 29,189,020
Costs and expenses:
Cost of goods sold 20,809,690 21,200,207
Sales and marketing 8,476,716 9,443,244
General and administrative 4,441,441 4,861,297
Total costs and expenses 33,727,847 35,504,748Income (Loss) from operations 5,507,992 (6,315,728 ) Other income (expense): Gain on extinguishment of debt
974,328 -
Interest income 5,581 158,091
Interest expense (8,953 ) (884 )
Loss on foreign currency exchange (603 ) (1,829 )
Total other income (expense), net 970,353 155,378
Income (Loss) before income taxes 6,478,345 (6,160,350 )
Income tax benefit (expense) 6,332,421 (1,733 )
Net income (loss) $ 12,810,766 $ (6,162,083 )
36-------------------------------------------------------------------------------- Table of Contents ConsolidatedNet Sales Consolidated net sales for the fiscal years endedJune 30, 2021 and 2020 comprise the following: Year Ended June 30, Change 2021 2020 Dollars Percent Finished jewelry$ 24,401,546 $ 16,777,628 $ 7,623,918 45 % Loose jewels 14,834,293 12,411,392 2,422,901 20 % Total consolidated net sales$ 39,235,839 $ 29,189,020 $ 10,046,819 34 % Consolidated net sales were$39.24 million for the fiscal year endedJune 30, 2021 compared to$29.19 million for the fiscal year endedJune 30, 2020 , an increase of$10.05 million , or 34%. In addition to the adverse impact that the COVID-19 pandemic had on consolidated net sales for the fiscal year endedJune 30, 2020 , the increase in consolidated net sales for the fiscal year endedJune 30, 2021 compared with consolidated net sales for the prior fiscal year was also principally due to robust calendar year-end holiday sales during our fiscal quarter endedDecember 31, 2020 , coupled with strong FebruaryValentine's Day sales andMarch St. Patrick's Day sales during our fiscal quarter endedMarch 31, 2021 . These higher sales for Fiscal 2021 were also related to increased consumer awareness and ongoing strong demand for our moissanite jewels, lab grown diamonds, and finished jewelry featuring both moissanite and lab grown diamonds. These increases resulted in higher finished jewelry product net sales during the fiscal year endedJune 30, 2021 in both our Online Channels segment and Traditional segment. One of the most profound changes in consumer buying habits over the past fiscal year was the shift to digital channels shopping from the more traditional brick-and-mortar platforms. We believe the COVID-19 pandemic accelerated this shift toward e-commerce, as consumers worldwide became more reliant on the digital channel while in isolation. Accordingly, we saw strong increases in our Online Channels segment net sales in the fiscal year endedJune 30, 2021 . As consumer confidence strengthened during the second half of Fiscal 2021, net sales in our Traditional segment increased over this period driven by stronger loose jewel sales in our distributor network. However, these increased loose jewel net sales in our Traditional segment were offset in part due to lower international sales during the fiscal year endedJune 30, 2021 . Sales of finished jewelry represented 62% and 57% of total consolidated net sales for the fiscal years endedJune 30, 2021 and 2020, respectively. For the fiscal year endedJune 30, 2021 , finished jewelry sales were$24.40 million compared to$16.78 million for the fiscal year endedJune 30, 2020 , an increase of$7.62 million , or 45%. This increase in finished jewelry sales was due primarily to higher finished jewelry sales of Moissanite by Charles & Colvard® and our Signature Collection line of products in our Online Channels segment as well as in our Traditional segment. Net sales of our Moissanite by Charles & Colvard® and our Signature Collection finished jewelry and loose jewels represented 15% and 9%, respectively, of total net sales for the fiscal year endedJune 30, 2021 , compared to that of 11% and 7%, respectively, for the prior fiscal year. Sales of loose jewels represented 38% and 43% of total consolidated net sales for the fiscal years endedJune 30, 2021 and 2020, respectively. For the fiscal year endedJune 30, 2021 , loose jewel sales were$14.83 million compared to$12.41 million for the fiscal year endedJune 30, 2020 , an increase of$2.42 million , or 20%. The increase for the fiscal year endedJune 30, 2021 was primarily a result of higher sales of loose jewels through our domestic distributors. However, these increased loose jewel sales were offset somewhat by lower sales of loose jewels through the international distribution network in our Traditional segment.U.S. net sales accounted for approximately 95% and 92% of total consolidated net sales during the fiscal years endedJune 30, 2021 and 2020, respectively.U.S. net sales increased during the fiscal year endedJune 30, 2021 principally as a result of increased sales toU.S. customers in both our Online Channels segment and Traditional segment. Our largestU.S. customer during the fiscal years endedJune 30, 2021 and 2020 accounted for 13% of total consolidated net sales during each of the respective periods then ended. Likewise, our second largestU.S. customer during the fiscal years endedJune 30, 2021 and 2020 accounted for 12% of total consolidated net sales during each of the respective periods. It should be noted that our largest and second largest customers in Fiscal 2021 were our second largest and largest customers, respectively, in Fiscal 2020. We expect that we will remain dependent on our ability, and that of our largest customers, to maintain and enhance retail and wholesale programs. A change in or loss of any of these customers or retailer relationships could have a material adverse effect on our results of operations. 37 -------------------------------------------------------------------------------- Table of Contents International net sales accounted for approximately 5% and 8% of total consolidated net sales during the fiscal years endedJune 30, 2021 and 2020, respectively. International net sales decreased to$2.01 million , or 15%, during the fiscal year endedJune 30, 2021 compared to$2.37 million in the fiscal year endedJune 30, 2020 . International sales decreased during the fiscal year endedJune 30, 2021 , compared to the prior fiscal year primarily as a result of lower demand in our international distributor market, which was partially offset by growth in our direct-to-consumer presence internationally reflecting solid direct-to-consumer sales from our Online Channels segment in international markets. In light of the effects of ongoing global economic conditions and as the world continues to recover from the COVID-19 pandemic, we continue to evaluate these and other potential distributors in international markets to determine the best long-term partners. As a result, and in light of the ongoing worldwide pandemic and international trade challenges, we expect our sales in these markets to continue to fluctuate significantly each reporting period.
We did not have an international customer account for 10% or more of total
consolidated sales during the fiscal years ended
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal years endedJune 30, 2021 and 2020 are as follows: Year Ended June 30, Change 2021 2020 Dollars Percent Product line cost of goods sold: Finished jewelry$ 11,272,012 $ 7,469,790 $ 3,802,222 51 % Loose jewels 6,857,755 6,062,186 795,569 13 %
Total product line cost of goods sold 18,129,767 13,531,976
4,597,791 34 %
Non-product line cost of goods sold 2,679,923 7,668,231 (4,988,308 ) (65 )%
Total cost of goods sold $ 20,809,690 $ 21,200,207 $ (390,517 ) (2 )%
Total cost of goods sold was $20.81 million for the fiscal year ended June 30,
2021 compared to $21.20 million for the fiscal year ended June 30, 2020 , a net
decrease of approximately $391,000 , or 2%. Product line cost of goods sold is
defined as product cost of goods sold in each of our Online Channels segment and
Traditional segment excluding non-capitalized expenses from our manufacturing
and production control departments, comprising personnel costs, depreciation,
rent, utilities, and corporate overhead allocations; freight out; inventory
write-offs; and other inventory adjustments, comprising costs of quality issues,
and damaged goods.
The decrease in total cost of goods sold for the fiscal year ended June 30, 2021
as compared to the fiscal year ended June 30, 2020 was driven primarily by the
prior year write-off during the quarter ended March 31, 2020 , of approximately
$5.26 million representing the carrying value of our legacy loose jewel
inventory and finished goods inventory set with these legacy gemstones. This
decrease in cost of goods sold for the fiscal year ended June 30, 2021 , was
offset in part by higher cost of goods sold principally driven by increased
sales of finished jewelry, which reflect higher material and labor costs, in
both our Online Channels segment and Traditional segment as a result of strong
product demand during the year.
The net decrease in non-product line cost of goods sold for the fiscal year
ended June 30, 2021 comprises a $5.71 million lower change in inventory
valuation adjustments principally related to the prior fiscal year's write-off
of the carrying cost of the Company's legacy material inventory of $5.26 million
during the quarter ended March 31, 2020 , as well as other inventory valuation
adjustments related to changes in obsolescence reserves in the fiscal year ended
June 30, 2021 , compared to those in the prior fiscal year. This decrease in
non-product line cost of goods sold was offset in part by a $503,000 increase in
freight out principally from increased shipments resulting from substantial
Online Channels segment sales growth during the fiscal year ended June 30, 2021 ;
a $147,000 increase in non-capitalized manufacturing and production control
expenses in the current year principally due to the timing when work-in-process
goods are received into inventory and applicable overhead costs are allocated;
and an approximate $76,000 change in other inventory adjustments primarily
relating to adverse changes in production standard cost variances compared to
those during the fiscal year ended June 30, 2020 .
38
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For further discussion of non-product line cost of goods sold, see Note 3 to our
consolidated financial statements in Item 8, "Financial Statements and
Supplementary Data", of this Annual Report on Form 10-K.
Sales and Marketing
Sales and marketing expenses for the fiscal years endedJune 30, 2021 and 2020 are as follows: Year Ended June 30, Change 2021 2020 Dollars Percent Sales and marketing$ 8,476,716 $ 9,443,244 $ (966,528 ) (10 )% Sales and marketing expenses were$8.48 million for the fiscal year endedJune 30, 2021 compared to$9.44 million for the fiscal year endedJune 30, 2020 , a decrease of approximately$967,000 , or 10%. The decrease in sales and marketing expenses for the fiscal year endedJune 30, 2021 compared to the fiscal year endedJune 30, 2020 was primarily due to a$1.31 million decrease in compensation-related expenses; a$164,000 decrease in professional services fees principally comprising non-recurring consulting services for cybersecurity and merchandising imaging incurred in the prior year; a$26,000 decrease in travel expenses as a result of COVID-19 cost-control measures; and a$1,000 net decrease in miscellaneous other general sales and marketing expenses. These decreases were partially offset by a$282,000 increase in advertising and digital marketing expenses; an$84,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; an$83,000 increase in general office-related expenses, which are principally related to higher credit card transaction fees from increased online sales levels; a$69,000 increase in depreciation and amortization expense relating to capitalized costs associated with information technology-related upgrades; and a$17,000 increase in employment-related recruiting fees. Compensation expenses for the fiscal year endedJune 30, 2021 compared to the fiscal year endedJune 30, 2020 decreased primarily as a result of a$1.25 million decrease in salaries, commissions, and related employee benefits in the aggregate as a result of ourJune 2020 management reorganization and workforce reduction; a$76,000 decrease in employee-related severance costs recognized in the prior year which also was a result of ourJune 2020 management reorganization and workforce reduction; and a$68,000 decrease in employee stock-based compensation expense associated with the modification of terms for certain participant stock options in Fiscal 2020 that resulted in the recognition of higher stock compensation expense in the prior fiscal year. These decreases were partially offset by an$84,000 increase in bonus expense reflecting improved operating results in the current year that impacts this performance-based compensation-related benefit. The increase in digital marketing expenses for the fiscal year endedJune 30, 2021 compared to the fiscal year endedJune 30, 2020 was primarily due to a$766,000 increase in Internet marketing costs and a$20,000 increase in print media expenses. Both increases reflect changes in our overall social media and print marketing strategies during Fiscal 2021 compared with those in Fiscal 2020. These increases were partially offset by a$386,000 decrease in outside agency fees, also as a consequence of modifications in our marketing strategy and reliance on internal resources during the current year; a$111,000 decrease in cooperative advertising; and a$7,000 decrease in promotion-related expenses.
General and Administrative
General and administrative expenses for the fiscal years endedJune 30, 2021 and 2020 are as follows: Year Ended June 30, Change 2021 2020 Dollars Percent General and administrative$ 4,441,441 $ 4,861,297 $ (419,856 ) (9 )% General and administrative expenses were$4.44 million for the fiscal year endedJune 30, 2021 compared to$4.86 million for the fiscal year endedJune 30, 2020 , a decrease of approximately$420,000 , or 9%. 39 -------------------------------------------------------------------------------- Table of Contents The decrease in general and administrative expenses for the fiscal year endedJune 30, 2021 compared to the fiscal year endedJune 30, 2020 was primarily due to a$428,000 decrease in professional services; a$206,000 decrease in compensation-related expenses; a$7,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy; and a$1,000 net decrease in miscellaneous other general and administrative expenses. These decreases were partially offset by a$58,000 increase in rent expense, primarily related to our corporate headquarters operating lease amendment that was executed inJanuary 2021 ; a$50,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; a$38,000 increase in housing allowances and travel-related expenditures; a$30,000 increase in insurance expenses principally related to higher renewal premiums; a$20,000 increase in bank charges as a result of transaction fees associated with increased online transactions; a$14,000 increase in Board member retainer fees due to the temporary reduction in fees paid to our Board of Directors in connection with cost control measures implemented during the COVID-19 pandemic in the prior year; a$9,000 increase in depreciation and amortization expense; and a$3,000 increase in business taxes and licenses. Professional services fees decreased for the fiscal year endedJune 30, 2021 compared to the fiscal year endedJune 30, 2020 primarily due to a$283,000 decrease in legal fees resulting from non-recurring non-capitalized fees incurred in connection with our underwritten public offering and corporate governance matters in the prior year; a$101,000 decrease in consulting and other professional services primarily in connection with accounting department support in the prior year; and a$66,000 decrease in investor relations fees. These decreases were partially offset by a$22,000 increase in fees associated with audit and tax services in the current year. Compensation expenses decreased for the fiscal year endedJune 30, 2021 compared to the fiscal year endedJune 30, 2020 primarily due to a$282,000 decrease in severance expenses recognized in the prior year related to ourJune 2020 management reorganization and workforce reduction; a$184,000 decrease in salaries and related employee benefits in the aggregate which also was a result of ourJune 2020 management reorganization and workforce reduction; and a$54,000 decrease in employee stock-based compensation expense associated with the modification of terms for certain participant stock options in Fiscal 2020 that resulted in the recognition of higher stock compensation expense in the prior fiscal year. These decreases were offset in part by a$314,000 increase in bonus expense reflecting improved operating results in Fiscal 2021 that impacts this performance-based compensation-related benefit.
Gain on Extinguishment of Debt
Gain on extinguishment of debt for the fiscal years endedJune 30, 2021 and 2020 is as follows: Year Ended June 30, Change 2021 2020 Dollars Percent
Gain on extinguishment of debt
100 %
OnJune 18, 2020 , we received the proceeds from our Paycheck Protection Program Loan, or the PPP Loan, pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, as administered by theU.S. Small Business Administration , or SBA. The PPP Loan in the principal amount of$965,000 was disbursed byNewtek Small Business Finance, LLC , or the Lender, pursuant to a promissory note, or the Promissory Note, datedJune 15, 2020 . During the period of time that the principal under the Promissory Note was outstanding, we accounted for the Promissory Note as debt within the accompanying consolidated financial statements. In accordance with applicable provisions of the CARES Act, effectiveJune 23, 2021 , our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of$965,000 . The full amount of interest expense to-date in the amount of approximately$9,000 that the Company recognized during the period the principal of the PPP Loan was outstanding was also forgiven by the SBA. Accordingly, the full amount of the gain in connection with the extinguishment of this debt, including the benefit from the forgiveness of the inception to-date interest expense, was recognized in the fiscal year endedJune 30, 2021 . 40 -------------------------------------------------------------------------------- Table of Contents Interest Income
Interest income for the fiscal years ended
Year Ended June 30, Change
2021 2020 Dollars Percent
Interest income $ 5,581 $ 158,091 $ (152,510 ) (96 )%
In June 2019 , we completed an underwritten public offering of 6,250,000 shares
of our common stock, which together with the partial exercise of the
underwriters' overallotment option for an additional 630,500 shares in July
2019 , resulted in net proceeds of approximately $9.99 million . The net proceeds
from this offering, along with excess operating cash, are deposited into and
maintained in an interest-bearing account with a federally insured commercial
bank. Accordingly, during the fiscal years ended June 30, 2021 and 2020, we
earned interest from cash on deposit in this interest-bearing account. The
decrease in earned interest reflects adverse changes in interest rate
fluctuations during Fiscal 2021 compared with Fiscal 2020.
Interest Expense
Interest expense for the fiscal years ended
Year Ended June 30, Change
2021 2020 Dollars Percent
Interest expense $ 8,953 $ 884 $ 8,069 913 %
In accordance with the terms of the Promissory Note, during the period of time
the principal of the PPP Loan was outstanding through June 23, 2021 , we accrued
interest at a fixed rate of 1% per annum. Our accrual for interest expense
associated with the PPP Loan began June 18, 2020 , the date we received the
proceeds for the PPP Loan from our Lender. Likewise, we accrued interest on the
PPP Loan during the fiscal year ended June 30, 2021 , through June 23, 2021 , the
date our PPP Loan was forgiven by the SBA.
Loss on Foreign Currency Exchange
Loss on foreign currency exchange related to foreign sales transacted in
functional currencies other than the
Year Ended June 30 , Change
2021 2020 Dollars Percent
Loss on foreign currency exchange
During the fiscal years endedJune 30, 2021 and 2020, we had international sales transactions denominated in currencies other than theU.S dollar that resulted in foreign currency exchange net losses. The decrease in these losses reflects the lower level of international sales denominated in foreign currencies as well as foreign currency exchange rate fluctuations during fiscal year endedJune 30, 2021 compared with those of the prior fiscal year.
Provision for Income Taxes
We recognized a net income tax benefit of approximately$6.33 million and a net income tax expense of approximately$2,000 for the fiscal years endedJune 30, 2021 and 2020, respectively. Our income tax provisions in these periods contain estimated taxes, penalties, and interest associated with uncertain tax positions. 41 -------------------------------------------------------------------------------- Table of Contents As of each reporting date, we consider new evidence, both positive and negative, that could impact our view with regard to future realization of deferred tax assets. Beginning in 2014, we determined that negative evidence outweighed the positive and established a full valuation allowance against our deferred tax assets and we maintained such full valuation allowance through the period endedJune 30, 2020 . However, as ofJune 30, 2021 , cumulative positive taxable income over the last three tax years had been generated in theU.S. , as compared to the negative evidence of cumulative losses in previous years. We also determined that our expectations of future taxable income in upcoming tax years, including estimated growth rates applied to future expected taxable income that includes significant management estimates and assumptions, would be sufficient to result in full utilization of our federal net operating loss carryforwards and certain of the deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence exists as ofJune 30, 2021 , to conclude that it is more likely than not deferred tax assets of approximately$6.35 million are realizable, and we reduced our valuation allowance accordingly. The reduction of the valuation allowances against these deferred tax assets was the main driver of the income tax benefit during the fiscal year endedJune 30, 2021 of approximately$6.33 million . A valuation allowance remains against certain deferred tax assets primarily relating to state net operating loss carryforwards from our e-commerce subsidiary due to the timing uncertainty of when it will generate positive taxable income to utilize the associated deferred tax assets. In addition, a valuation allowance also remains against certain deferred tax assets relating to operating loss carryforwards relating to our dormant subsidiary located inHong Kong . Our statutory tax rate as of the fiscal year endedJune 30, 2021 is 22.24% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.24%, net of the federal benefit.
Certain Operating Metrics
We believe that certain metrics are key to our business, including but not limited to monitoring our average order value, or AOV. We use the AOV computation in part to make strategic digital marketing related decisions and to monitor the performance and return on investment of our marketing activities. Our AOV is based on financial results and customer-related data for charlesandcolvard.com, LLC, our wholly owned subsidiary and through which we operate our primary transactional website. Our calculation for AOV is sensitive to several factors, including sales volume and product mix. Therefore, we believe that this metric may vary widely going forward as we respond to ever changing consumer demand and provide the products - that may have widely variable price points - which our audiences are seeking.
For the fiscal year ended
An additional metric that we use to manage charlesandcolvard.com operations and to make strategic digital marketing decisions for our transactional website is period-over-period revenue growth. Accordingly, we believe this level of growth reinforces our current year's digital marketing program and affirms our decision to increase our investment in consumer-driven marketing efforts in charlesandcolvard.com during Fiscal 2021. While we believe this metric is sensitive to many factors and may vary in future periods, we expect to continue to monitor and base our marketing-related investments in part on charlesandcolvard.com revenue growth going forward. For the fiscal year endedJune 30, 2021 , we experienced a 45% year-over-year growth in charlesandcolvard.com revenue compared to revenue for the fiscal year endedJune 30, 2020 .
Liquidity and Capital Resources
The full impact of the COVID-19 pandemic on the global and domestic economy remains uncertain and the world continues adapting to the ongoing pandemic and evolving viral variants and its adverse effects on global economics and worldwide business operations. The impact of the COVID-19 pandemic continues to place unprecedented pressures on global andU.S. businesses including our own. Depending on future developments, including the success of the global vaccine efforts to control the spread of the underlying virus and evolving variants, the pandemic could materially adversely impact our capital resources and liquidity in the future. We remain increasingly focused on the COVID-19 pandemic and are continually evaluating its potential effect on our business and liquidity and capital resources.
Capital Structure and Long-Term Debt
OnJune 18, 2020 , we received the proceeds from the PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of$965,000 was disbursed by the Lender pursuant to a promissory note, or the Promissory Note, issued by us onJune 15, 2020 . In accordance with applicable provisions of the CARES Act, effectiveJune 23, 2021 , our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of$965,000 . The full amount of the gain in connection with the extinguishment of this debt, including the forgiveness of accrued and unpaid interest of approximately$9,000 , was recognized in the fiscal year endedJune 30, 2021 . 42 -------------------------------------------------------------------------------- Table of Contents The CARES Act provided that existing AMT credit carryforwards were eligible for acceleration and refundable AMT credits were to be completely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, we elected to have our then existing AMT tax completely refunded and filed a refund claim for the remaining portion of our AMT tax credit. Accordingly, the remaining balance of our AMT credit refund in the amount of approximately$270,000 was completely refunded during the fiscal year endedJune 30, 2021 . We took advantage of available COVID-19 related payroll tax credits for certain wages and paid leave provided by us during the pandemic. A portion of these eligible tax credits are determined by qualified emergency paid sick and expanded family and medical leave wages pursuant to FFCRA. In addition, the Consolidated Appropriations Act, 2021, provides that employerswho received a PPP loan may also qualify for the Employee Retention Credit (the "ERC"). Previously, pursuant to the CARES Act, taxpayers that received a PPP loan were not eligible for the ERC and this change is retroactive toMarch 27, 2020 . We believe that we qualify for certain employer-related tax benefits pursuant to the ERC and expect to amend our applicable federal payroll tax returns for such benefit. Further, as permitted by the NC COVID-19 Relief Act, we expect to receive an incremental tax credit towards our contributions to theNorth Carolina Unemployment Insurance Fund . Accordingly, we will recognize any payroll tax credits related to these federal and state legislative actions in the period such benefits are received. For further discussion of the effects of the CARES Act, the Consolidated Appropriations Act, 2021, and the NC COVID-19 Relief Act on our provision for income taxes and deferred tax assets, see Note 13 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data", of this Annual Report on Form 10-K. As a component of our liquidity and capital structure, we have an effective shelf registration statement on Form S-3 on file with theSEC that allows us to periodically offer and sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total of$25.00 million , of which all is available. However, we may offer and sell no more than one-third of our public float (which is the aggregate market value of our outstanding common stock held by non-affiliates) in any 12-month period. Our ability to issue equity securities under the shelf registration statement is subject to market conditions, which may be in turn, subject to, among other things, the potential disruption and volatility that may be caused by ongoing effects of the COVID-19 pandemic. Any capital raise is not assured and may not be at terms that would be acceptable to us. Financing Activities InJune 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, inJuly 2019 , we issued an additional 630,500 shares of our common stock at a price of$1.60 per share for net proceeds of approximately$932,000 , net of the underwriting discount and fees and expenses of approximately$77,000 . After giving effect to the partial exercise of the over-allotment option, we sold an aggregate of 6,880,500 shares of our common stock at a price of$1.60 per share with total gross proceeds of approximately$11.01 million , before deducting the underwriting discount and fees and expenses of approximately$1.02 million . Early during Fiscal 2020, we began using the aggregate net proceeds of approximately$9.99 million from the offering for marketing and for general corporate and working capital purposes. In response to the COVID-19 pandemic and its impact on consumer confidence and spending, management drastically reduced related advertising and digital marketing expenditures inmid-March 2020 . However, we continue to monitor and adjust our advertising and digital marketing and professional services expenditure levels to correspond to market changes. As a result, we increased these expenditures during the fiscal year endedJune 30, 2021 , and may continue seeing an increase in these expenditure levels during Fiscal 2022 and beyond. As discussed above, onJune 18, 2020 , we received the proceeds from the PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of$965,000 was disbursed by the Lender pursuant to a Promissory Note issued by us onJune 15, 2020 . In accordance with applicable provisions of the CARES Act, effectiveJune 23, 2021 , our PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of$965,000 . The full amount of the gain in connection with the extinguishment of this debt, including the forgiveness of accrued and unpaid interest of approximately$9,000 , was recognized in the fiscal year endedJune 30, 2021 . 43 -------------------------------------------------------------------------------- Table of Contents Operating Activities and Cash Flows We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As ofJune 30, 2021 , our principal sources of liquidity were cash, cash equivalents, and restricted cash totaling$21.45 million , trade accounts receivable of$1.66 million , and net current inventory of$11.45 million , as compared to cash, cash equivalents, and restricted cash totaling$14.62 million , trade accounts receivable of$671,000 , and net current inventory of$7.44 million as ofJune 30, 2020 . We also had access during Fiscal 2021 to a$5.00 million asset-based revolving credit facility withWhite Oak , or the White Oak Credit Facility, which we terminated in accordance with its terms as ofJuly 9, 2021 . As described more fully herein, effectiveJuly 7, 2021 , we obtained fromJPMorgan Chase Bank, N.A ., or JPMorgan Chase, a$5.00 million cash collateralized line of credit facility, or the JPMorgan Chase Credit Facility. Also as described more fully herein, we had long-term debt in the form of a PPP Loan in the amount of$965,000 , of which$193,000 was classified as current as ofJune 30, 2020 . EffectiveJune 23, 2021 , the Company's PPP Loan forgiveness was approved and processed by the SBA for the full principal of the PPP Loan in the amount of$965,000 as well as forgiveness of accrued and unpaid interest of approximately$9,000 . During the fiscal year endedJune 30, 2021 , our working capital increased by approximately$12.72 million to$30.14 million from$17.42 million atJune 30, 2020 . As described more fully below, the increase in working capital atJune 30, 2021 is primarily attributable to an increase in our cash, cash equivalents, and restricted cash, principally resulting from cash provided by our operations, increase in our allocation of inventory from long-term to short-term due to a higher expected sell through of inventory on hand in the upcoming period, an increase in our accounts receivable, a decrease in our accounts payable, an increase in connection with the issuance of a short-term note receivable, a decrease in the current portion of our long-term debt, resulting from the forgiveness of our PPP Loan, and a decrease in our short-term operating lease liabilities. These factors were offset partially by an increase in our accrued expenses and other liabilities and a decrease in our prepaid expenses and other assets. During the fiscal year endedJune 30, 2020 , our working capital decreased by approximately$5.75 million to$17.42 million from$23.17 million atJune 30, 2019 . As described more fully below, the decrease in working capital atJune 30, 2020 is primarily attributable to a decrease in our allocation of inventory from long-term to short-term, a decrease in accounts receivable, an increase in short-term operating lease liabilities resulting from the adoption of the new lease accounting standard as ofJuly 1, 2019 , an increase in accrued expenses and other liabilities, an increase in accounts payable, and an increase in the current maturity of our long-term debt. These factors were offset partially by an increase in our cash, cash equivalents, and restricted cash resulting from cash provided by operating and financing activities and an increase in prepaid expenses and other assets. During the fiscal year endedJune 30, 2021 , approximately$6.47 million of cash was provided by our operations. The primary drivers of our cash flows from operations were the favorable effect of net income in the amount of$12.81 million ; an increase in accrued expenses and other liabilities of$3.71 million ; a decrease in inventory of$1.31 million ; and an increase in accrued income taxes in the amount of$2,000 . These factors were offset partially by an increase in prepaid expenses and other assets of$3.14 million ; an increase in accounts receivable of$955,000 ; and a decrease in accounts payable of$974,000 . In addition, the net effect of non-cash items included in net income totaling$6.29 million , driven by the benefit recognized for deferred income taxes in the amount of approximately$6.35 million in connection with the release of our valuation allowance and the gain on extinguishment of debt resulting from the forgiveness of our PPP Loan, including forgiveness of accrued and unpaid interest, in the amount of approximately$974,000 , also unfavorably impacted net cash provided by operating activities during the fiscal year endedJune 30, 2021 . During the fiscal year endedJune 30, 2020 , approximately$249,000 of cash was provided by our operations. The primary drivers underlying the cash provided by our operating activities were a decrease in accounts receivable of$1.32 million ; a decrease in prepaid expenses and other assets of$490,000 ; an increase in accounts payable of$469,000 ; and an increase in accrued expenses and other liabilities of$109,000 . In addition, non-cash items totaling$6.78 million also had a favorable impact on our cash flow from operations during the fiscal year endedJune 30, 2020 . These factors were offset partially by the unfavorable effect of our net loss in the amount of$6.16 million and an increase in inventory of approximately$2.76 million resulting from lower quantities of inventory items sold as a result of lower period sales stemming from the impact of the COVID-19 pandemic. 44 -------------------------------------------------------------------------------- Table of Contents During the fiscal year endedJune 30, 2021 , accounts receivable increased principally due to the increased level of sales during the three months endedJune 30, 2021 , as compared with the sales during the period leading up toJune 30, 2020 . As a result of the COVID-19 pandemic, from time to time we offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers during Fiscal 2021 and the second half of Fiscal 2020. Because of the ongoing impact of the pandemic on the global economy, the extension of these terms may not immediately increase liquidity as a result of ongoing current-period sales, which we expect may continue to be pressured due to the effects of the ongoing pandemic. In addition, we believe our competitors and other vendors in the wholesale jewelry industry have expanded their use of extended payment terms and, in aggregate, we believe that, through our use of extended payment terms, we provide a competitive response in our market during the current global economic environment. We believe that we are unable to estimate the impact of these actions on our net sales, but we believe that if we ceased providing extended payment terms, we would be at a competitive disadvantage for some Traditional segment customers in the marketplace during this economic period and that our net sales and profits would likely be adversely impacted. During the fiscal year endedJune 30, 2021 , prepaid expenses and other assets decreased principally as a result of the timing of payments, primarily for insurance-related premium expenses, in advance of goods or services received. During the fiscal year endedJune 30, 2021 , accrued expenses and other liabilities increased principally as a result of the increase in our operating lease liability associated with the new lease amendment for our corporate headquarters facilities that was executed inJanuary 2021 . During the fiscal year endedJune 30, 2021 , accounts payable decreased primarily as a result of the timing of payments for costs associated with inventory-related purchases and professional services incurred. As a result of the pandemic, we have from time-to-time paid certain vendor business partners in advance of their payment terms to secure and achieve supply chain needs. During the fiscal year endedJune 30, 2020 , prepaid expenses and other assets increased principally as a result of the timing of payments, principally for insurance-related expenses, in advance of goods or services received. During the fiscal year endedJune 30, 2020 , accounts payable increased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors' payment terms. Likewise, accrued expenses and other liabilities increased principally due to the severance accrual in connection with ourJune 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to payments received prior to shipment of good from customers. We manufactured approximately$7.63 million and$10.64 million in loose jewels and$12.72 million and$7.82 million in finished jewelry, which includes the cost of the loose jewels and the purchase of precious metals and labor in connection with jewelry production, during the fiscal years endedJune 30, 2021 and 2020, respectively. We expect our purchases of precious metals and labor to fluctuate in conjunction with the levels of our finished jewelry business. In addition, the price of gold has increased significantly over the past decade, resulting in higher retail price points for gold jewelry. Because the market price of gold and other precious metals is beyond our control, the upward price trends could continue and have a negative impact on our operating cash flow as we manufacture finished jewelry. Historically, our raw material inventories of SiC crystals had been purchased under exclusive supply agreements with a limited number of suppliers. Because the supply agreements restricted the sale of these crystals exclusively to us, the suppliers negotiated minimum purchase commitments with us that, when combined with reduced sales levels during prior periods in which the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As ofJune 30, 2021 and 2020,$17.72 million and$23.19 million , respectively, of our inventories were classified as long-term assets. Loose jewel sales and finished jewelry that we manufacture will utilize both the finished goods loose jewels currently on-hand and, as we deplete certain shapes and sizes, our on-hand raw material SiC crystals of$1.78 million and new raw material that we purchase pursuant to the Supply Agreement.
A more detailed description of our inventories is included in Note 6 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data", of this Annual Report on Form 10-K.
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Table of Contents
We made income tax payments of approximately $15,000 and $2,000 during the
fiscal years ended June 30, 2021 and 2020, respectively. As of June 30, 2021 ,
all of our remaining federal income tax credits had expired or been utilized,
and therefore, are not available to be carried forward to offset future income
taxes. As of June 30, 2021 and 2020, we had federal tax net operating loss
carryforwards of approximately $19.00 million and $23.72 million , respectively,
expiring between 2034 and 2037, or that have no expiration, which can be used to
offset against future federal taxable income; North Carolina tax net operating
loss carryforwards of approximately $19.87 million and $20.12 million ,
respectively, expiring between 2023 and 2035; and various other state tax net
operating loss carryforwards expiring between 2023 and 2040, which can be used
to offset against future state taxable income.
Contractual Commitment
OnDecember 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 onJune 24, 2018 , unless extended by the parties. EffectiveJune 22, 2018 , the Supply Agreement was amended to extend the expiration date toJune 25, 2023 . The Supply Agreement, as amended, also provides for the exclusive production of our premium moissanite product, Forever One™ and provided us with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following the expiration of the initial term. In addition, the amendment to the Supply Agreement established a process by which Cree may begin producing alternate SiC material based on our specifications that will give us the flexibility to use the materials in a broader variety of our products, as well as to permit us to purchase certain amounts of SiC materials from third parties under limited conditions. OnAugust 26, 2020 , the Supply Agreement was further amended, effectiveJune 30, 2020 , to extend the expiration date toJune 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, untilJune 2025 is approximately$52.95 million , of which approximately$32.85 million remains to be purchased as ofJune 30, 2021 . For more information regarding the second amendment to our Supply Agreement, executed onAugust 26, 2020 , see Note 10 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data", of this Annual Report on Form 10-K. During the fiscal years endedJune 30, 2021 and 2020, we purchased approximately$3.78 million and$7.47 million , respectively, of SiC crystals from Cree. Going forward, we expect to use existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, together with future cash expected to be provided by operating activities to finance our purchase commitment under the Supply Agreement, as amended. Line of Credit EffectiveJuly 7, 2021 , we obtained from JPMorgan Chase our$5.00 million cash collateralized JPMorgan Chase Credit Facility. The JPMorgan Chase Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions and certain additional indebtedness for borrowed money, installment obligations, and obligations under capital and operating leases. The JPMorgan Chase Credit Facility is secured by a cash deposit in the amount of$5.05 million held by JPMorgan Chase as collateral for the line of credit facility. Each advance accrues interest at a rate equal to JPMorgan Chase's monthlyLondon Interbank Offered Rate, or LIBOR, multiplied by a statutory reserve rate for eurocurrency funding to which JPMorgan Chase is subject with respect to the adjusted LIBOR rate as established by theU.S. Federal Reserve Board , plus a margin of 1.25% per annum. Interest is calculated monthly on an actual/360 day basis and payable monthly in arrears. Principal outstanding during an event of default, at JPMorgan Chase's option, accrues interest at a rate of 3% per annum in excess of the above rate. Any advance may be prepaid in whole or in part at any time. See Note 2, under the caption of Recently Issued Accounting Pronouncements, to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K for more detailed information relating to concerns about structural risks of interbank offered rates, or IBORs, and, particularly, the risk of cessation of the LIBOR. 46 -------------------------------------------------------------------------------- Table of Contents The JPMorgan Chase Credit Facility is evidenced by a credit agreement between us and JPMorgan Chase, or the JPMorgan Chase Credit Agreement, dated as ofJuly 12, 2021 , and customary ancillary documents, in the principal amount not to exceed$5.00 million at any one time outstanding and a line of credit note, or the JPMorgan Chase Line of Credit Note, in which we promise to pay on or beforeJuly 31, 2022 , the amount of$5.00 million or so much thereof as may be advanced and outstanding. In the event of default, JPMorgan Chase, at its option, may accelerate the maturity of advances outstanding under the JPMorgan Chase Credit Facility. The JPMorgan Chase Credit Agreement and ancillary documents contain customary covenants, representations, fees, debt, contingent obligations, liens, loans, leases, investments, mergers, acquisitions, divestitures, subsidiaries, affiliate transactions, and changes in control. In connection with the JPMorgan Chase Credit Facility, we incurred a non-refundable origination fee in the amount of$10,000 that was paid in full to JPMorgan Chase upon execution of the JPMorgan Chase Credit Facility onJuly 12, 2021 . We also agreed to maintain our primary banking depository and disbursement relationship with JPMorgan Chase. Events of default under the JPMorgan Chase Credit Facility include, without limitation, a default, event of default, or event that would constitute a default or event of default (pending giving notice or lapse of time or both), of any provision of the JPMorgan Chase Credit Agreement, the JPMorgan Chase Line of Credit Note, or any other instrument or document executed in connection with the JPMorgan Chase Credit Agreement or with any of our indebtedness, liabilities, and obligations to JPMorgan Chase or would result from the extension of credit to us by JPMorgan Chase.
On
Prior to obtaining the JPMorgan Chase Credit Facility, we and our wholly owned subsidiary, charlesandcolvard.com, LLC, collectively referred to as the Borrowers, had a$5.00 million asset-based revolving credit facility, or the White Oak Credit Facility, fromWhite Oak Commercial Finance, LLC , orWhite Oak , which we terminated in accordance with its terms as ofJuly 9, 2021 . The effective date of the White Oak Credit Facility wasJuly 13, 2018 , and it was scheduled to mature onJuly 13, 2021 . The White Oak Credit Facility was available for general corporate and working capital purposes, including permitted acquisitions and was guaranteed by the Borrowers. Under the terms of the White Oak Credit Facility, the Borrowers were required to maintain at least$500,000 in excess availability at all times. The White Oak Credit Facility contained no other financial covenants. Advances under the White Oak Credit Facility could have been either revolving or non-revolving. During the first year of the term of the White Oak Credit Facility, any revolving advances would have accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and any non-revolving advances would have accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins would have been reduced upon the Company's achievement of a specified fixed charge coverage ratio during the period of any outstanding advances. However, any advances were in all cases subject to a minimum interest rate of 5.50% and interest would have been calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default, which again did not occur during the term of the White Oak Credit Facility, would have accrued interest at a rate 2% in excess of the rate that would have been otherwise applicable. We had not borrowed against the White Oak Credit Facility as ofJuly 9, 2021 , the date upon which we terminated the White Oak Credit Facility in accordance with its terms. More detailed descriptions of both our JPMorgan Chase Credit Facility and former White Oak Credit Facility are included in Note 11 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data", of this Annual Report on Form 10-K. 47 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Trends We believe that our existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, and future cash expected to be provided by operating activities combined will be sufficient to meet our working capital and capital expenditure needs over the next twelve months. Our future capital requirements and the adequacy of available funds will depend on many factors, including the ongoing uncertainty surrounding COVID-19 that could lead to further disruption and volatility in the global capital markets as well as its impact on our rate of sales growth; the expansion of our sales and marketing activities; the timing and extent of raw materials and labor purchases in connection with loose jewel production to support our moissanite jewels and lab grown diamond business and precious metals and labor purchases in connection with jewelry production to support our finished jewelry business; the timing of capital expenditures; and the risk factors described in more detail in "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K. Currently, we have the JPMorgan Chase Credit Facility through its expiration onJuly 31, 2022 , which we believe would mitigate these risks to our cash and liquidity position. Also, we may make investments in, or acquisitions of, complementary businesses, which could also require us to seek additional equity or debt financing.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which we prepared in accordance with accounting principles generally accepted inthe United States , orU.S. GAAP. The future effects of the COVID-19 pandemic on our results of operations, cash flows, and financial position remain unclear. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosures of contingent assets and liabilities. "Critical accounting policies and estimates" are defined as those most important to the financial statement presentation and that require the most difficult, subjective, or complex judgments. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Under different assumptions and/or conditions, including the impact of the COVID-19 pandemic and the related responses, those actual results of operations may materially differ. The most significant estimates impacting our consolidated financial statements relate to the valuation and classification of inventories, accounts receivable reserves, deferred tax assets, and revenue recognition. We also have other policies that we consider key accounting policies, but these policies typically do not require us to make estimates or judgments that are difficult or subjective.
Valuation and Classification of Inventories
Inventories are stated at the lower of cost or net realizable value on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs. Any inventory on hand at the measurement date in excess of our current requirements based on historical and anticipated levels of sales is classified as long-term on our Consolidated Balance Sheets. The classification of our inventory as either current or long-term inventory requires us to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized in cost of sales over the next 12 months. Our work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. Our moissanite jewel manufacturing process involves the production of intermediary shapes, called "preforms", that vary depending upon the expected size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As ofJune 30, 2021 and 2020, work-in-process inventories issued to active production jobs approximated$2.23 million and$1.34 million , respectively. Each accounting period we evaluate the valuation and classification of inventories including the need for potential adjustments to inventory-related reserves and valuation allowances, which also include significant estimates by management. 48 -------------------------------------------------------------------------------- Table of Contents See Note 2 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K under the Inventories caption for a further description of our inventories accounting policy and see Note 6 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K for more detailed information relating to our accounting for inventory-related reserves and valuation allowances.
Revenue Recognition
Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To achieve this principle, we perform the following five steps: (i) identification of a contract with a customer; (ii) identification of any separate performance obligations; (iii) determination of the transaction price; (iv) allocation of the transaction price to the performance obligations in the contract; and (v) recognition of revenue when we have satisfied the underlying performance obligations. We recognize substantially all of our revenue at a point in time when control of our goods has passed to the customer with the exception of consigned goods. We consider our performance obligation related to the shipment of goods satisfied at the time this control is transferred. We also have a variable consideration element related to most of our contracts in the form of product return rights. At the time revenue is recognized, an allowance for estimated returns is established and any change in the allowance for returns is charged against net sales in the current period. For our customers (excluding those of charlesandcolvard.com), the returns policy generally allows for the return of jewels and finished jewelry with a valid reason for credit within 30 days of shipment, except for returns during the COVID-19 pandemic during which we generally extended the return period for an additional 30 days. Customers in both our charlesandcolvard.com and moissaniteoutlet.com websites may generally return purchases within 60 days and 30 days, respectively, of the shipment date in accordance with our returns policies as disclosed on our charlesandcolvard.com and moissaniteoutlet.com websites. Periodically, we ship loose jewel goods and finished goods to Traditional segment customers on consignment terms. Under these consignment terms, the customer assumes the risk of loss and has an absolute right of return for a specified period that typically ranges from six months to one year. Our Online Channels segment and Traditional segment customers are generally required to make payments on consignment shipments within 30 to 60 days upon the customer informing us that such inventory will be kept by the customer. Accordingly, we do not recognize revenue on these consignment transactions until the earlier of (i) the customer informing us that the inventory will be kept by the customer; (ii) the expiration of the right of returns period; or (iii) the customer informing us that the inventory has been sold. See Note 2 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data", of this Annual Report on Form 10-K under the Revenue Recognition caption for additional information regarding the underlying required disclosures arising from contracts with customers as well as a more detailed description of our revenue recognition accounting policy.
Accounts Receivable Reserves
Estimates are used to determine the amount of two reserves against trade accounts receivable. The first reserve is an allowance for sales returns. At the time revenue is recognized, we estimate future returns using a historical return rate that is reviewed quarterly with consideration of any contractual return privileges granted to customers, including any current extenuating economic conditions resulting from the COVID-19 pandemic, and we reduce sales and trade accounts receivable by this estimated amount. Our allowance for sales returns was$675,000 and$704,000 atJune 30, 2021 and 2020, respectively. The second reserve is an allowance for uncollectible accounts for the measurement of estimated credit losses resulting from the failure of our customers to make required payments. This allowance reduces trade accounts receivable to an amount expected to be collected. We use a current expected credit loss ("CECL") model whereby we estimate credit losses expected over the life of our pool of exposures based on historical percentages of uncollectible accounts, changes in payment history, and facts and circumstances, including any current extenuating economic conditions, for example those resulting from the COVID-19 pandemic, regarding specific accounts that become known to, or forecasted by, us when evaluating the adequacy of the allowance for uncollectible accounts. We determine a credit loss percentage based on the age of the receivable that we deem uncollectible related to potential credit losses. We record an allowance for such credit losses, which includes a provision for expected losses based on historical write-offs, adjusted for current conditions as deemed necessary, reasonable and supportable forecasts about future conditions, and a specific reserve for accounts deemed at risk. The allowance is our estimate for accounts receivable as of the balance sheet date that ultimately will not be collected. Any changes in the allowance are reflected in the results of operations in the period in which the change occurs. We write-off accounts receivable and the related allowance recorded previously when it becomes probable, based upon customer facts and circumstances, that such amounts will not be collected. We generally use internal collection efforts, which may include our sales personnel as deemed appropriate. After all internal collection efforts have been exhausted, we generally write-off the underlying account receivable. 49 -------------------------------------------------------------------------------- Table of Contents Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstances of the specific underlying customer account. During our review for the fiscal years endedJune 30, 2021 and 2020, we determined no additional reserves were necessary for specific accounts. Based on these criteria, we determined that allowances for uncollectible accounts receivable of$71,000 and$79,000 atJune 30, 2021 and 2020, respectively, were required.
Deferred Tax Assets
As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of available deferred tax assets. As of the fiscal year endedJune 30, 2020 , we did not recognize an income tax benefit for any of our deferred tax assets, primarily related to net operating loss carryforwards and inventory valuation reserves, because management determined that sufficient negative evidence continued to exist to conclude it was uncertain that we would have sufficient future taxable income to utilize our deferred tax assets. However, as ofJune 30, 2021 , cumulative positive taxable income over the last three tax years had been generated in theU.S. , as compared to the negative evidence of cumulative losses in previous years. We also determined that our expectation of future taxable income in upcoming tax years, including estimated growth rates applied to future expected taxable income that includes significant management estimates and assumptions, would be sufficient to result in full utilization of our federal net operating loss carryforwards and certain of the deferred tax assets prior to any statutory expiration. As a result, we determined that sufficient positive evidence exists as ofJune 30, 2021 , to conclude that it is more likely than not deferred tax assets of approximately$6.35 million are realizable, and we reduced our valuation allowance accordingly. The reduction of the valuation allowances against these deferred tax assets was the main driver of the income tax benefit during the fiscal year endedJune 30, 2021 of approximately$6.33 million . A valuation allowance remains against certain deferred tax assets primarily relating to state net operating loss carryforwards from our e-commerce subsidiary due to the timing uncertainty of when it will generate positive taxable income to utilize the associated deferred tax assets. In addition, as detailed below, a valuation allowance also remains against certain deferred tax assets relating to operating loss carryforwards relating to our dormant subsidiary located inHong Kong . As ofJune 30, 2021 , all of our remaining federal income tax credits had expired or been utilized, and therefore, are not available to be carried forward to offset future income taxes. As ofJune 30, 2021 and 2020, we had federal tax net operating loss carryforwards of approximately$19.00 million and$23.72 million , respectively, expiring between 2034 and 2037, or that have no expiration, which can be used to offset against future federal taxable income;North Carolina tax net operating loss carryforwards of approximately$19.87 million and$20.12 million , respectively, expiring between 2023 and 2035; and various other state tax net operating loss carryforwards expiring between 2023 and 2040, which can be used to offset against future state taxable income. As of each ofJune 30, 2021 and 2020, there was approximately$6.03 million in net operating loss carryforwards inHong Kong . In accordance with theHong Kong tax code, these amounts can be carried forward indefinitely to offset future taxable income inHong Kong . Our deferred tax assets inHong Kong were fully reserved with a valuation allowance of$996,000 as of each ofJune 30, 2021 and 2020, and had been fully reserved in all prior fiscal periods due to the uncertainty of future taxable income in this jurisdiction to utilize the deferred tax assets.Charles & Colvard (HK) Ltd. , ourHong Kong subsidiary, was entered into dormancy as ofSeptember 30, 2020 , following its re-activation inDecember 2017 .Charles & Colvard (HK) Ltd. previously became dormant in the second quarter of 2009 and has had no operating activity since 2008. If we use any portion of our deferred tax assets in future periods, the valuation allowance would need to be reversed and may impact our future operating results. For discussion of the effects of the CARES Act, the Consolidated Appropriations Act, 2021, and the NC COVID-19 Relief Act on our provision for income taxes and deferred tax assets, see Note 13 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data", of this Annual Report on Form 10-K. 50 -------------------------------------------------------------------------------- Table of Contents Uncertain Tax Positions We account for the de-recognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positions in accordance withU.S. GAAP. Determining which tax positions qualify as uncertain positions and the subsequent accounting for these positions requires significant estimates and assumptions. Our net accrued income tax liability under the provisions of this guidance was approximately$10,000 and$8,000 atJune 30, 2021 and 2020, respectively. This liability is only resolved when we obtain an official ruling from the tax authority on the positions or when the statute of limitations expires. Our liability for accrued interest on these uncertain tax positions has increased by approximately$2,000 for each of the fiscal years endedJune 30, 2021 and 2020.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements in Item 8, "Financial Statements and Supplementary Data", of this Annual Report on Form 10-K under the Recently Issued Accounting Pronouncements caption for the description of recent accounting pronouncements, including the expected date of adoption and estimated effects, on our consolidated financial statements.
Off-Balance Sheet Arrangements
We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As ofJune 30, 2021 and 2020, we did not have any off-balance sheet arrangements.
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