NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
|
DESCRIPTION OF BUSINESS
|
Charles & Colvard, Ltd. (the “Company”), a North Carolina corporation founded in 1995, manufactures, markets, and distributes Charles & Colvard Created Moissanite® (hereinafter referred to as moissanite or moissanite jewels) and finished jewelry featuring moissanite for sale in the worldwide jewelry market. Moissanite, also known by its
chemical name silicon carbide (“SiC”), is a rare mineral first discovered in a meteorite crater. Because naturally occurring SiC crystals are too small for commercial use, larger crystals must be grown in a laboratory. The Company sells loose
moissanite jewels and finished jewelry at wholesale prices to distributors, manufacturers, retailers, and designers, including some of the largest distributors and jewelry manufacturers in the world. The Company’s finished jewelry and loose moissanite
jewels that are mounted into fine jewelry by other manufacturers are sold at retail outlets and via the Internet. The Company sells at retail prices to end-consumers through its wholly owned operating subsidiary, charlesandcolvard.com, LLC, third-party
online marketplaces, drop-ship, and other pure-play, exclusively e-commerce outlets.
2.
|
BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
|
Basis of Presentation and Principles of Consolidation – The accompanying consolidated financial statements as of and for the fiscal years ended June 30, 2020 and 2019, include the accounts
of the Company and its wholly owned subsidiaries charlesandcolvard.com, LLC; Charles & Colvard Direct, LLC; and Charles & Colvard (HK) Ltd., the Company’s Hong Kong subsidiary, which was re-activated in December 2017. Charles & Colvard
Direct, LLC, had no operating activity during the fiscal years ended June 30, 2020 or 2019. Charles & Colvard (HK) Ltd. previously became dormant in the second quarter of 2009 and has had no operating activity since 2008. All intercompany accounts
have been eliminated.
Use of Estimates – The future effects of the COVID-19 pandemic on the Company’s results of operations, cash flows, and financial position
continue to remain unclear. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”)
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses
during the reporting period. The most significant estimates impacting the Company’s consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions, and
revenue recognition. Actual results could differ materially from those estimates.
Reclassifications – Certain amounts in the Company’s consolidated financial statements for the fiscal year ended June 30, 2019 have been reclassified to conform to
current presentation related to certain customer credit balances that were reclassified from accounts payable to accrued expenses and other liabilities in the amount of approximately $93,000. These reclassifications had no impact on the Company’s
consolidated financial position or consolidated results of operations as of or for the fiscal years ended June 30, 2020 and 2019.
Changes in Accounting Policy – Effective July 1, 2019, the Company adopted the new lease accounting standard issued by the Financial Accounting Standards Board (the “FASB”), which
requires leases to be recorded as right-of-use (“ROU”) assets and lease liabilities on the consolidated balance sheet and provides guidance on the recognition of lease expense and income. The new guidance requires the modified retrospective
transition approach when applying the new standard to an entity’s leases existing at the date of initial application. The guidance further states that an entity’s date of initial application may be either the effective date upon which it adopts the
new standard or the beginning of the earliest comparative period presented in the financial statements during the period in which it adopts the new guidance. The Company used the date of initial application as the effective date, and as such,
financial information and disclosures required under the new accounting standard will not be provided for dates and periods prior to July 1, 2019.
The new standard provides a number of practical expedients for transition and policy elections for ongoing accounting. The Company elected the “package of practical expedients”, which permits the Company to not reassess its prior conclusions about
lease identification, lease classification, and initial direct costs. The standard provides policy election options for recognition exemption for short-term leases and separation of lease and non-lease components. The Company elected the “short-term
lease recognition” exemption and elected not to separate lease and non-lease components for all underlying asset classes. The Company determines lease and non-lease components based on observable information, including terms provided by the lessor.
The adoption of the new accounting standard resulted in the recognition of ROU assets and lease liabilities of approximately $983,000 and $1.38 million, respectively, for operating leases as of July 1, 2019. For purposes of adopting this new
guidance, the Company’s most appropriate option for an incremental borrowing rate assumption was to assume that it would be based on the underlying fully-collateralized borrowing rate in effect within the Company’s credit facility with White Oak
Commercial Finance, LLC (“White Oak”). Pursuant to the terms of the Company’s credit facility with White Oak (the “White Oak Credit Facility”), as of July 1, 2019, the Company’s incremental borrowing rate for funds in the form of non-revolving
advances would have been White Oak’s one-month LIBOR (2.3878%) plus 4.75%, or 7.1378%. Management believes that this rate represents the incremental borrowing rate that would have been in effect if the Company had borrowed such funds from its White
Oak Credit Facility on July 1, 2019. Currently, the Company has no other material leases that qualify as finance, variable, or short-term leases. The adoption did not have a material impact on the Company’s consolidated statement of operations or
consolidated statement of cash flows.
Subsequent to the date of adoption, the Company determines if a contract is or contains a lease at inception of the agreement. Operating leases are recognized as ROU assets and the related obligations are recognized as current or noncurrent
liabilities on the Company’s consolidated balance sheet. Leases with an initial lease term of one year or less are not recorded on the balance sheet.
ROU assets, which represent the Company’s right to use an underlying asset, and lease liabilities, which represent the Company’s obligation to make lease payments arising from the lease, are recognized based on the present value of the future
lease payments over the lease term at the commencement date. The ROU asset also includes any lease payments made at or before the commencement date and any initial direct costs incurred and excludes lease incentives. Certain of the Company’s leases
contain renewal and/or termination options. The Company recognizes renewal or termination options as part of its ROU assets and lease liabilities when the Company has the unilateral right to renew or terminate and it is reasonably certain these
options will be exercised. The Company determines the present value of lease payments based on the implicit rate, which may be explicitly stated in the lease if available or the Company’s estimated collateralized incremental borrowing rate based on
the term of the lease. For operating leases, lease expense is recognized on a straight-line basis over the lease term.
Some leases could require the Company to pay non-lease components, which may include taxes, maintenance, insurance and certain other expenses applicable to the leased property, and are primarily considered variable costs. When applicable, such
costs are expensed as incurred.
For additional information regarding the Company’s accounting for lease arrangements, see Note 9, “Commitments and Contingencies.”
Cash and Cash Equivalents – All highly liquid investments with an original maturity of three months or less from the date of purchase are considered to be cash equivalents. The Company’s
cash and cash equivalents include cash on deposit and a money market fund. See the Restricted Cash caption below for further details on the nature and classifications of the Company’s restricted cash
balances.
Restricted Cash – In accordance with cash management process requirements relating to the Company’s asset-based revolving credit facility from White Oak,
there are access and usage restrictions on certain cash deposit balances for periods of up to two business days during which time such deposits are held by White Oak for the benefit of the Company. During the period these cash deposits are held by
White Oak, such amounts are classified as restricted cash for reporting purposes on the Company’s Consolidated Balance Sheets. In the event that the Company has an outstanding balance on its revolving credit facility from White Oak, restricted cash
balances held by White Oak would be applied to reduce such outstanding amounts.
The Company has full access to its cash balances without restriction following the period of time such cash is held by White Oak. For additional information regarding the Company’s asset-based revolving credit facility, see Note 10, “Line of
Credit.”
The reconciliation of cash, cash equivalents, and restricted cash, as presented on the Consolidated Statements of Cash Flows, consists of the following as of the dates presented:
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Cash and cash equivalents
|
|
$
|
13,993,032
|
|
|
$
|
12,465,483
|
|
Restricted cash
|
|
|
624,202
|
|
|
|
541,062
|
|
Total cash, cash equivalents, and restricted cash
|
|
$
|
14,617,234
|
|
|
$
|
13,006,545
|
|
Concentration of Credit Risk – Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash on deposit and cash equivalents
held with one bank and trade accounts receivable. At times, cash and cash equivalents balances may exceed the Federal Deposit Insurance Corporation (“FDIC”) insurable limits. The Company’s money market fund investment account (recognized as cash and
cash equivalents) is with what the Company believes to be a high-quality issuer. The Company has never experienced any losses related to these balances. Non-interest-bearing amounts on deposit in excess of FDIC insurable limits at June 30, 2020 and
2019 approximated $2.01 million and $2.12 million, respectively. Interest-bearing amounts on deposit in excess of FDIC insurable limits at June 30, 2020 and 2019 approximated $11.64 million and $10.01 million, respectively.
Trade receivables potentially subject the Company to credit risk. Payment terms on trade receivables for the Company’s Traditional segment customers are generally between 30 and 90 days, though it may offer
extended terms with specific customers and on significant orders from time to time. The Company extends credit to its customers based upon a number of factors, including an evaluation of the customer’s financial condition
and credit history that is verified through trade association reference services, the customer’s payment history with the Company, the customer’s reputation in the trade, and/or an evaluation of the Company’s opportunity to introduce its moissanite
jewels or finished jewelry featuring moissanite to new or expanded markets. Collateral is not generally required from customers. The need for an allowance for doubtful accounts is determined based upon factors surrounding the credit risk of
specific customers, historical trends, and other information.
See Note 13, “Major Customers and Concentration of Credit Risk”, for further discussion of credit risk within trade accounts receivable.
Accounts Receivable Reserves – Estimates are used to determine the amount of two reserves against trade accounts receivable. The first reserve is an allowance for sales returns. At the
time revenue is recognized, the Company estimates future returns using a historical return rate that is reviewed quarterly with consideration of any contractual return privileges granted to customers, including any current extenuating economic
conditions resulting from the COVID-19 pandemic, and it reduces sales and trade accounts receivable by this estimated amount. The Company’s allowance for sales returns was $704,000 and $746,000 at June 30, 2020 and 2019, respectively.
The following are reconciliations of the allowance for sales returns balances as of the periods presented:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Balance, beginning of year
|
|
$
|
746,000
|
|
|
$
|
648,000
|
|
Additions charged to operations
|
|
|
|
|
|
|
4,533,077
|
|
Sales returns
|
|
|
|
)
|
|
|
(4,435,077
|
)
|
Balance, end of year
|
|
$
|
704,000
|
|
|
$
|
746,000
|
|
The second reserve is an allowance for doubtful accounts for estimated losses resulting from the failure of the Company’s customers to make required payments. This allowance reduces trade accounts receivable to an
amount expected to be collected. Based on historical percentages of uncollectible accounts by aging category, changes in payment history, and facts and circumstances, including any current extenuating economic conditions resulting from the
COVID-19 pandemic, regarding specific accounts that become known to management when evaluating the adequacy of the allowance for doubtful accounts, the Company determines a percentage based on the age of the receivable that it deems uncollectible. The
allowance is then calculated by applying the appropriate percentage to each of the Company’s accounts receivable aging categories, with consideration given to individual customer account activity subsequent to the current period, including cash
receipts, in determining the appropriate allowance for doubtful accounts in the current period. Any increases or decreases to this allowance are charged or credited, respectively, as a bad debt expense to general and administrative expenses. The Company generally uses an internal collection effort, which may include its sales personnel as it deems appropriate. After all internal collection efforts have been exhausted, the Company generally writes off the account
receivable.
Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstances of the specific account. During its review for the fiscal years ended June
30, 2020 and 2019, the Company determined no additional reserves were necessary for specific accounts. Based on these criteria, management determined that allowances for doubtful accounts receivable of $79,000 and $249,000
at June 30, 2020 and 2019, respectively, were required.
The following are reconciliations of the allowance for doubtful accounts balances as of the periods presented:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Balance, beginning of year
|
|
$
|
249,000
|
|
|
$
|
233,000
|
|
Additions charged to operations
|
|
|
8,788
|
|
|
|
27,056
|
|
Write-offs, net of recoveries
|
|
|
(178,788
|
)
|
|
|
(11,056
|
)
|
Balance, end of year
|
|
$
|
79,000
|
|
|
$
|
249,000
|
|
Although the Company believes that its reserves are adequate, if the financial condition of its customers deteriorates, resulting in an impairment of their ability to make payments, or if it underestimates the
allowances required, additional allowances may be necessary, which would result in increased expense in the period in which such determination is made.
Inventories - Inventories are stated at the lower of cost or net realizable value on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs. Any inventory on hand at the measurement date in excess of the Company’s current
requirements based on historical and anticipated levels of sales is classified as long-term on the Company’s Consolidated Balance Sheets. The Company’s classification of its inventory as either current or long-term inventory requires it to estimate the
portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized in cost of sales over the next 12 months.
Each accounting period, the Company evaluates the valuation and classification of inventories including the need for potential adjustments to inventory-related reserves, which also include significant estimates by management. The Company’s
inventory-related valuation allowances are recorded in the aggregate rather than an individual item approach for each obsolescence, rework, and shrinkage valuation allowance.
Property and Equipment – Property and equipment are stated at cost and are depreciated over their estimated useful lives using the straight-line method as follows:
Machinery and equipment
|
5 to 12 years
|
Computer hardware
|
3 to 5 years
|
Computer software
|
3 years
|
Furniture and fixtures
|
5 to 10 years
|
Leasehold improvements
|
Shorter of the estimated useful life or the lease term
|
Intangible Assets – The Company capitalizes costs associated with obtaining or defending patents issued or pending for inventions and license rights related to the manufacture of
moissanite jewels. Such costs are amortized over the life of the patent, generally 15 years. The Company also capitalizes licenses it obtains for the use of certain advertising images and external costs incurred for trademarks. Such costs are amortized
over the period of the license or estimated useful life of the trademark, respectively.
Impairment of Long-Lived Assets – The Company
evaluates the recoverability of its long-lived assets by reviewing them for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.
Recoverability of assets to be held and used is measured by comparing the carrying amount of the asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment is
measured as the amount by which the carrying amount exceeds the fair value and is recognized as an operating expense in the period in which the determination is made. Assets to be disposed are reported at the lower of the carrying amount or fair
value less costs to sell once the held-for-sale criteria are met. As of June 30, 2020, the Company did not identify any indicators of long-lived asset impairment.
In addition to the recoverability assessment, the Company routinely reviews the remaining estimated useful lives of its long-lived assets. Any reduction in the useful-life assumption will result in increased depreciation and
amortization expense in the period when such determination is made, as well as in subsequent periods.
Revenue Recognition – Revenue is recognized to depict the transfer of promised
goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. To achieve this principle, the Company performs the following five steps: (i) 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 the
Company has satisfied the underlying performance obligations. The Company recognizes substantially all of its revenue at a point in time when control of the Company’s goods has passed to the customer with the exception of consigned goods. The Company
considers its sole performance obligation related to the shipment of goods satisfied at the time this control is transferred. Customer payment terms for these shipments typically range between 30- and 90-days. The Company has elected to treat
shipping and handling performed after control has transferred to customers as a fulfillment activity, and additionally, has elected the practical expedient to report sales taxes on a net basis. The Company records shipping and handling expense
related to product sales as cost of sales.
The Company has a variable consideration element related to most of its contracts in the form of product return rights. At the time revenue is recognized, an allowance for estimated returns is established and any change in
the allowance for returns is charged against net sales in the current period. For the Company’s 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. The Company’s charlesandcolvard.com customers can return purchases for any reason within 60 days of such purchase in accordance with the Company’s returns policy as disclosed on the charlesandcolvard.com website.
Periodically, the Company ships loose jewel goods and finished goods to Traditional segment customers on consignment terms. Under these consignment terms, the customer assumes the risk of loss and has an absolute right of
return for a specified period that typically ranges from six months to one year. The Company’s Online Channels segment and Traditional segment customers are generally required to make payments on consignment shipments within 30 to 60 days upon the
customer informing the Company that it will keep the inventory. Accordingly, the Company does not recognize revenue on these consignment transactions until the earlier of (i) the customer informing the Company
that it will keep the inventory; (ii) the expiration of the right of return period; or (iii) the customer informing the Company that the inventory has been sold.
The Company presents disaggregated net sales by its Online Channels segment and its Traditional segment for both finished jewelry and loose jewels product lines. The Company also presents disaggregated net sales by geographic
area between the United States and international locations. For financial reporting purposes, disaggregated net sales amounts are presented in Note 3, “Segment Information and Geographic Data.”
Returns Asset and Refund Liabilities
The Company maintains a returns asset account and a refund liabilities account to record the effects of its estimated product returns and sales returns allowance. The Company’s returns asset and refund liabilities are updated
at the end of each financial reporting period and the effect of such changes are accounted for in the period in which such changes occur.
The Company estimates anticipated product returns in the form of a refund liability based on historical return percentages and current period sales levels. The Company also accrues a related returns asset for goods
expected to be returned in salable condition, less any expected costs to recover such goods, including return shipping costs that the Company may incur. As of June 30, 2020 and 2019, the Company’s refund liabilities balances were $704,000 and
$746,000, respectively, and are included as allowances for sales returns within accounts receivable, net, in the accompanying consolidated balance sheets. As of June 30, 2020 and 2019, the Company’s returns asset balances were $289,000 and $279,000,
respectively, and are included within prepaid expenses and other assets in the accompanying consolidated balance sheets.
Cost of Goods Sold – Cost of goods sold is primarily composed of inventory sold during the period; inventory written off during the period due to ongoing quality and obsolescence reviews
or through customer returns; salaries and payroll-related expenses for personnel involved in preparing and shipping product to customers; an allocation of shared expenses such as rent, utilities, communication expenses, and depreciation related to
preparing and shipping product to customers; and outbound freight charges.
Advertising Costs – Advertising production costs are expensed as incurred. Media placement costs are expensed the first time the underlying advertising appears.
The Company also offers a cooperative advertising program to certain of its distributor and retail partners that reimburses, via a credit towards future purchases, a portion of their marketing costs based on the customers’ net purchases from the
Company and is subject to the customer providing documentation of all advertising performed that includes the Company’s products. For the fiscal years ended June 30, 2020 and 2019, these approximate amounts were $491,000 and $381,000, respectively, and
are included as a component of sales and marketing expenses.
Advertising expenses, inclusive of the cooperative advertising program, for the fiscal years ended June 30, 2020 and 2019, were approximately $3.96 million and $2.82 million, respectively.
Sales and Marketing – Sales and marketing costs are expensed as incurred. These costs include all expenses of promoting and selling the Company’s products and include such items as the
salaries, payroll-related expenses, and travel of sales and marketing personnel; digital marketing; advertising; trade shows; market research; sales commissions; and an allocation of overhead expenses attributable to these activities. Except for an
allocation to general and administrative expenses, these costs also include the operating expenses of charlesandcolvard.com, LLC, the Company’s wholly owned operating subsidiary.
General and Administrative – General and administrative costs are expensed as incurred. These costs include the salaries and payroll-related expenses of executive, finance, information
technology, and administrative personnel; legal, investor relations, and professional fees; general office and administrative expenses; Board of Directors fees; rent; bad debts; and insurance.
Research and Development – Research and development costs are expensed as incurred. These costs primarily comprise salary allocations, samples of competitive products entering the market,
and consultant fees associated with the study of product enhancement and manufacturing process efficiencies.
Stock-Based Compensation – The Company recognizes compensation expense for stock-based awards based on estimated fair values on the date of grant. The
Company uses the Black-Scholes-Merton option pricing model to determine the fair value of stock options. The fair value of other stock-based compensation awards is determined by the market price of the Company’s common stock on the date of grant. The
expense associated with stock-based compensation is recognized on a straight-line basis over the requisite service period of each award.
Fair value of stock options using the Black-Scholes-Merton option pricing model is estimated on the date of grant utilizing certain assumptions for dividend yield, expected volatility, risk-free interest rate, and expected lives of the awards, as
follows:
Dividend Yield. Although the Company issued dividends in prior years, a dividend yield of zero is used due to the lack of recent dividend
payments and the uncertainty of future dividend payments;
Expected Volatility. Volatility is a measure of the amount by which a financial variable such as share price has
fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company estimates expected volatility giving primary consideration to the historical volatility of its common stock;
Risk-Free Interest Rate. The risk-free interest rate is based on the published yield available on U.S. Treasury issues with an equivalent term
remaining equal to the expected life of the stock option; and
Expected Lives. The expected lives of the issued stock options represent the estimated period of time until exercise or forfeiture and are
based on the simplified method of using the mid-point between the vesting term and the original contractual term.
The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change
and the Company uses different assumptions, the Company’s stock-based compensation expense could be materially different in the future. In addition, the Company is required to estimate the expected forfeiture rates of stock-based awards and only
recognize expense for those shares expected to vest. In estimating the Company’s forfeiture rates, the Company analyzed its historical forfeiture rates, the remaining lives of unvested stock-based awards, and the number of vested awards as a percentage
of total awards outstanding. If the Company’s actual forfeiture rates are materially different from its estimates, or if the Company re-evaluates the forfeiture rates in the future, the stock-based compensation expense could be significantly different
from what the Company has recorded in the current period.
Income Taxes – Deferred income taxes are recognized for the income tax consequences of “temporary” differences by applying enacted statutory income tax rates applicable to future years to
differences between the financial statement carrying amounts and the income tax bases of existing assets and liabilities. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount that is more likely than
not to be realized.
The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) provides that existing alternative minimum tax (“AMT”) credit carryforwards are now eligible for
acceleration and refundable AMT credits are to be completely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, the Company has elected to have the AMT tax completely refunded and
has filed a tentative refund claim for the remaining AMT tax credit. For further discussion of the effects of the CARES Act on the Company’s income tax provision and deferred tax assets, see Note 12, “Income Taxes.”
Net (Loss) Income per Common Share – Basic net (loss) income per common share is computed by dividing net (loss) income by the weighted average number of common shares outstanding during
the periods. Diluted net (loss) income per common share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the periods. Common equivalent shares consist of stock options and unvested
restricted shares that are computed using the treasury stock method. Anti-dilutive stock awards consist of stock options that would have been anti-dilutive in the application of the treasury stock method.
The following table reconciles the differences between the basic and diluted net (loss) income per share presentations:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Numerator:
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(6,162,083
|
)
|
|
$
|
2,275,467
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
28,644,133
|
|
|
|
21,860,699
|
|
Effect of dilutive securities
|
|
|
-
|
|
|
|
250,524
|
|
Diluted
|
|
|
28,644,133
|
|
|
|
22,111,223
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income per common share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.22
|
)
|
|
$
|
0.10
|
|
Diluted
|
|
$
|
(0.22
|
)
|
|
$
|
0.10
|
|
For the fiscal year ended June 30, 2020, stock options to purchase approximately 2.81 million shares were excluded from the computation of diluted net loss per common share because the effect of inclusion of such
amounts would be anti-dilutive to net loss per common share. For the fiscal year ended June 30, 2019, stock options to purchase approximately 2.33 million were excluded from the computation of diluted net income
per common share because the exercise price of the stock options was greater than the average market price of the common shares or the effect of inclusion of such amounts would be anti-dilutive to net income per common share. The quantity of 162,500
shares of unvested restricted stock are excluded from the computation of diluted net loss per common share as of June 30, 2020 because the shares are performance-based and the underlying conditions have not been met as of the periods presented
and the effects of the inclusion of such shares would be anti-dilutive to net loss per common share.
Immaterial Correction of an Error – An immaterial error correction was made within the Company’s financial statements for the quarterly period
ended December 31, 2019. The Company determined that an accrued income tax liability for uncertain tax positions should have been derecognized in the prior years. Specifically, the Company had a liability of approximately $492,000 relating to
uncertain tax positions that should have been derecognized between the fiscal years ended December 31, 2012 and December 31, 2015. The Company evaluated the effect of this error and concluded it was not material to any of its previously issued
consolidated financial statements. Upon revision, the Company recorded a reduction to the accrued income tax liability and related accumulated deficit balance of approximately $492,000 which has been reflected in the June 30, 2019 consolidated
balance sheet presented in this annual report on Form 10-K for the fiscal year ended June 30, 2020. The impact of this error on the consolidated statement of operations for the fiscal years ended June 30, 2020 and 2019, including for interim
financial reporting periods therein, was de minimis and had no impact on the consolidated statements of cash flows for the fiscal years ended June 30, 2020
and 2019. Related balances within Note 12, “Income Taxes”, associated with the federal tax benefit on state income taxes under uncertain tax positions and the related valuation allowance have also been recast for the two-year period ended
June 30, 2020.
Recently Issued Accounting Pronouncements – In June 2016, the FASB issued guidance related to the measurement of credit losses on financial instruments
and to provide more information in financial statements about expected credit losses on financial instruments and other commitments to extend credit. The new guidance is effective for fiscal years beginning after December
15, 2019. The Company does not expect the adoption of the new guidance to have a material impact to the Company’s financial statements.
In August 2018, the FASB issued additional guidance in connection with accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. The updated guidance is effective for fiscal years beginning after
December 15, 2019. The Company is in the process of finalizing its analysis and believes the effect of the adoption of this new pronouncement is not expected to be material to the Company’s financial statements.
In December 2019, the FASB issued guidance on simplifying the accounting for income taxes that is intended to reduce the complexity while maintaining or improving the usefulness of tax disclosure information in
financial statements. The new guidance is effective for fiscal years beginning after December 15, 2020. The Company does not expect the impact of the new guidance to have a material impact to the Company’s financial statements.
In March 2020, in response to concerns about structural risks of interbank offered rates (“IBORs”), and, particularly, the risk of cessation of the London Interbank Offered Rate (“LIBOR”), the FASB issued new guidance to ease the burden in
accounting for or recognizing the effects of referenced interest rate reform on financial reporting. The new guidance is effective as of March 12, 2020 through December 31, 2022. As described in more detail in Note 10, “Line of Credit”, borrowings
under the Company’s line of credit are based on a rate equal to the one-month LIBOR. As of June 30, 2020, the Company had not borrowed against its line of credit, and therefore, is not subject to recognizing or disclosing any effect of referenced rate
reform as of its fiscal year ended June 30, 2020.
3.
|
SEGMENT INFORMATION AND GEOGRAPHIC DATA
|
The Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of the Company’s operating and reportable segments.
The Company manages its business through two operating and reportable segments based on its distribution channels to sell its product lines – finished jewelry and loose jewels: its “Online Channels” segment, which consists of e-commerce outlets
including charlesandcolvard.com, third-party online marketplaces, drop-ship, and other pure-play, exclusively e-commerce outlets; and its “Traditional” segment, which consists of wholesale and retail customers. The accounting policies of the Online
Channels segment and Traditional segment are the same as those described in Note 2, “Basis of Presentation and Significant Accounting Policies.”
The Company evaluates the financial performance of its segments based on net sales; product line gross profit, or the excess of product line sales over product line cost of goods sold; and operating (loss) income. The Company’s product line cost of
goods sold is defined as product cost of goods sold, excluding non-capitalized expenses from the Company’s manufacturing and production control departments, comprising personnel costs, depreciation, rent, utilities, and corporate overhead allocations;
freight out; inventory valuation allowance adjustments; and other inventory adjustments, comprising costs of quality issues, damaged goods, and inventory write-downs.
The Company allocates certain general and administrative expenses between its Online Channels segment and its Traditional segment based on net sales and number of employees to arrive at segment operating (loss) income. Unallocated expenses remain in
its Traditional segment. Summary financial information by reportable segment for the periods presented is as follows:
|
|
Year Ended June 30, 2020
|
|
|
|
Online
Channels
|
|
|
Traditional
|
|
|
Total
|
|
Net sales
|
|
|
|
|
|
|
|
|
|
Finished jewelry
|
|
$
|
13,680,440
|
|
|
$
|
3,097,188
|
|
|
$
|
16,777,628
|
|
Loose jewels
|
|
|
2,944,100
|
|
|
|
9,467,292
|
|
|
|
12,411,392
|
|
Total
|
|
$
|
16,624,540
|
|
|
$
|
12,564,480
|
|
|
$
|
29,189,020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product line cost of goods sold
|
|
|
|
|
|
|
|
|
|
|
|
|
Finished jewelry
|
|
$
|
5,760,413
|
|
|
$
|
1,709,377
|
|
|
$
|
7,469,790
|
|
Loose jewels
|
|
|
1,198,275
|
|
|
|
4,863,911
|
|
|
|
6,062,186
|
|
Total
|
|
$
|
6,958,688
|
|
|
$
|
6,573,288
|
|
|
$
|
13,531,976
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product line gross profit
|
|
|
|
|
|
|
|
|
|
|
|
|
Finished jewelry
|
|
$
|
7,920,027
|
|
|
$
|
1,387,811
|
|
|
$
|
9,307,838
|
|
Loose jewels
|
|
|
1,745,825
|
|
|
|
4,603,381
|
|
|
|
6,349,206
|
|
Total
|
|
$
|
9,665,852
|
|
|
$
|
5,991,192
|
|
|
$
|
15,657,044
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
$
|
(249,016
|
)
|
|
$
|
(6,066,712
|
)
|
|
$
|
(6,315,728
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
$
|
177,703
|
|
|
$
|
312,532
|
|
|
$
|
490,235
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
$
|
305,570
|
|
|
$
|
153,284
|
|
|
$
|
458,854
|
|
|
|
Year Ended June 30, 2019
|
|
|
|
Online
Channels
|
|
|
Traditional
|
|
|
Total
|
|
Net sales
|
|
|
|
|
|
|
|
|
|
Finished jewelry
|
|
$
|
12,641,687
|
|
|
$
|
2,815,656
|
|
|
$
|
15,457,343
|
|
Loose jewels
|
|
|
3,697,069
|
|
|
|
13,089,697
|
|
|
|
16,786,766
|
|
Total
|
|
$
|
16,338,756
|
|
|
$
|
15,905,353
|
|
|
$
|
32,244,109
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product line cost of goods sold
|
|
|
|
|
|
|
|
|
|
|
|
|
Finished jewelry
|
|
$
|
5,220,551
|
|
|
$
|
1,638,561
|
|
|
$
|
6,859,112
|
|
Loose jewels
|
|
|
1,583,404
|
|
|
|
6,659,426
|
|
|
|
8,242,830
|
|
Total
|
|
$
|
6,803,955
|
|
|
$
|
8,297,987
|
|
|
$
|
15,101,942
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product line gross profit
|
|
|
|
|
|
|
|
|
|
|
|
|
Finished jewelry
|
|
$
|
7,421,136
|
|
|
$
|
1,177,095
|
|
|
$
|
8,598,231
|
|
Loose jewels
|
|
|
2,113,665
|
|
|
|
6,430,271
|
|
|
|
8,543,936
|
|
Total
|
|
$
|
9,534,801
|
|
|
$
|
7,607,366
|
|
|
$
|
17,142,167
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
1,643,552
|
|
|
$
|
622,005
|
|
|
$
|
2,265,557
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
$
|
172,819
|
|
|
$
|
308,500
|
|
|
$
|
481,319
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
$
|
69,975
|
|
|
$
|
291,465
|
|
|
$
|
361,440
|
|
The Company does not allocate any assets to the reportable segments, and therefore, no asset information is reported to the chief operating decision-maker or disclosed in the financial information for each segment.
The reconciliations of the Company’s product line cost of goods sold to cost of goods sold, as reported in the consolidated financial statements for the periods presented, are as follows:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Product line cost of goods sold
|
|
$
|
13,531,976
|
|
|
$
|
15,101,942
|
|
Non-capitalized manufacturing and production control expenses
|
|
|
1,443,698
|
|
|
|
1,442,446
|
|
Freight out
|
|
|
510,612
|
|
|
|
578,772
|
|
Inventory write-off
|
|
|
|
|
|
|
393,000
|
|
Other inventory adjustments
|
|
|
|
)
|
|
|
(163,993
|
)
|
Cost of goods sold
|
|
$
|
21,200,207
|
|
|
$
|
17,352,167
|
|
The Company recognizes sales by geographic area based on the country in which the customer is based. Sales to international end consumers made through the Company’s transactional website, charlesandcolvard.com, are included in international sales
for financial reporting purposes. During periods prior to the quarter ended December 31, 2018, sales to international end consumers made through charlesandcolvard.com were included in U.S. sales because during those prior periods products were shipped
and invoiced to a U.S.-based intermediary that assumed all international shipping and credit risks. Currently, sales to international end consumers are made directly by the Company’s own transactional website. A portion of the Company’s Traditional
segment sales made to international wholesale distributors represents products sold internationally that may be re-imported to U.S. retailers.
All intangible assets, as well as property and equipment, as of June 30, 2020 and 2019, are held and located in the United States.
The following presents net sales data by geographic area for the periods presented:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Net sales
|
|
|
|
|
|
|
United States
|
|
$
|
26,814,024
|
|
|
$
|
27,979,835
|
|
International
|
|
|
2,374,996
|
|
|
|
4,264,274
|
|
Total
|
|
$
|
29,189,020
|
|
|
$
|
32,244,109
|
|
4.
|
FAIR VALUE MEASUREMENTS
|
Under U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S.
GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs
are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability.
The fair value hierarchy consists of three levels based on the reliability of inputs, as follows:
Level 1. Quoted prices in active markets for identical assets and liabilities;
Level 2. Inputs other than Level 1 quoted prices that are directly or indirectly observable; and
Level 3. Unobservable inputs that are not corroborated by market data.
The Company evaluates assets and liabilities subject to fair value measurements on a recurring and non-recurring basis to determine the appropriate level to classify them for each reporting period. This determination requires significant judgments
to be made by management of the Company. The financial instruments identified as subject to fair value measurements on a recurring basis are cash and cash equivalents, trade accounts receivable, and trade accounts payable. All financial instruments
are reflected in the consolidated balance sheets at carrying value, which approximates fair value due to the short-term nature of these financial instruments.
Assets that are measured at fair value on a non-recurring basis include property and equipment, leasehold improvements, and intangible assets, comprising patents, license rights, and trademarks. These items are
recognized at fair value when they are considered to be impaired. As of June 30, 2020 and 2019, no assets were identified for impairment. Level 3 inputs are primarily based on the estimated future cash flows of the asset determined by market
inquiries to establish fair market value of used machinery or future revenue expected to be generated with the assistance of patents and trademarks.
The Company’s total inventories, net of reserves, consisted of the following as of the dates presented:
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Finished jewelry:
|
|
|
|
|
|
|
Raw materials
|
|
$
|
821,536
|
|
|
$
|
643,797
|
|
Work-in-process
|
|
|
602,390
|
|
|
|
487,680
|
|
Finished goods
|
|
|
6,019,985
|
|
|
|
6,332,533
|
|
Finished goods on consignment
|
|
|
2,297,907
|
|
|
|
1,867,549
|
|
Total finished jewelry
|
|
|
9,741,818
|
|
|
|
9,331,559
|
|
Loose jewels:
|
|
|
|
|
|
|
|
|
Raw materials
|
|
|
3,526,399
|
|
|
|
3,806,681
|
|
Work-in-process
|
|
|
10,453,586
|
|
|
|
10,384,143
|
|
Finished goods
|
|
|
6,619,487
|
|
|
|
9,878,691
|
|
Finished goods on consignment
|
|
|
204,635
|
|
|
|
203,535
|
|
Total loose jewels
|
|
|
20,804,107
|
|
|
|
24,273,050
|
|
Total supplies inventory
|
|
|
88,034
|
|
|
|
129,111
|
|
Total inventory
|
|
$
|
30,633,959
|
|
|
$
|
33,733,720
|
|
As of the dates presented, the Company’s total inventories, net of reserves, are classified as follows:
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Short-term portion
|
|
$
|
7,443,257
|
|
|
$
|
11,909,792
|
|
Long-term portion
|
|
|
23,190,702
|
|
|
|
21,823,928
|
|
Total inventory
|
|
$
|
30,633,959
|
|
|
$
|
33,733,720
|
|
The Company’s work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in
the manufacture of finished jewelry. The Company’s moissanite jewel manufacturing process involves the production of intermediary shapes, called “preforms,” that vary depending upon the expected size and shape of the finished jewel. To maximize
manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of June 30, 2020 and 2019, work-in-process inventories issued to active production jobs approximated $1.34
million and $1.23 million, respectively.
The Company’s jewels do not degrade in quality over time and inventory generally consists of the shapes and sizes most commonly used in the jewelry industry. In addition, the majority of jewel inventory is not mounted in finished jewelry settings
and is therefore not subject to fashion trends, and product obsolescence is closely monitored and reviewed by management as of and for each financial reporting period.
The Company manufactures finished jewelry featuring moissanite. Relative to loose moissanite jewels, finished jewelry is more fashion-oriented and subject to styling trends that could render certain designs obsolete over time. The majority of the
Company’s finished jewelry featuring moissanite is held in inventory for resale and largely consists of such core designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets that tend not to be subject to significant obsolescence
risk due to their classic styling. In addition, the Company generally holds smaller quantities of designer-inspired and trend moissanite fashion jewelry that is available for resale through retail companies and through its Online Channels segment. The
Company also carries a limited amount of inventory as part of its sample line that is used in the selling process to its customers.
The Company’s continuing operating subsidiaries carry no net inventories, and inventory is transferred without intercompany markup from the parent entity as product line cost of goods sold when sold to the end consumer.
The Company’s inventories are stated at the lower of cost or net realizable value on an average cost basis. Each accounting period the Company evaluates the valuation and classification of inventories including the need
for potential adjustments to inventory-related reserves, which also include significant estimates by management. As a result of the deterioration of marketability of the Company’s legacy inventory, management determined that the inventory has lost
its revenue-generating ability and the net realizable value of this inventory has fallen below that of its historical carrying cost. The Company recognized a loss in net realizable value in the quarterly period ended March 31, 2020, for its legacy
material inventory, i.e., raw materials, or boules, preforms, work-in-process gemstones, finished gemstones, and
gemstones set in finished jewelry, the carrying cost of which was approximately $5.26 million.
Included in cost of goods sold during the fiscal year ended June 30, 2020, is the above-referenced write-off of approximately $5.26 million representing the carrying value of the Company’s legacy loose jewel inventory and finished jewelry inventory
set with these legacy gemstones. The legacy inventory raw materials were purchased and finished gemstone products were produced through the period ended August 2015. These gemstone products and finished jewelry
items are known and marketed as the Company’s older Forever ClassicTM, Forever
Brilliant®, and lower-grade gemstones.
The need for adjustments to inventory-related reserves and valuation allowances is evaluated on a period-by-period basis. Changes to the Company’s inventory reserves and allowances are accounted for in the current accounting period in which a change
in such reserves and allowances is observed and deemed appropriate, including changes in management’s estimates used in the process to determine such reserves and valuation allowances. Total inventory write-downs were $5.86 million and $393,000 for the
years ended June 30, 2020 and 2019, respectively.
6.
|
PROPERTY AND EQUIPMENT
|
Property and equipment consists of the following as of the dates presented:
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Computer software
|
|
$
|
1,827,581
|
|
|
$
|
1,512,533
|
|
Machinery and equipment
|
|
|
1,145,525
|
|
|
|
1,100,629
|
|
Computer hardware
|
|
|
1,158,559
|
|
|
|
1,064,302
|
|
Leasehold improvements
|
|
|
1,158,807
|
|
|
|
1,158,218
|
|
Furniture and fixtures
|
|
|
347,872
|
|
|
|
343,808
|
|
Total
|
|
|
5,638,344
|
|
|
|
5,179,490
|
|
Less accumulated depreciation
|
|
|
(4,639,283
|
)
|
|
|
(4,153,392
|
)
|
Property and equipment, net
|
|
$
|
999,061
|
|
|
$
|
1,026,098
|
|
Depreciation expense for the fiscal years ended June 30, 2020 and 2019 was approximately $486,000 and $480,000, respectively.
Intangible assets consist of the following as of the dates presented:
|
|
June 30,
|
|
|
Weighted
Average
Remaining
Amortization
Period
(in Years)
|
|
2020
|
|
|
2019
|
Patents
|
|
$
|
1,024,267
|
|
|
$
|
1,007,497
|
|
|
|
14.6
|
|
Trademarks
|
|
|
160,683
|
|
|
|
100,331
|
|
|
|
9.7
|
|
License rights
|
|
|
6,718
|
|
|
|
6,718
|
|
|
|
-
|
|
Total
|
|
|
1,191,668
|
|
|
|
1,114,546
|
|
|
|
|
|
Less accumulated amortization
|
|
|
(1,021,517
|
)
|
|
|
(1,017,173
|
)
|
|
|
|
|
Intangible assets, net
|
|
$
|
170,151
|
|
|
$
|
97,373
|
|
|
|
|
|
Amortization expense for the fiscal years ended June 30, 2020 and 2019 was approximately $4,000 and $2,000, respectively. Amortization expense on existing intangible assets is estimated to be approximately $16,000 for the fiscal year ending June 30,
2021 and $15,000 for each of the fiscal years ending June 30, 2022, 2023, 2024 and 2025. The amortization expense for the remaining unamortized balance of the total intangible assets, net, will be recognized in fiscal years ending after June 30, 2025.
8.
|
ACCRUED EXPENSES AND OTHER LIABILITIES
|
Total accrued expenses and other liabilities consist of the following as of the dates presented:
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Deferred revenue
|
|
$
|
794,740
|
|
|
$
|
100,088
|
|
Accrued compensation and related benefits
|
|
|
395,006
|
|
|
|
760,324
|
|
Accrued severance
|
|
|
338,355
|
|
|
|
-
|
|
Accrued sales tax
|
|
|
295,651
|
|
|
|
286,864
|
|
Deferred rent
|
|
|
-
|
|
|
|
156,306
|
|
Accrued cooperative advertising
|
|
|
89,517
|
|
|
|
73,033
|
|
Other
|
|
|
9,063
|
|
|
|
41,617
|
|
Accrued expenses and other liabilities
|
|
$
|
1,922,332
|
|
|
$
|
1,418,232
|
|
9.
|
COMMITMENTS AND CONTINGENCIES
|
Lease Arrangements
On December 9, 2013, the Company entered into a Lease Agreement, as amended on December 23, 2013 and April 15, 2014 (the “Lease Agreement”), for its corporate headquarters, which occupies approximately 36,350 square feet of office, storage, and
light manufacturing space and is classified as an operating lease for financial reporting purposes. The base term of the Lease Agreement expires on October 31, 2021 and the terms of the Lease Agreement contain no early termination provisions. Provided
there is no outstanding uncured event of default under the Lease Agreement, the Company has two options to extend the lease term for a period of five years under each option. The Company’s option to extend the term of the Lease Agreement must be
exercised in writing on or before 270 days prior to expiration of the then-current term. If the options are exercised, the monthly minimum rent for each of the extended terms will be adjusted to the then prevailing fair market rate.
The Company took possession of the leased property on May 23, 2014, once certain improvements to the leased space were completed and did not have access to the property before this date. These improvements and other lease related incentives offered
by the landlord totaled approximately $623,000, of which approximately $393,000 was unamortized as of July 1, 2019, the effective date upon which the Company adopted the new lease accounting standard as described in more detail in Note 2, “Basis of
Presentation and Significant Accounting Policies.”
The Company has no other material operating leases and is not party to leases that would qualify for classification as a finance lease, variable lease, or short-term lease.
As of June 30, 2020, the Company’s balance sheet classifications of its leases are as follows:
Operating Leases:
|
|
|
|
Noncurrent operating lease ROU assets
|
|
$
|
584,143
|
|
|
|
|
|
|
Current operating lease liabilities
|
|
$
|
622,493
|
|
Noncurrent operating lease liabilities
|
|
|
203,003
|
|
Total operating lease liabilities
|
|
$
|
825,496
|
|
The Company’s total operating lease cost was approximately $469,000 for the fiscal year ended June 30, 2020.
As of June 30, 2020, the Company’s estimated incremental borrowing rate used and assumed discount rate with respect to operating leases was 7.14% and the remaining operating lease term was 1.33 years.
As of June 30, 2020, the Company’s remaining future payments under operating leases for each fiscal year ending June 30 are as follows:
2021
|
|
$
|
642,997
|
|
2022
|
|
|
219,723
|
|
Total lease payments
|
|
|
862,720
|
|
Less: imputed interest
|
|
|
(37,224
|
)
|
Present value of lease payments
|
|
|
825,496
|
|
Less: current lease obligations
|
|
|
622,493
|
|
Total long-term lease obligations
|
|
$
|
203,003
|
|
The Company makes cash payments for amounts included in the measurement of its lease liabilities. During the fiscal year ended June 30, 2020, cash paid for operating leases was approximately $668,000 and, except for the ROU assets recorded upon
adoption of the new lease accounting standard as of July 1, 2019, there were no ROU assets obtained in exchange for new operating lease liabilities.
Lease Disclosures for the fiscal year ended June 30, 2019, as reported
The Company recognized rent expense on a straight-line basis, having given consideration to the rent holidays and escalations, the lease signing and moving allowance paid to the Company, and the rent abatement.
The Company’s total rent expense for operating leases was approximately $528,000 for the fiscal year ended June 30, 2019. The Company also had future minimum payments as of June 30, 2019 under its operating leases for each fiscal year ending June 30
that were as follows:
2020
|
|
$
|
625,788
|
|
2021
|
|
|
642,997
|
|
2022
|
|
|
219,723
|
|
Total
|
|
$
|
1,488,508
|
|
Purchase Commitments
On December 12, 2014, the Company entered into an exclusive supply agreement (the “Supply Agreement”) with Cree, Inc. (“Cree”). Under the Supply Agreement, subject to certain terms and conditions including a security interest as defined, the Company
agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of the Company’s required SiC materials in quarterly installments that must equal or exceed a set minimum order quantity. The initial term of the Supply Agreement was
scheduled to expire on June 24, 2018, unless extended by the parties.
Effective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement was also amended to (i) provide the Company with one option, subject to certain
conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following expiration of the initial term; (ii) establish a process by which Cree may begin producing
alternate SiC material based on the Company’s specifications that will give the Company the flexibility to use the materials in a broader variety of its products; and (iii) permit the Company to purchase certain
amounts of SiC materials from third parties under limited conditions.
The Company’s total purchase commitment under the Supply Agreement until June 2023 is approximately $52.95 million, of which approximately $36.60 million remains to be purchased as of June 30, 2020. Over the life of
the Supply Agreement, as amended, the Company’s future minimum annual purchase commitments of SiC crystals range from approximately $9 million to $12 million each year.
During the fiscal year ended June 30, 2020 and 2019, the Company purchased approximately $7.47 million and $8.91 million, respectively, of SiC crystals from Cree.
See Note 15, “Subsequent Event”, for details in connection with the second amendment to the Supply Agreement executed on August 26, 2020. Amendments to the Supply Agreement include, among other things, changes to the expiration date and an extension
of the period over which the Company must fulfill the total purchase commitment, which remains unchanged under the Supply Agreement, as amended.
COVID-19 Update
In March 2020, the novel strain of coronavirus, known as COVID-19, was declared a pandemic by the World Health Organization and declared a national emergency by the U.S. Government,
and has negatively affected the U.S. and global economies. In response to this pandemic, federal, state, county, and local governments and public health organizations and authorities around the world have
implemented a variety of measures intended to control the spread of the virus, including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing, and hygiene requirements. These measures have adversely affected workforces, customers, economies, and global supply chains, and resulted in significant travel and transport restrictions – all of which have combined to lead to an economic downturn. It
has also disrupted the normal operations of many businesses, including that of the Company’s. In early 2020 in the Asia Pacific region and during our quarter ended March 31,
2020 globally, the pandemic and related governmental and business responses began to have an adverse effect on the Company’s operations, supply chains, distribution channels, and consumer buying behaviors. Cumulatively, these things also impacted the
net realizable value and marketability of the Company’s legacy inventory, which was subsequently written-off.
The overall impacts of the COVID-19 pandemic include the following:
|
•
|
Across the Company’s supply chain, it experienced instances of suppliers temporarily closing their operations, delaying order fulfillment, or limiting their production. Where applicable, the Company utilized
alternative supply arrangements with partners whose businesses are not under stay-at-home orders or whose production came back online. During the quarter ended June 30, 2020, many of the Company’s suppliers began returning to normal operating
and production levels. However, the Company and its suppliers remain subject to ongoing changes to governmental closure requirements that may have a long-term impact on the Company’s supply chain and ability to produce gemstones and finished
jewelry for sale.
|
|
•
|
In the Company’s Online Channels segment, its transactional website charlesandcolvard.com remained open under restricted fulfillment capabilities. However, a quickly rising unemployment rate combined with consumer
uncertainty and lack of confidence began reducing website traffic and conversions in March 2020. Beginning in March 2020, the Company maintained limited shipping functions with support from third-party production and fulfillment partners. The
Company was also able to support only a certain level of active products on marketplaces and drop-ship partner websites such as Macys.com, Helzberg.com, Overstock.com, ShopHQ.com, and more. This ongoing e-commerce presence was restricted to
available stock and the limited production capacity of functioning suppliers. During the quarter ended June 30, 2020, the Company began seeing orders in our transactional website, along with orders in our marketplaces and drop-ship partner
websites, increase as consumer confidence strengthened and the Company’s operating and shipping functions began to return to normal activity levels. However, until business resumes to pre-pandemic levels across our entire supply chain, the
Company’s Online Channels segment is expected to continue to be adversely impacted by the pandemic.
|
|
•
|
In the Company’s Traditional segment, brick and mortar customers began closing their stores to foot traffic in March 2020, with tentative plans to re-open on a rolling schedule that may lead into the fall timeframe
or later. The Company also experienced instances of distributors, whose businesses rely on sales into retail organizations, reducing or closing their operations. These adverse effects impacted the Company’s ability to maintain significant
levels of sales through our wholesale customers. In addition, trade shows and industry events have been preemptively cancelled for the critical production season leading up to the calendar year-end 2020 holiday season. As a result, the
Company’s selling activities in its Traditional segment were significantly modified, and its ability to convert those activities into sales have been adversely impacted by the pandemic. Consistent with the trends the Company is experiencing
in its Online Channels segment, it has begun seeing business strengthen with its brick and mortar customers as these customers begin to move forward with their re-opening plans following their closures in March 2020, but until business
resumes to pre-pandemic levels, the Company’s Traditional segment is expected to continue to be adversely impacted by the pandemic.
|
|
•
|
As global and U.S economic activity slowed in response to the COVID-19 pandemic, the Company experienced and anticipates ongoing constraints on its cash and working capital, including experiencing potential
liquidity challenges. The impact of the pandemic has had – and is expected to continue having – an adverse effect on the Company’s operations and financial condition as revenues declined and, despite the Company’s cost-saving efforts, many business and operating expenses remained flat or continued to rise. Cash flow
scrutiny will be crucial for the Company’s business in the months ahead as the Company anticipates seeing lower revenues resulting in less cash flow, along with delayed accounts receivable collections, as needs grow to step up payables to
important suppliers. The Company continues to focus on being more nimble in managing its inventory levels given the uncertainty in the supply chain, which may also place further demands on working capital.
|
The COVID-19 pandemic has had a significant adverse impact on the Company’s business, results of operations, financial condition, and liquidity during Fiscal 2020. The full extent of the impact of the COVID-19
pandemic on the Company’s operational and financial performance is currently uncertain and will depend on many factors outside of its control, including, without limitation, the timing, extent, trajectory and duration of the pandemic, the
development and availability of effective treatments and vaccines, the imposition of protective public safety measures, and the impact of the pandemic on the global economy and demand for consumer and wholesaler products.
Since the onset of the pandemic domestically, the Company has implemented the following measures:
|
•
|
The Company deployed a work-from-home option for its employees on March 13, 2020, and effective March 27, 2020, instituted a mandatory work-from-home policy for all, but essential, employees due to mandated
stay-at-home orders by the State of North Carolina and local governmental authorities;
|
|
•
|
The Company temporarily suspended all hiring of employees starting April 13, 2020 and it furloughed approximately 50% of its employee base at that time, principally within our operations area. While
most of the Company’s operations employees returned to full-time status as it moved forward with its phased reopening plans during May 2020, these actions materially impacted the Company’s productivity;
|
|
•
|
The Company extended new benefits to assist employees who participate in its 401(k) plan with additional distribution and new borrowing terms;
|
|
•
|
The Company implemented temporary salary and wage reductions for all employees, including a 25% reduction in salary for the President and Chief Executive Officer and a 15% reduction for each of the Chief Financial
Officer and Chief Operating Officer. All employee salaries and wages were returned to pre-reduction levels in July 2020;
|
|
•
|
The Company reorganized its management and reduced its workforce. Effective June 1, 2020, Suzanne Miglucci, the Company’s former President and Chief Executive Officer, resigned and Don O’Connell was
appointed as its new President and Chief Executive Officer. At the same time, the Company enacted a significant reduction-in-force, or RIF, that reduced its active workforce by approximately 25%. Included in the RIF were the elimination of
senior-level sales, marketing, information technology, and operations personnel as well as executive-level sales and marketing positions. These RIF actions resulted in the Company’s recognition of severance-related expenses during the fourth
quarter of Fiscal 2020 in the amount of approximately $427,000. The liability for the unpaid portion of the Company’s severance-related accrual in the amount of approximately $338,000 is included in accrued expenses and other liabilities in
the accompanying consolidated balance sheet as of June 30, 2020;
|
|
•
|
The Company instituted a temporary 50% reduction in fees paid to its Board of Directors for the quarterly period ended June 30, 2020, which were also returned to pre-reduction levels in July 2020;
|
|
•
|
The Company successfully applied for and received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The loan in the
principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, a nationally licensed lender under the SBA, on June 18, 2020 pursuant to a Promissory Note issued by us on June 15, 2020. As provided under the CARES Act, the
Company intends to use the proceeds from this loan to enhance cash flow, to help maintain operations and fund current payroll requirements, and to assist the Company with the reopening phase of its business as it navigates the COVID-19
pandemic recovery efforts. There can be no assurance that such PPP loan will be forgiven; and
|
|
•
|
The Company reduced non-payroll operating expenses, including decreased digital marketing spend and significantly reduced product development investments and travel expenditures.
|
The Company is continuing to take the following steps to further address the impact of the COVID-19 pandemic:
|
•
|
The Company is actively renegotiating contracts with vendors and suppliers to amend commitments to size its supply with current demand and delivery terms with others to reduce its cost of goods and services;
|
|
•
|
The Company is negotiating extended payment terms with select partners;
|
|
•
|
The Company is continuing to align variable expenses to match current sales trends as it continues to move forward with its phased reopening; and
|
|
•
|
The Company is currently continuing to offer the flexibility of a work-from-home option for its employees who are able to perform full-time duties effectively from home as the State of North Carolina continues to
reopen through its predetermined phased reopening plan.
|
Paycheck Protection Program Loan
The Company received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the U.S. Small Business Administration (the “SBA”). The loan in the principal amount of $965,000 (the “PPP Loan”) was disbursed by
Newtek Small Business Finance, LLC, (“Lender”), a nationally licensed lender under the SBA, on June 18, 2020 pursuant to a promissory note issued by the Company (the “Promissory Note”) on June 15, 2020. The
Company accounted for the Promissory Note as debt within the accompanying consolidated financial statements.
The Promissory Note matures June 18, 2022 and may be extended with the consent of the Lender under the provisions of the CARES Act. The Promissory Note bears interest at a fixed rate of 1% per annum. Pursuant to the
terms of the Promissory Note, monthly principal and interest payments in the amount of approximately $41,000 will commence on April 1, 2021. For financial reporting purposes, as of June 30, 2020, the classification of the current maturity of
long-term debt assumes there will be no principal forgiveness and principal repayment for the full outstanding principal amount of the PPP Loan are assumed to be spread in equal monthly installments over the period from April 1, 2021 through the
maturity date of the Promissory Note. If the Company is required to repay the full outstanding principal amount of the PPP Loan, approximately $193,000 of the principal is expected to be paid during the fiscal year ending June 30, 2021 and
approximately $772,000 is expected to be paid during the fiscal year ending June 30, 2022.
The Company did not provide any collateral or guarantees for the PPP Loan, nor did the Company pay any facility charge to obtain the PPP Loan. The Promissory Note provides for customary events of default, including, among
others, those relating to failure to make payment and breaches of representations. The Company may prepay the principal of the PPP Loan at any time without incurring any prepayment charges.
Under the CARES Act and the Promissory Note, loan forgiveness is available for the sum of documented payroll costs, covered rent payments, and covered utilities during the 24-week period beginning on the date of first
disbursement of the PPP Loan. For purposes of the CARES Act, payroll costs exclude cash compensation of an individual employee in excess of $100,000, prorated annually. Not more than 40% of the forgiven amount can be attributable to non-payroll
costs. Although the Company currently believes that its use of the PPP Loan will meet the conditions for forgiveness of the PPP Loan, the Company cannot assure its future adherence to the forgiveness criteria and that the PPP Loan will be forgiven, in whole or in part.
Line of Credit
On July 13, 2018, the Company and its wholly-owned subsidiary, charlesandcolvard.com, LLC (collectively, the “Borrowers”), obtained a $5.00 million asset-based revolving credit facility (the “White Oak Credit Facility”) from
White Oak Commercial Finance, LLC (“White Oak”). The White Oak Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions. The White Oak Credit Facility, which matures on July 13, 2021, is
guaranteed by Charles & Colvard Direct, LLC, a wholly-owned subsidiary of the Company (the “Guarantor”). Under the terms of the White Oak Credit Facility, the Borrowers must maintain at least $500,000 in excess availability at all times. The White
Oak Credit Facility contains no other financial covenants.
Advances under the White Oak Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers’ eligible accounts receivable and inventory, plus the value of
precious metal jewelry components, less reserves. The inclusion of inventory and precious metal jewelry components in the borrowing base was subject to the completion of an inventory appraisal, which was completed subsequent to the execution of the
White Oak Credit Facility. Eligible inventory is further limited to 60% of the net borrowing base, while precious metal jewelry components are limited to $500,000.
Advances may be either revolving or non-revolving. Non-revolving advances are limited to $1.00 million in aggregate principal amount outstanding and must be repaid on each January 15 (which may be effected by conversion to
revolving advances, absent an event of default). There are no other mandatory prepayments or line reductions. The Company may elect to prepay advances in whole or in part at any time without penalty. In addition, the White Oak Credit Facility may be
terminated by the Company at any time, subject to a $100,000 fee in the first year of the term of the White Oak Credit Facility, a $50,000 fee in the second year, and no fee thereafter. In connection with the White Oak Credit Facility, the Company
incurred a non-refundable origination fee in the total amount of $125,000 that is due and payable to White Oak in three installments. The first installment in the amount of $41,667 was paid upon execution of the White Oak Credit Facility on July 13,
2018 and the second installment in the amount of $41,667 was paid on July 15, 2019. The third and final installment in the amount of $41,666 was paid on August 14, 2020.
During the first year of the term of the White Oak Credit Facility, 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 non-revolving
advances will accrue interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins will reduce upon the Company’s achievement of a specified fixed charge coverage ratio. However, advances are in all cases subject to a minimum interest rate
of 5.50%. Interest is calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default accrues interest at a rate 2% in excess of the rate otherwise applicable.
The White Oak Credit Facility is secured by a lien on substantially all assets of the Borrowers, each of which is jointly and severally liable for all obligations thereunder. White Oak’s security interest in certain SiC
materials is subordinate to Cree’s security interest in such materials pursuant to the Company’s Supply Agreement and an Intercreditor Agreement by and among the Borrowers and the Guarantor with White Oak. In addition, White Oak’s security interest in
certain tangible personal property of the Company is subordinate to its landlord’s security interest in such tangible personal property.
The White Oak Credit Facility is evidenced by a credit agreement, dated as of July 13, 2018 (the “Credit Agreement”), a security agreement, dated as of July 13, 2018 (the “Security Agreement”), and customary ancillary
documents. The Credit Agreement, Security Agreement, and ancillary documents contain customary covenants, representations, fees, and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt,
liens, loans, investments, mergers, acquisitions, divestitures, and affiliate transactions.
Events of default under the White Oak Credit Facility include, without limitation, a change in control, an event of default under other indebtedness of the Borrowers or Guarantor in excess of $250,000, a material adverse
change in the business of the Borrowers or Guarantor or in their ability to perform their obligations under the White Oak Credit Facility, and other defined circumstances that White Oak believes may impair the prospect of repayment. If an event of
default occurs, White Oak is entitled to take enforcement action, including acceleration of amounts due under the White Oak Credit Facility and foreclosure upon collateral.
The White Oak Credit Facility contains other customary terms, that include indemnity, collateral monitoring fee, minimum interest charge, expense reimbursement, yield protection, and confidentiality provisions.
As of June 30, 2020, the Company had not borrowed against the White Oak Credit Facility. As a result of the Company’s diminished borrowing base, which is tied to its accounts receivable, its ability to draw down funds from
the White Oak Credit Facility is currently restricted.
11.
|
SHAREHOLDERS’ EQUITY AND STOCK-BASED COMPENSATION
|
Common Stock
The Company is authorized to issue 50,000,000 shares of common stock, no par value. As of June 30, 2020 and 2019, it had 28,949,410 and 28,027,569 shares of common stock outstanding, respectively. Holders of the Company’s common stock are entitled
to one vote for each share held.
Preferred Stock
The Board of Directors is authorized, without further shareholder approval, to issue up to 10,000,000 shares of preferred stock, no par value. The preferred stock may be issued from time to time in one or more series. No shares of preferred stock had been issued as of June 30, 2020.
Dividends
The Company has paid no cash dividends during the fiscal years ended June 30, 2020 and 2019.
Shelf Registration Statement
The Company has an effective shelf registration statement on Form S-3 on file with the U.S. Securities and Exchange Commission (the “SEC”) which allows it to periodically offer and
sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total
of $25.00 million, of which approximately $13.99 million remains available after giving effect to the Company’s June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option, as described
below. However, the Company may offer and sell no more than one-third of its public float (which is the aggregate market value of the Company’s outstanding common stock held by non-affiliates) in any 12-month
period. The Company’s ability to issue equity securities under its effective shelf registration statement is subject to market conditions, which are in turn, subject to, among other things, the disruption and
volatility caused by the COVID-19 pandemic.
On June 11, 2019, the Company completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the public of $1.60 per share, pursuant to its effective shelf registration
statement on Form S-3. Net proceeds from the offering were approximately $9.06 million, net of the underwriting discount and fees and expenses in the amount of approximately $941,000. Pursuant to the terms of the underwriting agreement entered in
connection with this offering, the underwriters were granted a 30-day option to buy up to an additional 937,500 shares of the Company’s common stock to cover over-allotments. Pursuant to the partial exercise of the
underwriters’ over-allotment option, on July 3, 2019, the Company issued an additional 630,500 shares of its common stock at a price of $1.60 per share for net proceeds of approximately $932,000, net of
the underwriting discount and fees and expenses of approximately $77,000. After giving effect to the partial exercise of the over-allotment option, the Company sold an aggregate of 6,880,500 shares of its common stock at a
price of $1.60 per share with total gross proceeds of approximately $11.01 million, before deducting the total underwriting discount and fees and expenses of approximately $1.02 million.
Equity Compensation Plans
2018 Equity Incentive Plan
On November 21, 2018, the shareholders of the Company approved the adoption of the Charles & Colvard, Ltd. 2018 Equity Incentive Plan, (the “2018 Plan”). The 2018 Plan will expire by its terms on September 20, 2028.
The 2018 Plan provides for the grant of equity-based awards to selected employees, directors, and consultants of the Company and its affiliates. The aggregate number of shares of the Company’s common stock that could be issued pursuant to awards
granted under the 2018 Plan are not to exceed the sum of 3,300,000 plus the number of shares of common stock underlying any award granted under any stock incentive plan maintained by the Company prior to the 2018 Plan (each, a “2018 Prior Plan”) that
expires, terminates or is canceled or forfeited under the terms of the 2018 Prior Plans. Stock options granted to employees under the 2018 Plan generally vest over four years and have terms of up to 10 years. The vesting schedules and terms of stock
options granted to independent contractors vary depending on the specific grant, but the terms are no longer than 10 years. Stock option awards granted to members of the Board of Directors generally vest at the end of one year from the date of the
grant. The vesting schedules of restricted stock awards granted to employees or independent contractors vary depending on the specific grant but are generally four years or less. Only stock options and restricted stock have been granted under the 2018
Plan. As of June 30, 2020 and 2019, there were 790,407 and 285,025 stock options outstanding under the 2018 Plan, respectively.
2008 Stock Incentive Plan
In May 2008, the shareholders of the Company approved the adoption of the Charles & Colvard, Ltd. 2008 Stock Incentive Plan, as amended on March 31, 2015 and approved by the shareholders of the Company on May 20, 2015 and further amended on March 15, 2016 and approved by the shareholders of the Company on May 18, 2016 (the “2008 Plan”). The 2008 Plan expired (with respect to future grants) on May 26, 2018.
The 2008 Plan authorized the Company to grant stock options, stock appreciation rights, restricted stock, and other equity awards to selected employees, directors, and independent contractors. The aggregate number of shares of the Company’s common
stock that could be issued pursuant to awards granted under the 2008 Plan were not to exceed the sum of 6,000,000 plus any shares of common stock subject to an award granted under any stock incentive plan maintained by the Company prior to the 2008
Plan (each, a “2008 Prior Plan”) that is forfeited, cancelled, terminated, expires, or lapses for any reason without the issuance of shares pursuant to the award, or shares subject to an award granted under a 2008 Prior Plan which shares are forfeited
to, or repurchased or reacquired by, the Company. Stock options granted to employees under the 2008 Plan generally vest over four years and have terms of up to 10 years. The vesting schedules and terms of stock options granted to independent
contractors vary depending on the specific grant, but the terms are no longer than 10 years. Stock option awards granted to members of the Board of Directors generally vest at the end of one year from the date of the grant. The vesting schedules of
restricted stock awards granted to employees or independent contractors vary depending on the specific grant but are generally four years or less. Only stock options and restricted stock had been granted under the 2008 Plan. As of June 30, 2020 and
2019, there were 2,018,688 and 2,238,613 stock options outstanding under the 2008 Plan, respectively.
Stock-Based Compensation
The following table summarizes the components of the Company’s stock-based compensation included in net (loss) income for the periods presented:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Employee stock options
|
|
$
|
309,999
|
|
|
$
|
235,984
|
|
Restricted stock awards
|
|
|
149,539
|
|
|
|
266,821
|
|
Total
|
|
$
|
459,538
|
|
|
$
|
502,805
|
|
Due to the Company’s valuation allowance against deferred tax assets as discussed further in Note 12, “Income Taxes”, any income tax benefits associated with these grants and awards for the fiscal years ended June 30, 2020 and 2019 were fully
reserved.
No stock-based compensation was capitalized as a cost of inventory during the fiscal years ended June 30, 2020 and 2019.
Stock Options
The following is a summary of the stock option activity for the fiscal years ended June 30, 2020 and 2019:
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
Outstanding at June 30, 2018
|
|
|
2,388,169
|
|
|
$
|
1.46
|
|
Granted
|
|
|
285,025
|
|
|
$
|
1.00
|
|
Exercised
|
|
|
(52,500
|
)
|
|
$
|
1.21
|
|
Forfeited
|
|
|
(30,000
|
)
|
|
$
|
1.20
|
|
Expired
|
|
|
(67,056
|
)
|
|
$
|
1.71
|
|
Outstanding at June 30, 2019
|
|
|
2,523,638
|
|
|
$
|
1.39
|
|
Granted
|
|
|
605,387
|
|
|
$
|
0.95
|
|
Forfeited
|
|
|
(125,005
|
)
|
|
$
|
1.02
|
|
Expired
|
|
|
(194,925
|
)
|
|
$
|
1.18
|
|
Outstanding at June 30, 2020
|
|
|
2,809,095
|
|
|
$
|
1.33
|
|
The weighted average grant date fair value of stock options granted during the fiscal year ended June 30, 2020 and 2019 was $0.50 and $0.57, respectively. The total fair value of stock options that vested during the fiscal
year ended June 30, 2020 and 2019 was approximately $282,000 and $176,000, respectively.
The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option pricing model with the following weighted average assumptions for stock options granted during the periods
presented:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Dividend yield
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
Expected volatility
|
|
|
63.2
|
%
|
|
|
61.0
|
%
|
Risk-free interest rate
|
|
|
0.82
|
%
|
|
|
3.09
|
%
|
Expected lives (years)
|
|
|
5.2
|
|
|
|
5.5
|
|
The following tables summarize information in connection with stock options outstanding at June 30, 2020:
Options Outstanding
|
|
|
Options Exercisable
|
|
|
Options Vested or Expected to Vest
|
|
Balance
as of
6/30/2020
|
|
|
Weighted
Average
Remaining
Contractual
Life
(Years)
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Balance
as of
6/30/2020
|
|
|
Weighted
Average
Remaining
Contractual
Life
(Years)
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Balance
as of
6/30/2020
|
|
|
Weighted
Average
Remaining
Contractual
Life
(Years)
|
|
|
Weighted
Average
Exercise
Price
|
|
|
2,809,095
|
|
|
|
5.74
|
|
|
$
|
1.33
|
|
|
|
2,396,208
|
|
|
|
5.11
|
|
|
$
|
1.37
|
|
|
|
2,743,077
|
|
|
|
5.66
|
|
|
$
|
1.34
|
|
As of June 30, 2020, the unrecognized stock-based compensation expense related to unvested stock options was approximately $155,000, which is expected to be recognized over a weighted average period of approximately 17 months.
The aggregate intrinsic value of stock options outstanding, exercisable, and vested or expected to vest at June 30, 2020 was approximately $500. These amounts are before applicable income taxes and represent the closing
market price of the Company’s common stock at June 30, 2020, less the grant price, multiplied by the number of stock options that had a grant price that is less than the closing market price. These amounts represent the amounts that would have been
received by the optionees had these stock options been exercised on those dates. No stock options were exercised during the fiscal year ended June 30, 2020. The aggregate intrinsic value of stock options exercised during the fiscal year ended June 30,
2019 was approximately $51,000.
Restricted Stock
The following is a summary of the restricted stock activity for the fiscal years ended June 30, 2020 and 2019:
|
|
Shares
|
|
|
Weighted
Average
Grant Date
Fair Value
|
|
Unvested at June 30, 2018
|
|
|
264,000
|
|
|
$
|
1.25
|
|
Granted
|
|
|
129,500
|
|
|
$
|
1.07
|
|
Vested
|
|
|
(154,396
|
)
|
|
$
|
1.20
|
|
Canceled
|
|
|
(109,604
|
)
|
|
$
|
1.31
|
|
Unvested at June 30, 2019
|
|
|
129,500
|
|
|
$
|
1.08
|
|
Granted
|
|
|
325,000
|
|
|
$
|
1.57
|
|
Vested
|
|
|
(258,341
|
)
|
|
$
|
1.07
|
|
Canceled
|
|
|
(33,659
|
)
|
|
$
|
1.07
|
|
Unvested at June 30, 2020
|
|
|
162,500
|
|
|
$
|
1.57
|
|
The unvested restricted shares as of June 30, 2020 are all performance-based restricted shares that are scheduled to vest, subject to achievement of the underlying performance goals, in July 2020. As of June 30,
2020, the estimated unrecognized stock-based compensation expense related to unvested restricted shares subject to achievement of performance goals was approximately $255,000. However, pursuant to the estimated success rates related to the
performance-based criteria of the restricted shares, none of which are expected to vest, none of the underlying compensation expense related to the unvested shares is expected to be recognized.
In connection with filing its 2017 U.S. corporate income tax return in June 2018, the Company’s management analyzed the income tax effects of the Tax Cuts and Jobs Act (the “Tax Act”), enacted in December 2017, and
the effect on its existing corporate AMT deferred tax asset, including the recoverability of its AMT-related deferred tax credit carryforwards. As a result, management determined that it was able to recognize the underlying tax benefit relating to the
realization of the recoverable portion of its AMT-related deferred tax credit carryforwards, net of an anticipated sequestration reduction in the amount of approximately $328,000. Accordingly, the Company recorded the expected AMT credit refund as a
receivable, net of an anticipated sequestration reduction and such amount was included with other long-term assets as of June 30, 2018.
In January 2019, the Internal Revenue Service (the “IRS”) announced that refund payments and refund offset transactions due to refundable minimum tax credits associated with the repeal of the corporate AMT as part of the Tax Act would not be subject
to sequestration. Accordingly, in January 2019 the Company recognized the additional available underlying tax benefit in the amount of approximately $23,000 relating to the sequestered portion of its AMT credit. This amount, net of amounts received,
was also included in other long-term assets in the accompanying consolidated balance sheet as of June 30, 2019.
The Company received installment refunds in May 2019 and April 2020 of approximately $75,000 and $6,000, respectively, from the IRS in accordance with the AMT refundability schedule as set forth in the Tax Act.
Pursuant to provisions of the CARES Act, existing AMT credit carryforwards are now eligible for acceleration and refundable AMT credits are to be completely refunded to companies for taxable years beginning in
2019, or by election, taxable years beginning in 2018. Accordingly, the Company has elected to have the AMT tax completely refunded and has filed a tentative refund claim for the remaining AMT tax credit. Consequently, the remaining balance of the
Company’s AMT credit refund in the amount of approximately $270,000 is expected to be completely refundable. Accordingly, the full amount of our AMT credit refund has been classified as current as of June 30, 2020.
The Company continues to monitor future developments and interpretations of the CARES Act for any material impacts on its future results of operations, financial position, and liquidity.
Pursuant to provisions of the State of North Carolina General Assembly Senate Bill 704: COVID-19 Recovery Act, enacted in May 2020, the Company will receive a tax credit towards its contribution to the North Carolina Unemployment Insurance Fund (the
“Fund”) that is equal to the amount of the Company’s contribution to the Fund for the calendar quarter ended March 31, 2020. Accordingly, in June 2020 the Company recognized the available tax benefit in the amount of approximately $7,000 and such
amount is included in prepaid expenses and other current assets in the accompanying consolidated balance sheet as of June 30, 2020.
The Company accounts for income taxes under the liability method. Under the liability method, deferred income taxes are recognized for the income tax consequences of “temporary differences” by applying enacted statutory income tax rates applicable
to future years to differences between the financial statement carrying amounts and the income tax bases of existing assets and liabilities.
The Company’s income tax net (expense) benefit for the periods presented comprises the following:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Current:
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
23,149
|
|
State
|
|
|
(1,733
|
)
|
|
|
(21,706
|
)
|
Total current (expense) benefit
|
|
|
(1,733
|
)
|
|
|
1,443
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Federal
|
|
|
-
|
|
|
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
Total deferred (expense) benefit
|
|
|
-
|
|
|
|
-
|
|
Income tax net (expense) benefit
|
|
$
|
(1,733
|
)
|
|
$
|
1,443
|
|
Significant components of the Company’s deferred income tax assets as of the dates presented are as follows:
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
|
|
|
|
|
|
Reversals and accruals
|
|
$
|
476,666
|
|
|
$
|
970,516
|
|
Prepaid expenses
|
|
|
(39,943
|
)
|
|
|
(38,552
|
)
|
Federal NOL carryforwards
|
|
|
4,980,513
|
|
|
|
4,911,437
|
|
State NOL carryforwards
|
|
|
663,918
|
|
|
|
674,522
|
|
Hong Kong NOL carryforwards
|
|
|
995,566
|
|
|
|
995,566
|
|
Federal benefit on state taxes under uncertain tax positions
|
|
|
1,668
|
|
|
|
1,304
|
|
Stock-based compensation
|
|
|
392,924
|
|
|
|
194,524
|
|
Research tax credit
|
|
|
252
|
|
|
|
83,315
|
|
Contributions carryforward
|
|
|
7,184
|
|
|
|
-
|
|
Depreciation
|
|
|
(172,010
|
)
|
|
|
(157,310
|
)
|
Inventory valuation reserve
|
|
|
1,594,795
|
|
|
|
-
|
|
Operating lease liabilities
|
|
|
185,422
|
|
|
|
-
|
|
Operating lease right-of-use assets
|
|
|
(131,008
|
)
|
|
|
-
|
|
Accrued rent
|
|
|
-
|
|
|
|
88,923
|
|
Loss on impairment of long-lived assets
|
|
|
32,749
|
|
|
|
32,985
|
|
Valuation allowance
|
|
|
(8,988,696
|
)
|
|
|
(7,757,230
|
)
|
Total deferred income tax assets, net
|
|
$
|
-
|
|
|
$
|
-
|
|
The following are reconciliations between expected income taxes, computed at the applicable statutory federal income tax rate applied to pretax accounting loss, and the income tax net (expense) benefit for the periods presented:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Anticipated income tax benefit (expense) at statutory rate
|
|
$
|
1,293,673
|
|
|
$
|
(477,545
|
)
|
State income tax benefit (expense), net of federal tax effect
|
|
|
64,034
|
|
|
|
(42,334
|
)
|
Income tax effect of uncertain tax positions
|
|
|
17,508
|
|
|
|
17,494
|
|
Return to provision adjustments
|
|
|
1
|
|
|
|
126
|
|
Stock-based compensation
|
|
|
(31,195
|
)
|
|
|
(3,929
|
)
|
Other changes in deferred income tax assets, net
|
|
|
(114,288
|
)
|
|
|
(280,066
|
)
|
(Increase) Decrease in valuation allowance
|
|
|
(1,231,466
|
)
|
|
|
787,697
|
|
Income tax net (expense) benefit
|
|
$
|
(1,733
|
)
|
|
$
|
1,443
|
|
The Company’s statutory tax rate as of the fiscal year ended June 30, 2020 is 22.11% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.11%, net of the federal benefit. The Company’s statutory tax rate as of
June 30, 2019 was 22.16% and consisted of the federal income tax rate of 21% and a blended state income tax rate of 1.16%, net of the federal benefit.
As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. As of June 30, 2020 and June 30,
2019, the Company’s management determined that sufficient negative evidence continued to exist to conclude it was uncertain that the Company would have sufficient future taxable income to utilize its deferred tax assets, and therefore, the Company
maintained a valuation allowance against its deferred tax assets.
As of June 30, 2020 and 2019, the Company had approximately $309 and $102,000, respectively, of remaining federal income tax credits all of which expire in 2021 and can be carried forward to offset future income taxes. As of June 30, 2020 and 2019,
the Company also had federal tax net operating loss carryforwards of approximately $23.72 million and $23.39 million, respectively, expiring between 2022 and 2037, which can be used to offset against future federal taxable income; North Carolina tax
net operating loss carryforwards of approximately $20.12 million and $20.20 million, respectively, expiring between 2023 and 2033; and various other state tax net operating loss carryforwards expiring between 2021 and 2040, which can be used to offset
against future state taxable income.
As of each of June 30, 2020 and 2019, there was approximately $6.03 million in net operating loss carryforwards in Hong Kong. In accordance with the Hong Kong tax code, these amounts can be carried forward indefinitely to offset future taxable
income in Hong Kong. The Company’s deferred tax assets in Hong Kong were fully reserved with a valuation allowance of $996,000 as of each of June 30, 2020 and 2019, and had been fully reserved in all prior fiscal periods due to the uncertainty of
future taxable income in this jurisdiction to utilize the deferred tax assets. Charles & Colvard (HK) Ltd., the Company’s Hong Kong subsidiary, which was re-activated in December 2017, but had no operating activity during the fiscal years ended
June 30, 2020 and 2019, previously ceased operations during 2008 and became a dormant entity during 2009. If the Company uses any portion of its deferred tax assets in future periods, the valuation allowance would need to be reversed and may impact
the Company’s future operating results.
Uncertain Tax Positions
The gross liability for income taxes associated with uncertain tax positions at June 30, 2020 and June 30, 2019, was approximately $8,000 and $6,000, respectively. The gross liability, if recognized, would favorably affect the Company’s effective
tax rate.
The Company’s policy for recording interest and penalties associated with tax audits is to record such items as a component of the provision for income taxes. The Company accrued approximately $2,000 and $1,000 of interest and penalties associated
with uncertain tax positions for the fiscal years ended June 30, 2020 and 2019, respectively. Including the interest and penalties recorded for uncertain tax positions, there is a total of approximately $5,000 and $4,000 of interest and penalties
included in the accrued income tax liability for uncertain tax positions as of June 30, 2020 and 2019, respectively. To the extent interest and penalties are not ultimately incurred with respect to uncertain tax positions, amounts accrued will be
reduced and reflected as a reduction of the overall income tax provision.
In all significant federal and state jurisdictions where it is required to file income tax returns, the Company has analyzed filing positions for all tax years in which the statute of limitations is open. The only periods subject to examination by
the major tax jurisdictions where the Company does business are the tax years ended December 31, 2015 through June 30, 2019. The Company does not believe that the outcome of any examination will have a material impact on its consolidated financial
statements and does not expect settlement on any uncertain tax positions within the next 12 months. Beginning with the transition period ended June 30, 2018, the Company’s tax year conforms with its fiscal accounting period year ending on June 30 of
each year.
The following table summarizes the activity related to the Company’s accrued gross income tax liability for uncertain tax positions for the two-year period ended June 30, 2020:
Balance at June 30, 2018
|
|
$
|
4,891
|
|
Increases related to prior fiscal year tax positions
|
|
|
1,323
|
|
Balance at June 30, 2019
|
|
|
6,214
|
|
Increases related to prior fiscal year tax positions
|
|
|
1,733
|
|
Balance at June 30, 2020
|
|
$
|
7,947
|
|
For information regarding the Company’s decision during the fiscal year ended June 30, 2020 to reduce its accrued gross income tax liability for uncertain tax positions that should have been derecognized in prior
years, see the Immaterial Correction of an Error section in Note 2, “Basis of Presentation and Significant Accounting Policies.”
13.
|
MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
|
At times, a portion of the Company’s accounts receivable will be due from customers that have individual balances of 10% or more of the Company’s total gross accounts receivable.
The following is a summary of customers that represent greater than or equal to 10% of total gross accounts receivable as of the dates presented:
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Customer A
|
|
|
26
|
%
|
|
|
13
|
%
|
Customer B
|
|
|
14
|
%
|
|
|
25
|
%
|
Customer C
|
|
|
13
|
%
|
|
|
*
|
%
|
Customer D
|
|
|
**
|
%
|
|
|
15
|
%
|
* Customer C did not have individual balances that represented 10% or more of total gross accounts receivable as of June 30, 2019.
** Customer D did not have individual balances that represented 10% or more of total gross accounts receivable as of June 30, 2020.
A significant portion of sales is derived from certain customer relationships. The following is a summary of customers that represent greater than or equal to 10% of total net sales for the periods presented:
|
|
Year Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Customer A
|
|
|
12
|
%
|
|
|
10
|
%
|
Customer B
|
|
|
13
|
%
|
|
|
14
|
%
|
The Company records its sales returns allowance at the corporate level based on several factors including historical sales return activity and specific allowances for known customer returns.
14.
|
EMPLOYEE BENEFIT PLAN
|
All full-time employees who meet certain length of service requirements are eligible to participate in and receive benefits from the Company’s 401(k) Plan. This plan provides for matching contributions by the Company in such amounts as the Board of
Directors may annually determine, as well as a 401(k) option under which eligible participants may defer a portion of their salaries. The Company contributed a total of $82,000 and $67,000 to this employee benefit plan during the fiscal years ended
June 30, 2020 and 2019, respectively.
On August 26, 2020, the Supply Agreement was amended, effective June 30, 2020, to extend the expiration date to June 29, 2025, which may be further extended by mutual agreement of the parties. The Supply Agreement was also amended to, among other
things, (i) spread the Company’s total purchase commitment under the Supply Agreement in the amount of approximately $52.95 million, of which approximately $36.60 million remains to be purchased as of June 30,
2020, over the term of the Supply Agreement, as amended; (ii) establish a process by which Cree has agreed to accept purchase orders in excess of the agreed-upon minimum purchase commitment, subject to certain
conditions; and (iii) permit the Company to purchase revised amounts of SiC materials from third parties under limited conditions.
Over the life of the Supply Agreement, as amended, the Company’s future minimum annual purchase commitments of SiC crystals range from approximately $4 million to $10 million each year.