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Q3 2023 Charles & Colvard Ltd Earnings Call

Participants

Clint J. Pete; CFO & Treasurer; Charles & Colvard, Ltd.

Don O'Connell; President, CEO & Director; Charles & Colvard, Ltd.

Adam P. Lowensteiner; VP-New York; Lytham Partners, LLC

Presentation

Operator

Good day, and welcome to the Charles & Colvard Q3 Fiscal Year 2023 Earnings Conference Call and Webcast. (Operator Instructions) The earnings call may contain forward-looking statements as defined in Section 27A of the Securities Act of 1933 as amended, including statements regarding, among other things, the company's business strategy and growth. Expressions that identify forward speaking statements are based largely on our company's expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond our control. Future evolvements and actual results could differ materially from those set forth and contemplated by or underlying the forward-looking statements. In light of the risks and uncertainties, there can be no further assurance that the forward-looking information will prove to be accurate.

Accompanying today's call is a supporting PowerPoint slide deck, which is available in the Investor Relations section of the company's website at ir.charleandcolvard.com/events. The company will be hosting a Q&A session at the conclusion of our prepared remarks. Should you have any questions you'd like to submit, please e-mail cthr@lythampartners.com. Please note, this event is being recorded. I would now like to turn the conference over to Don O'Connell, President and Chief Executive Officer. Please go ahead.

Don O'Connell

Good afternoon, everyone, and welcome to our third quarter fiscal 2023 earnings conference call. At a high level, this quarter we experienced a continuation of the direction of the last few quarters against a challenging overall macroeconomic backdrop. This, combined with the changing behaviors and dynamics in the jewelry marketplace, particularly related to lab-grown diamonds, prompted us to refocus our efforts in the short term on prudent capital and inventory management while also shifting some of our core strategies.

We are pleased that the jewelry industry is now experiencing a shift towards responsible practices in response to the increased consumer interest in the origins of the fine jewelry they purchase. We deem this to be a long-term favorable circumstance for us at Charles & Colvard. We believe that this shift will allow us to highlight our strengths, maintain positioning, and educate those consumers on the brand equity we have built for nearly 3 decades. And to become an ideal destination for responsibly made fine gems and jewelry. Lab-grown gemstones and lab-grown diamonds specifically are gaining significant popularity in the marketplace, becoming more mainstream for price-conscious consumers seeking larger carat weights with eco-friendly and conflict-free options.
Our core engagement and fashion assortment set with our Forever One Moissanite and Caydia Lab Grown diamonds offer these discerning consumers the ability to acquire more at a far greater value than comparable mined options. Our Forever One Moissanite offers an advantage over mined and lab-grown diamonds from both a competitive perspective and a value proposition. Admittedly, the most recent downward pricing pressure on lab-grown diamonds is being felt throughout the industry. Look to us to position ourselves aggressively against this backdrop to remain a force delivering the quality consumers seek when considering their engagement in fashion fine jewelry needs.

We passionately believe that our key strategy to offer the consumer the choice between our Forever One Moissanite and our Caydia Lab Grown diamonds has positioned us well for future growth. These product brands and our core values enable us to stay ahead of the curve, and we continue to vie for market share beyond the global economic lows of today.

We also believe the short-term pressure facing the lab-grown diamond industry will find its way and settle on a pricing methodology that keeps its credibility while maintaining its intrinsic value at its core. Forever One Moissanite will continue to be the premium moissanite in the market, reinforced by its warranty and its value proposition, and remains essential to our business. We will continue to educate the trade and consumers alike to increase our overall positioning against what we believe to be inferior moissanite claiming to be comparable in nature and composition to what we have perfected over nearly 3 decades.

With that being said, the increasing demand for lab-grown diamonds amplifies the need to grow our Caydia Lab Grown Diamond product brand in a responsive way, as we seek to capture consumers predisposed to buying a diamond. Since introducing lab-grown diamonds, we have become more vertical as we continuously seek to be a competitively priced industry leader in the overall lab-grown fine jewelry market. We have recently expanded our cutting and fastening capabilities for lab-grown diamonds in support of our Caydia Lab Grown Diamond growth, enabling us to become more self-sufficient while differentiating ourselves from other players in the industry who simply buy, sell, and trade to the bottom. We believe the brands that are aligned with today's consumers that act responsibly and offer an interactive and experiential relationship, delivering the quality and design aesthetic they seek, will remain relevant and at the forefront of these times.

According to Deloitte Insights, the majority of consumers are focused on saving compared to spending during these turbulent economic times. We believe that we must continue to execute upon our core strategies to bridge ourselves past the global economic uncertainty while responsibly managing our business. The past few years, we've spent a considerable amount of time and capital to position our company in a more diversified posture to take advantage of the shift by consumers in the fine jewelry marketplace towards responsibly sourced lab-grown gems and fine jewelry that provide quality, price and value.

Our prudent efforts to reinvest in our business meaningfully to elevate our technology and expand our infrastructure in support of new revenue streams that we intend to monetize in the quarters and years to come, continued in fiscal 2023. Additionally, we believe our expanded product portfolio, inclusive of our proprietary signature collection designs, along with several new sales initiatives will enable us to reach a broader customer base that seeks what we have to offer. We believe these deliberate investments will create greater shareholder value over time.

Despite the challenging market conditions, consumers are still purchasing high-end jewelry while becoming more aware of the practices and resources used in the creation of their fine jewelry. We are pleased with the pace by which the lab-grown market continues to grow, estimated to be a compound annual growth rate of 9.8% by 2031, and we believe our continued focus on responsibly sourced gems and our commitment to recycle precious metals will position us well for future growth.

Fundamentally, our goal is to find ways to reach that consumer more effectively while strengthening our moat and overall position in the market. Signet, the world's largest retailer of diamond jewelry, has predicted a surge of engagements in 2024 and 2025. Should that prove to be the case, we believe that Charles & Colvard is poised to capture a greater share of this market opportunity. The eco and ethical movement has disrupted the traditional jewelry industry in various ways, with 85% of people saying they have shifted to more sustainable purchase habits according to a study published by Simon Kucher & Partners, a consulting firm. Established brands are facing pressure to adjust their practices or risk losing market share to new entrants that can respond to ethical concerns. Charles & Colvard has always been a lab-grown gemstone company, and we are committed to utilizing 100% recycled precious metals in the fine jewelry we create.

The sustainability shift in the jewelry industry appears to be not just a passing fad, but rather a lasting movement set to gain even more traction. With consumers becoming more informed and discerning, the industry needs to be able to adapt to the changing landscape to meet customers' needs. By embracing responsible and ethical practices, jewelry brands can stay competitive and appeal to the growing demand for earth-friendly and conflict-free jewelry. According to Forbes, millennials are driving brands to practice social responsibility by emphasizing buying from ethical and eco-friendly companies like ours.

In addition to responsible practices, the jewelry industry is also responding to changing consumer preferences in the terms of brand values, design aesthetic and convenience. Over recent quarters, another key movement that has driven the retail and jewelry industry has been a shift in consumer buying habits towards more experiential purchases with an emphasis on interactive shoppable commerce. For us, this includes our own properties, charlesandcolvard.com and moissaniteoutlet.com, our virtual consultations that enable us to showcase our quality price and value in real time, our retail signature showroom located at our headquarters campus, which allows customers to experience our premium jewelry selection firsthand, and our most recent expansion into developing a long-form shoppable streaming capability.

Charles & Colvard is becoming well positioned to take advantage of these key drivers. By continuing to diligently focus on and invest in our mission and values, we remain confident in our ability to drive growth and provide value in the years to come.

Q3 fiscal 2023 was a time marked by continued strategic investments, which I highlighted earlier, to resonate with a broader segment of the total achievable market. These investments are, we believe, setting Charles & Colvard up for long-term success by positioning us to enhance our brand experience and meet discerning consumer demand. Ultimately, our business decisions continue to be made with a focus on long-term growth and stability of our product brands by elevating our brand presence and direct-to-consumer relationships, which we anticipate will capture a greater share of wallet.

To support our business, we offer a broad range of assorted fine jewelry to meet discerning consumer demands. Most notably, during Q3, we launched 55 new designs of our patented signature collection and engagement rings and wedding bands. We continue to expand our Caydia Lab Grown Diamond Couture collection to include additional ring, necklace, earring and bracelet styles. We expanded our created color line of products featuring Caydia Lab Grown Diamonds. We are energized by the positive customer response to this product addition.

And our finished fine jewelry products have been featured in multiple local and national electronic and print publications, including The Knot, AC Magazine, Insider.com, Yahoo!, Byrdie.com and Brides Magazine. Charles & Colvard's strategy of focusing on customer-centric initiatives, expanding our product offerings, and leveraging our unique brand position will, we believe, drive growth in the upcoming quarters. We are confident in our plan to continue optimizing technology and infrastructure, operations and brand marketing initiatives to help ensure that we can meet customer demands in a more efficient yet conscious way.

What does this mean? This means we'll expand our lab-grown diamond offerings, including larger carat total weights in response to the consumer demands. We'll continue to shift our moissanite assortment to bolster our value proposition there. We'll continue to elevate the competitive landscape and the value proposition between moissanite and lab-grown diamonds and its overall impact to our business and responsibly position ourselves accordingly. We'll continue to make calculated investments in our direct-to-consumer web properties and video streaming and broadcast capabilities in order to better reach consumers. And we'll seek to form new alliances and strategic partnerships as the industry consolidates.

With the online segments representing 70% of revenue in fiscal Q3 2023, we believe that this continues to present a long-term opportunity. We believe the investments we are making will put us in a solid position to capture market share. We continue strategic investments. Executive management is optimistic about our future position in the industry and our ability to capitalize on customer expectations. I will now turn the presentation over to Clint Pete, our CFO, to provide more detailed insight into Q3's financial performance. Clint?

Clint J. Pete

Thanks, Don. Today, I'll provide a summary of key financials for the third quarter ended March 31, 2023. Additional detail can be found in our earnings press release that we issued this afternoon and our Form 10-Q, which we expect to file tomorrow. Please note that all percentage comparisons are to the third quarter ended March 31, 2022, unless specified otherwise.

First, we will start on Slide 10 with the comparative analysis of the third quarter of fiscal 2023 compared to the same period 1 year ago. In total, net sales for Q3 2023 totaled $6.6 million versus $9.8 million, a decrease of 32% due primarily to the economic factors Don discussed.

Net sales for our online channel segment, which is primarily direct-to-consumer and includes charlesandcolvard.com, moissaniteoutlet.com, marketplaces, drop ship retail, and other pure-play outlets, totaled $4.6 million for the quarter or a decrease of 27%, but now representing 70% of total net sales, up from 65% one year ago.

Net sales from our traditional segment, which consists of wholesale and brick-and-motor customers, totaled $2 million for the quarter or a decrease of 40%, representing now approximately 30% of total net sales, down from 35% of sales in the same quarter a year ago. Finished jewelry net sales decreased 28% for the quarter but represented 80% of total sales in the quarter, up from 76% of sales in the third quarter one year ago. Loose jewel net sales decreased 43% for the quarter, as we mentioned in prior calls, due in part to our shift towards finished jewelry and direct-to-consumer strategies. While many domestic and international distributors reduced their forecasts and overall inventories due to the softer economic environment.

Looking at sales by geography, nearly all sales in the third quarter were derived in the U.S., while international net sales reported in the quarter were only $100,000. As we discussed in recent quarters, as certain of our international distribution partners continued facing ongoing COVID-19 restrictions and enclosures, demand has slowed due to overall consumer inflation, recessionary concerns, and the global geopolitical unrest.

As you can see at the high levels, our areas of strategic focus including direct-to-consumer and finished jewelry were somewhat less impacted as evidenced by the lesser decline in online channels and finished jewelry net sales than our traditional segment and loose jewels net sales.

Moving onto Slide 11 to discuss gross margin and profit, we delivered a gross margin of 32% versus 46% in the year ago quarter, delivering $2.1 million in gross profit versus $4.5 million in the year ago quarter. Most notably, the decrease in the gross margin in the quarter was principally because we took advantage of an opportunity to monetize certain nonperforming jewelry items, along with continued sales promotions.

For Q3 2023 total operating expenses increased 7%, representing 65% of total net sales compared to 41% in the year ago quarter. Sales and marketing expenses increased 11% to $3.3 million in support of our growth and brand awareness initiatives and G&A expenses were $1.05 million for the quarter compared to $1.1 million in the year ago quarter or a 5% decrease. We continue to invest in marketing and brand awareness initiatives that we believe will allow us to build upon our brands and have direct access to the consumer.

We reported a net loss in Q3 2023 of $8.4 million or $0.28 loss per diluted share compared with a net income of $339,000 or $0.01 earnings per diluted share in the year ago period. Included in our net loss for Q3 2023 is an income tax expense of $6.3 million compared to an income tax expense of $78,000 in the year ago period. $6.3 million tax expense was primarily driven by the establishment of a deferred tax asset valuation allowance on our net deferred tax assets as we determined that our expectation of future taxable income in the upcoming tax years may not be sufficient to result in full utilization of available net operating loss carryforwards and other deferred tax assets.

Our weighted average shares outstanding on a diluted basis used in the calculation of the loss per share for the quarter were approximately 30.3 million shares for the period ended March 31, 2023 compared to 31.3 million shares for the period ended March 31, 2022. Decrease in shares outstanding is partially driven by the impact of the company's share repurchase program.

Now let's move onto a snapshot of our balance sheet. Our liquidity and capital position remained strong as we ended the quarter with $16 million of total cash compared to $17 million at the end of the second quarter ended December 31, 2022. Working capital remained strong, ending at $20.5 million. In addition, the company continues to be debt-free. We believe our capital structure remains strong and able to weather the inflationary and geopolitical factors in the near term.

Our cash flow used in operations was $800,000 during the quarter compared to $1 million of cash flow provided from operations in the same quarter a year ago. In terms of other sources of liquidity, we have access to our $5 million cash secured credit facility with JPMorgan Chase Bank. As of March 31, 2023 and through today, we have not accessed funds through our credit facility agreement.

Inventory as of March 31, 2023, totaled $33.3 million compared to $35 million as of December 31, 2022, a reduction of nearly $1.7 million. Loose jewels inventory was $15.6 million as of March 31, 2023 and compares to $16 million as of the same quarter a year ago. Finished jewelry inventory was $17.4 million as of March 31, 2023 when compared to $18.8 million as of December 31, 2022, a reduction of $1.4 million demonstrating a solid sell-through of our finished jewelry in the direct-to-consumer online channels, while still maintaining a higher percentage of in-stock rates to meet our service level agreements. We plan to remain focused on prudent inventory management strategies going forward.

Book value per share was $1.60 per share, but sequentially lower to the Q2 2023 due to the establishment of a deferred tax asset valuation allowance on our net deferred tax assets of $6.3 million as I previously mentioned.

In summary, we remain confident in our financial strength and our continued efforts to increase shareholder value. As we continue to focus on the fundamentals of the business during the current macroeconomic environment, which actions include diligent management of our cash, inventories and expenses, all while making necessary investments to grow the business. With that, I'll turn it back over to Don.

Don O'Connell

Thank you, Clint. At Charles & Colvard, our goal is to become a premium direct-to-consumer destination that's an e-commerce-driven interactive brand that resonates with today's complex consumer, that's aligned with customers' core values and aesthetics, and that focuses on quality first. A leader in moissanite and lab-grown diamond fine jewelry through prudent strategic investments, we strive to offer the highest quality products available at a meaningful value, continue to utilize ethical and responsible sourcing practices, and further advance our technology to stay ahead of the curve.

As we move into the future, we will continue to position ourselves responsibly to take advantage of the shifts that are happening in the jewelry industry. We remain committed to meeting the customer needs through continued innovation and consumer education. As the jewelry industry continues to evolve, we will continue to refine our strategies to remain successful in the competitive market. Over the last few quarters, we have implemented strategic initiatives to help ensure that Charles & Colvard remains innovative, reliable, and current. As we move into fiscal Q4 2023, we remain confident that our long-term growth plan is on the right path for success.

Last, but certainly not least, we would like to thank our employees who continue to go above and beyond during these difficult times and our shareholders for their continued support. At this time, I will turn the call back over to the operator, who will open up the lines for any questions.

Question and Answer Session

Operator

(Operator Instructions)

Adam P. Lowensteiner

Scott, this is Adam Lowensteiner. I'll ask the management team a few questions. Don, the gross margin was lower to past trends. Can you repeat again the reasons behind the shortfall? Is this new normal going forward, or should we be able to regain to 45% to 50% levels?

Don O'Connell

Yes. Certainly, this is what we believe to be a short-term situation that was primarily driven by a couple of business decisions that we elected to do. Number one is this is the time where we want to kind of preserve cash, raise additional cash, and we sought out some opportunities to move through some what we call obsolescence or nonperforming inventory. We took advantage of that, and that was a good thing, so we were able to kind of maintain our cash position. The other situation that's really important that we need to keep an eye on is the commodities market right now. If you look at gold right now, new gold is trading upwards of $2,060, $$2,080 an ounce. Everyone within the industry is starting to kind of take note of that situation against the economic environment. Look to us to kind of hedge against that as best we can. But certainly, for inventory that we have on the shelf, which we have ample inventory of finished jewelry, thank goodness for that, that's a really good thing because that inventory is appreciating day by day as the commodity market kind of increases as well with it. However, when we do a made-to-order, we don't have the piece in stock, we've got to go into the market and we need to procure those goods. We get some margin compression on that. And then lastly, just let's talk a little bit about lab-grown diamonds and the impact that lab-grown diamonds have had to every business within our industry in the last few quarters, more so in the last quarter, primarily with a downward pressure in pricing on the lab-grown diamond entire sector. Lab-grown diamonds are trying to find where that normalization is. A lot of inventory in a lot of areas was purchased at the higher end of the market, inclusive of us. We had some inventory on the shelf that was at the higher price. We've seen a significant drop in price. On the first part, it was good that we were able to convert that inventory into cash by selling off that inventory at a discounted price. Also, it enables us to get and procure new goods at the current price and the current level where it's at. I said in my opening remarks, we believe there will be a normalization there, and we believe that we're taking the necessary steps to kind of manage through these what we call 3 main pressures of the business. And we believe we've got a good answer to it, and we're making executive decisions every day to try to make sure we position ourselves properly moving forward. I think there'll be some compression in the short term, but certainly, we're optimistic in the long term for what we're planning on.

Adam P. Lowensteiner

You discussed a pivot towards lab-grown diamonds and their trends. Can moissanite compete? If so, how? And what happens then to mined gems then?

Don O'Connell

I believe, it's my belief that mined diamonds and mined gems will always be here. I mean they'll always show strength in the market because there's those consumers that are predisposed to having a diamond, and that's just the way it is. I will tell you that the lab-grown movement is very much here, very strong, and it's prevalent in every single retailer in the country. And those who haven't kind of adopted that strategy have been left behind and are trying to play catch up. The problem that we have is this downward pressure that I just alluded to is putting some additional pressure between the moissanite gemstones that we carry and really this kind of the pinnacle of what we offer against the pricing of the lab-grown diamonds. Whereas we had an incredible delta between the 2 with kind of the valuation proposition, that proposition is tightening. Look to us to make prudent decisions to be able to kind of maintain that gap and maintain that pricing competitiveness with moissanite, offering that choice to the consumer that has a really nice delta between the two. We believe we have an answer to that. It's going to take a little bit of time to kind of navigate. Also, one other consideration, Adam, is us transitioning our entire assortment of products to be able to kind of accentuate why moissanite has a greater value in larger carat weights that lab-grown diamonds still is not competitive with. Whereas before, we had a 1 carat moissanite and we had a 1 carat diamond, you'd be able to see the difference very clearly. Now lab-grown diamond and moissanite in 1 carat are pretty much getting closer and closer. Even though there is still a big difference, probably a 2x or 3x, we're leaning more toward the consumer where they're going in larger carat weights to 2, 3, 4 and 5 carats. We'll also take a look at all of our inventory and take a look at our supply, take a look at a lot of different variables that we believe are necessary to continue to be more competitive against anything that comes at us. And again, we believe that we're well positioned. We believe that our Forever One is the premium in the market. And I'll take it another step here, if I may. Moissanite is rarer than a diamond. I mean that's a fact. The bottom line is that as lab-grown diamonds become prevalent and they're everywhere, and it becomes more commercialized, we believe that we can elevate Forever One, elevate the brand, and put some more energy in and find the catalyst to be able to claim that moissanite is actually rarer, and therefore, the intrinsic value should be higher. However, we will maintain a cost valuation proposition to the customer even though it is of greater value in our mind. Of course, that's subjective to what I believe. We're Charles & Colvard. That's what we're built on. That's our foundation. But the choice to go into lab-grown diamonds was the right choice, and we believe we're expanding that within all of our channels in the organization, and we believe it's going to be a tremendous growth factor for us once we start to get it more into the mainstream of our channels. I don't know if that answered the question, but I think pretty much we're there.

Adam P. Lowensteiner

Thank you. Don, you mentioned also making certain investments for the future, some on the technology side. Can you elaborate or add some color to those initiatives? How long will it take to implement these initiatives? When can we start hearing some clarity on them? And also, what type of cost should we expect these investments to be? Just want to get a gauge on your cash runway given the investments during a difficult macroeconomic environment.

Don O'Connell

Yes, another great question. We've really, really focused on preserving cash. At $16 million in cash, we feel good about the cash. We feel that that's really critical. We feel good about no debt. That's really important. We feel that as we're continuing to kind of position the company for the future in these hard times, we have to make strategic investments to stay ahead of the curve, to stay ahead of the competition. What does that mean? That means we have to kind of reface and look at all the functionality of our web properties, charlesandcolvard.com, moissaniteoutlet.com, and make sure that we're -- we have best practices. We're having to make investments there, and we have been doing so without drawing down cash, just using regular cash flow that's coming in and out and doing what we need to do. Look to us for SMS, strategically retargeting consumers that like our products, that are in kind of the ether that have shown interest in what we offer, targeting those consumers, getting them to opt in, looking to third-party best in practices, best-of-breed companies to partner with to do that without being specific. We're going in that route. E-mail marketing, retargeting, it's something that we've done before. We need to enhance that. We need to do a better job. We're continuing to make investments in that and that capability. Influencer marketing too as well. Partnerships and platforms to be able to reach out and touch influencers that want to endorse our product, become ambassadors with our product. And then the telephony systems to be able to upgrade and be really at the cutting edge of our CRM systems and make sure on the cutting edge that we really can capture all the data we need to make informed decisions on that consumer, on that consumer journey, where that consumer started and where that consumer finishes from first touch to last touch. Those are really, really important ingredients to success, and we've had and we'll continue to make investments there. And then lastly, we've been talking for quarters and quarters now about our streaming capability. We believe that the future is in video. We believe that the future is really important to convert that video into the ability to simulcast live interactive shoppable commerce in multiple ways. And I know in the past few quarters have been talking and talking we're getting better and better. We're making more and more investments in doing so. One would imagine that we could do a live interactive shopping opportunity, and we could simulcast that anywhere in the world, both domestic and international, should we choose. And then we believe that's going to be a long-term play for us, and it's going to be great. More to come on that. We really can't disclose too much, but that's an exciting opportunity for us, and we can't wait to kind of shout what that looks like.

Adam P. Lowensteiner

Operator, I'm sorry. That's all the questions I have.

Operator

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Dan O'Connell, President and Chief Executive Officer, for any closing remarks.

Don O'Connell

Yes. Thanks, Scott. These are challenging times, there's no question, but we believe that we've got plenty of cash. We have no debt. Like I said, inventory levels are at $33.3 million. We believe that we have a mix of inventory. We believe that we need to kind of take a look and make strategic prudent decisions on how we operate the business, the products that we bring forward, and the customers that we target. Certainly, the consumer is under some pressure right now. We'll navigate through that. We'll do some creative things to be able to grow the business and maintain the business where we're at. And we're confident that we'll continue to strive forward. And I just want to thank our investors for kind of supporting us and certainly, again, the employees that have worked very, very hard for everyone to get some incredible, beautiful jewelry. Thank you, appreciate it.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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