Charles & Colvard Ltd.

Good day and welcome to the Charles and Colvard second quarter fiscal year 2021 earnings conference call and webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one on your touchtone phone. To withdraw your question, please press star and then two. This 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 strategy. Expressions which identify forward-looking statements speak only as of the date the statement is made. These forward-looking 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 developments and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. In light of these risks and uncertainties, there can be no 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.charlesandculvard.com forward slash events. The company will be hosting a Q&A session at the conclusion of prepared remarks. Should you have questions you'd like to submit, please email ir at charlesandculvard.com. Please note that 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.

Welcome, everyone. Good afternoon. Today, we're going to report Charles and Colvard's fiscal 2021 second quarter results. I'm pleased to share with you that we had a record-breaking quarter, delivering the highest revenue and income from operations in company history. We were able to generate $12.1 million in revenue and achieve a net income of $2.5 million with strong gross margins of 49% and a positive cash flow of $3 million for the quarter. This was a 14% increase in revenue versus the year-ago quarter, with an EPS of $0.09 per diluted share, which represents a 200% increase over last year. For the six months ended December 31, 2020, we recognized a 232% increase in net income and a 300% increase in earnings per diluted share compared to the year-ago period. Additionally, we bolstered our total cash to $16.9 million. which is a 26% increase from the year-ago quarter. Our team executed with purpose and precision during the critical holiday quarter, making it possible for us to achieve such positive results. Now I'll turn the call over to Clint Peete, our CFO, to unwrap the numbers in more detail.

Thanks, Don. Today I'll provide a summary of our key financials for Q2 2021. 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 this evening. Please note that all percentage comparisons are to the year-ago quarter, unless specified. We'll start with the revenue. In total, net sales for Q2 2021 totaled $12.1 million, versus $10.7 million, or an increase of 14%. In our online channel segment, which includes CharlesandCobar.com, marketplaces, dropship retail, and other pure play outlets. Net sales for the quarter totaled $7.6 million, or an increase of 25%, representing 62% of total net sales. Net sales for my transactional website, CharlesandCobar.com, increased 16%. In the company's traditional segment, which consists of wholesale and brick-and-mortar customers, Net sales for the quarter was $4.6 million, or flat to the year-ago quarter, representing 38% of total sales. Finished jewelry net sales increased 28% for the quarter. This was primarily due to the strong demand for our premium jewelry on our online direct-to-consumer channels and with our brick-and-mortar retail customers. Loose jewel net sales decreased 8% for the quarter, as there continued to be a lower demand from our international distributors during the entire quarter related to COVID-19. Overall, international net sales decreased 25% due to limited orders from Asian distributors combined with lower cross-border trade sales on our transactional website. Moving on, we continued to maintain a strong bullish margin of 49% compared to 48% in the year-ago quarter. For Q2 2021, total operating expenses decreased 21%, representing 28% of total net sales, compared to 41% in the year-ago quarter. Sales and marketing expenses decreased 22%, to $2.5 million, and G&A expenses decreased 19%, to $978,000 for the quarter. We reported net income for Q2 2021 of $2.5 million, or $0.09 per diluted share, compared to with net income of approximately $814,000, or $0.03 per diluted share in the year-ago period. Now, let's move on to a snapshot of our balance sheet. Our liquidity and capital position remained strong as we ended the quarter with $16.9 million of total cash. compared to $14.6 million at our last fiscal year ended June 30, 2020. Our cash flow from operations was $3 million for the quarter, compared to $985,000 in the year-ago quarter. In terms of other sources of liquidity, we continue to have access to a $5 million asset-based credit facility with White Oak Commercial Finance. As of December 31st, 2020, we have not accessed funds through this credit facility. Inventory as of December 31st, 2020 totaled $28.7 million, paired with $30.6 million as of June 30th, 2020. Loose drills inventory was $17.6 million, compared to $20.8 million as of June 30th, 2020. Finished jewelry inventory was $11 million, compared to $9.7 million as of June 30, 2020, to support the upcoming Valentine's Day selling season and maintain stock levels for our direct-to-consumer channels. In summary, we had a record-setting Q2 for both a net sales and operating income perspective, even in the pandemic-impacted environment. We will build on this progress in the remainder of fiscal 2021 as we position Charles and Covard for long-term growth, generating value for all of our stakeholders.

With that, I'll turn the call back over to Don. Thanks, Clint.

These positive financial results are reflective of the transformational changes made across the business to become more data-driven, enhance operational efficiencies, attract new customers, and improve the customer experience. This renewed approach, along with our diversified product lines, positioned us to capitalize on the holiday season. We believe business intelligence was a key factor in our success, since we invested a significant amount of time and energy into building out analytics tools. These tools allowed us to pull data in real time to better understand our business and make informed decisions. Clint addressed our current inventory levels, and I'd like to take the opportunity to elaborate on these numbers. We were able to make meaningful progress on the balance and concentration of our inventory, supportive of our current business needs. Our inventory totaled $28.7 million at the end of the quarter, which represents a 6% decrease from June 30, 2020. I'd like to help break this down and add some clarity You can visualize our inventory in two major buckets. 48% of our inventory falls into bucket number one, which consists of our raw material, loose gems, and jewelry components that are in process, or what we call internal or external WIP, or our work in progress. These goods are in the process of being cut, faceted, graded, engraved, or manufactured. Naturally, a large portion of the percentage, or this percentage, appears in our long-term inventory classification because of longer cycle times. The remaining 52% of our inventory is in the second bucket, which consists of in-stock finished goods that are ready to pick, pack, and ship. And a small portion of this bucket is in consignment inventory located in our retail partners' brick and mortar stores. Operationally, we were well positioned to meet the holiday demand. We were able to effectively overcome supply chain challenges and logistical constraints due to the global pandemic. We shipped a record number of packages for the company, resulting in a 9% increase versus a year ago quarter, all the while decreasing our operating expenses by 21%. Merchandising and product development were additional key factors in our success during the quarter. We were able to bring to market an elegant and aesthetically pleasing product mix that resonated well with our growing audience. I'm pleased to say that our traditional channel segment performed better than expected, with brick-and-mortar sales offsetting our continued challenges faced by international distributors due to COVID-19. Our Forever One Moissanite and our Moissanite by Charles & Colvard product brands remain in high demand with our retail and distribution partners. Our overall revenue growth was fueled by our online segment, which experienced a 25% increase year-over-year, with CharlesandColvard.com representing nearly 60% of online sales this quarter. Our third-party online sellers also recognized growing demand for our Forever One Moist Night and our Charles and Colvard products, with several customers experiencing double growth with our products year-over-year. Contributing to our online growth was our first quarter offering Cadia lab-grown diamond in our product brand, which is currently only sold and marketed on our direct-to-consumer website. Here's what we learned from this product launch. Brand equity matters. Consumers trust the Charles and Colvard name and adopted our Cadia lab-grown diamond product brand with confidence, recognizing us as a premium destination for lab-created diamond-fine jewelry. Product selection is also critical. The careful considerations made to launch classic bridal styles and fashion pieces featuring our patented signature collection was meaningful and appealed to our greater audience. We learned that we needed to expand our product assortment to meet the growing demand for Cadia Lab grown diamonds, so we continue to capture and can capture greater market share and tap into that multi-billion dollar opportunity. Arcadia Lab-Grown Diamond brand attracted a new, broader customer base, allowing us to educate consumers on the broader Lab-Grown movement. This movement also elevated Forever One Moisture Night awareness and sales in a meaningful and measurable way. Our newly integrated sales and marketing teams worked together to develop and execute successful holiday campaigns that resonated with our target audience. and help to ensure an optimal customer experience throughout the buying journey. A redefined real campaign brought awareness to our Forever One Moissanite and Cadia lab-grown diamonds by emphasizing that we now offer our customers a choice in premium lab-grown gems. This ongoing campaign challenges the idea that the origin of a gem is what defines its authenticity. Additionally, we were keenly focused on our digital marketing spend carefully targeting specific audiences that drove greater conversions. Going forward, we will continue to build upon this momentum we gained in Q2. We believe in the future of our omnichannel strategy with an emphasis on new digital commerce opportunities and capabilities. We will remain focused on engaging customers in new cutting-edge ways. We will continue to expand and educate the Charles and Colvard product brands. We will seek to expand product distribution across all new channels, and we will strive to increase our brand equity and shareholder value by prioritizing discipline growth. With that, I'd like to turn it back over to the operator. Let's open the lines for your questions.

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then two. Please limit yourself to one question and one follow-up. If you have further questions, you may re-enter the question queue. At this time, we will pause momentarily to assemble our roster. The first question comes from Matt Koranda with Roth Capital. Please go ahead.

Hey guys, good evening and thanks. Just wanted to start off with CADIA and the performance since the launch. So what metrics can you guys provide on revenue contribution during the quarter? Can you help us in terms of AOVs at CADIA and how they might compare to kind of the core Charles and Colvard Moissanite AOBs that you guys have disclosed before?

Sure. So, Matt, we don't disclose product brands or performance in individual product brands, but what I can tell you is that it was absolutely additive to the business. It was accretive to the business. It also helped to kind of bring awareness and put us into conversation. And by being in that conversation, those customers also realized were exposed to our Moissanite Forever One, right? So with that being said, we started to see a lift in that, too, as well. But we can just say right now at this time that it was meaningful within the quarter, and we're very pleased with those results. As it relates to the AOV, we did learn some things with the Cadia lab-grown diamonds throughout the quarter. As we started to kind of introduce more and more to our social campaigns and everything, we had a very large consumer base gravitating to our fashion, let's just say our smaller accented stones. What that did for us was it leveled out our AOV and it actually maintained consistent AOV where our moissanite AOV is, which is anywhere from $1,000 to $1,200 in our diamond cadia. It's not to say that we didn't experience some nice movement on the bridal categories with the larger centers, but we're pleased that it's It's made the business more well-rounded for us.

Okay, great to hear. Thanks, Don. And then in terms of the channels for CADIA, I know you guys mentioned, obviously, it's proprietary to your own website, the DTC website. But how should we think about the plans for that over the next 12 months, if you will, just in terms of I would assume you guys may get some requests from some of your traditional channels for the product. What's your thought process on how you roll that out to additional channels, or do you keep it sort of proprietary to the Charles and Colvard website?

Great question. So we're always open to listening to what the consumer and what the retail is pretty much dictating what they want and what their requests are. So we have gotten a lot of responses from our channel partners that they want to go ahead and explore KD Lab-grown diamonds. for the most part right now, what we want to do is we want to learn more. We want to better understand that consumer and better understand what that consumer wants. And basically right now it's proprietary to our charlesandcobart.com channel. And we'll probably keep that a little bit for right now. But we're constantly kind of open to exploring, you know, what's next and how we can kind of grow and tap into that multi-billion dollar opportunity across the board between our retail partners or our drop ship partners or, It really depends, but the CADIA is generally a premium. Right now, we came to market with the premium lab-grown diamonds, so that would have certain limitations of where we would go with the channel as far as the CADIA lab-grown diamonds, but as we learn more, it's not to say that we won't explore other product brands within the space that may not be CADIA, but maybe something else in that nature.

Great, great. And then just if I could sneak one more in on the online channel, the reacceleration and growth is really encouraging there. So I just wanted to see if you guys could speak for a moment on what you're seeing in terms of performance marketing return on ad spend. I mean, it looks like sales and marketing, the line item overall decreased year over year. So that would imply you guys are getting a lot of efficiency, but I guess there probably are some moving pieces within that sales and marketing line on kind of bottom of funnel performance marketing spend. So you could talk about the puts and takes there and just what that's done to your customer acquisition costs. That would be very helpful.

Sure. So we have a different approach, a different, you know, as we spoke about and we alluded to in Q2, kind of we were learning during Q1, I mean in Q1, sorry, in Q1, we were learning what that consumer wanted. We were learning where that consumer was shopping. We were learning Basically, what was the click-through that was driving that consumer to convert on our website? Also, what we did there was we basically also just changed our paid social campaigns to reflect those conversion-based customers or consumers. So by doing that, we were able to also flex our spend, which allowed us to open up kind of the market a little bit more and be there when that consumer was there, resonating with our products, and then clicking through to our products, and then we were able to capture more market share. We'll continue to look at that. We'll continue to learn from that. But really, it's more of a focused approach to mid to lower funnel. It's conversion-based. It's really we did a bottoms-up analysis on all keywords, phrases. We had some efficiencies there. Also, one thing that's really, really critical is we built out some incredible BI tools with our team, and we put together some tremendous analytics that helped us make real-time decisions that really dictate a lot of what we did to drive the growth. So that's something that we needed to do a better job before. It's something that we're doing a great job with now and we'll continue to look at and do better in the future. But certainly data-driven decisions that are very specific to key questions that drive the traffic is really critical to really the next chapter in Charles and Cobart and where we're going and where we're growing besides the product brands that we offer.

Great. Very helpful, Don. I'll jump back to you guys. Thank you. Bye.

The next question comes from Jason Ersiner with Bumbershoot Holdings. Please go ahead.

Congratulations. And I really appreciate all the details and specifics you walked through. It's actually, I found it very helpful in terms of understanding where you want to be headed. In terms of the growth in the quarter, could you maybe talk just at a high level qualitatively, you know, coming the COVID impact, whether that's kind of a benefit or negative, obviously this focus on the bottom quarter, funnel spend, you know, Keisha Adams, the TikTok movement, you know, what, what kind of drove some of the growth rate in the quarter and how do you think about that growth rate as you kind of go from holiday season to holiday season with Valentine's day in terms of seasonality?

Yeah. So, I mean, I probably won't elaborate on any individual, you know, influencer or influencer campaign that's outside our own doing that drives the traffic, but, You know, certainly more awareness, more brand awareness, more of what we're doing socially is driving more awareness to the overall brand. And basically being in that conversation to where, you know, that consumer is purchasing our Moissanite, loving our Moissanite and the Forever One, understanding its quality, making that choice to go with that, and then literally posting it organically throughout the web. You know, as it relates to TikTok or Instagram, you know, Reels or Instagram or Facebook outside of what we publish, we're probably not going to comment on that. And any new movement related to those, you know, mediums are fairly new and weren't reflective in the quarter. So all of the benefits of what we've done here internally driving the business is all what drove the growth of the business. Mostly online, most of the business was online. You know, there's probably some credence to, you know, more people being at home, more people seeing the brand for the first time, understanding what we offer and purchasing. But we're also pleased on the traditional side of it too as well between our traditional brick and mortar retail, which we were very pleased to be flat, which we had anticipated that we'd have some, you know, retraction from that aspect of the business due to COVID. But overall, you know, I would say that the international piece is probably the biggest pain for us right now on the business side, and we're pleased that the traditional brick and mortar and our online was able to fill those gaps. But we see, you know, we've seen a constant growth with the organic movement in our online traffic over the entire quarter, even coming off of Q1 straightforward.

Okay. And I guess just following up on that, I'm not, I guess I'm not trying to ask about any specific campaigns if you can't give details but are they do they tend to be formal you know ongoing arrangements or are they more one-off thing yeah i mean look i'm not i'm not trying to admit that i watched the bachelorette on a public earning call but yeah i was surprised when it came up you know something like that it was an amazing product placement i thought and and really resonated with the brand are these things that are like formalized uh or do they tend to kind of just emerge and then kind of be a one-off type of thing?

So specifically related to the Bachelorette, that was an internal campaign within our marketing teams to push out goods, and that was totally an alignment between, you know, Charles and Cobart and who we would align ourselves with. So to answer your point blank with that specifically, that was a specific marketing campaign you know, project with our teams together, working together in coordination.

Okay. And then I loved hearing you say, you know, brand equity matters. When you think about kind of growth in the Moissanite sector or area and then kind of becoming the brand within that, is there a way to accelerate some of the spending to kind of capture that first mover advantage and all the things you've done? in the brand in terms of maybe willing to forego a little bit of profit in the short term? You know, I mean, you have 25% of your market cap still in cash and your cash generative. So is there any risk to, you know, going forward a little bit in terms of spending more to try to capture some of that growth and, you know, transcend into really the brand in the space?

Yeah, so all great questions. So Let's talk about the growth in this sector and let's talk about the sector in general. As it relates to Moissanite, I'm from the opinion that we own the market and we have the greatest market share. We're also the innovators and the creators of Moissanite. I will also say that what a lot of people don't know is that all Moissanite, well, I shouldn't say all Moissanite, but a lot of the Moissanite through our distribution partners are also in white label or they could be forever one. Basically, those service all of our independent retailers. There's 40,000 independent retailers out there that buy that product through distributors that you may not even know that it's Charles and Colvard product. So that helps lift our traditional segment or really the foundation that the business was built on as far as our, you know, building the foundation and all the loose gems being out there, building more awareness to Moissanite. So when that awareness continues and keeps driving where it is, it's going to lift us up too as well. So we're really pleased with the growth that's happening right now, being in the conversation of the lab-grown space as it relates to moissanite, and even now the elevation of moissanite and what it has to offer. But make no mistake, our moissanite is not limited to just Charles and Colvard and what you hear. It's moissanite in general overall. As far as foregoing profit for more awareness, certainly right now we're early into this. We're about two quarters into this. If you look at the kind of the revised transition between Q1 and Q2. This is indicative of the leadership here. It's indicative of how we want to run and operate the business. We look at top and bottom line, so we're constantly looking how can we drive top line growth, but we also want to be mindful of the fact that we have a very profitable business right now and we're making responsible decisions with the money. That's not to say that we won't look for you know, something in the future that could catapult us to the next level and get over this, you know, idea that we're just limited to where we are here and grow the business exponentially further. So certainly we'll be open and we are listening and we are looking at other opportunities, whether, you know, I mean, I guess your, your inferences, you know, whether it could be through a celebrity endorsement or something like that, or even pushing more money into the marketing industry, kind of awareness campaign and giving us more exposure. Um, without a doubt, we're looking at those options and opportunities right now, but I will tell you that, uh, you know, we wanted to get the house in order and I believe that we've proven that the house is absolutely in order and it's, um, performing quite well right now.

Okay. Fantastic. And I apologize. Just one more. I just want to clarify in terms of, I think you had said Charles and Colvard bringing people to Cadia. Or is it the other way around? I guess my interpretation was that CADIA is kind of helping with this education process of, I think you kind of called it like a gem is a gem movement, and then maybe that leading people even more towards the Moissanite.

So I guess... So you are correct, but let me just... So Charles and Colvard is the house of brand. Under that brand consists of our product brands, which is Forever One, and it's currently Cadia lab-grown diamonds. So those are our two product brands, and also Moistenite by Charles and Colvard as well. So basically we're pushing Charles and Colvard as the brand of choice for all your lab-grown gemstones, and we want Charles and Colvard to be the pinnacle. We want Charles and Colvard to represent that kind of taste of quality, price, and value. And then from there, we want to build as much awareness as we can. But to be quite frank, a lot of people just – were predisposed to the diamond market or predisposed to diamonds, and they basically just didn't want to hear about moissanite. And even when we tried to push in some cases to educate that consumer. So with our product brand, Cadia, lab-grown diamonds, we're now in that conversation. We're getting press, you know, from Forbes Magazine to Brides.com to Refinery29, you know, to The Knot, some great publications. where we're able to actually speak about Charles and Colbert, the brand, and then educate more on those product brands, which is now resonating more, which we believe that is going to lift us entirely moving forward within the quarters. So I guess it's a combination of both. It's just the overall conversation of Labrador and Diamonds that people are listening to, hey, who are the players in that space? and now Charles and Colvard, which is associated with all the quality of our jewelry and craftsmanship and recyclable metals and stuff like that, comes into play, and now the difference is they have the choice.

Understood. I appreciate that. Thanks for taking my questions, and again, congratulations on the results.

No, we really appreciate it.

As a reminder, if you have a question, please press star and then 1 to be joined into the queue. Our next question comes from Paul Zimniski with PZDA. Please go ahead.

Hi, guys. Thanks for taking the question. Congrats on the strong performance. I guess I have more of a general question. How are you finding the end consumer responding to the option of moissanite versus lab diamond when it comes to engagement ring in particular? You know, for the consumers that are choosing a diamond, are you getting any feedback as to why they're choosing moissanite the diamond over the moissanite or vice versa?

Actually, that's a great question. You know, it's kind of early on for us a little bit to kind of give you a definitive answer on that. I can tell you my team did a fantastic job in kind of laying out, you know, both channels on our direct-to-consumer website. So really we're just having that consumer, that consumer is actually making that choice when they're clicking. So, you know, if I could just, Put that aside for right now. Maybe we'll answer that a little bit in the future. You and I can get on a call. I think it's a great question. I need to better understand what the consumer is doing related to that and then look at some type of heat map and going through that. But I can tell you vocally that consumer is not saying anything. The consumer is either choosing either the lab-grown diamond in Acadia or they're choosing the Forever One Moissanite. I do think that we are getting a tremendous amount of calls within our customer service group that's actually probably walking through and educating that consumer, telling them what the choice is, whether they're choosing MoistureNet because it's the value proposition or whether it's Diamond because they're predisposed to a Diamond. I don't have enough information on that, and I'd like to get back to you on that.

Fair enough. We wish you guys the best going forward. Wish you the best, I guess, for the rest of the year.

Sure. We appreciate it. Thanks.

This concludes our question and answer session. Oh, actually, pardon me. The next question comes from Eric Landry with BML Capital. Please go ahead.

Hi. Thanks for taking the question. Have you had any feedback about what's going on with your PPP loan?

Yeah, so I'll let Clayton go ahead and answer that. He'll walk you through that. Sure.

Hey, Eric, how you doing? Great. Listen, we have not filed our forgiveness application today. Our lender has basically told us that we should expect to file our forgiveness application no sooner than April 1st of this year, 2021. So we hope to file it sometime in our fiscal year, our fiscal quarter Q4 2021. Okay.

Can I speak one more in here? You probably can't answer this, but I'll give it a shot anyways.

I'll try. Go ahead.

Okay. Could either one of you mention which of the two product categories grew faster in the quarter, whether it was the lab-grown or the moissanite?

That's a great question. Can't really answer it, but we had very nice steady growth on both fronts. I mean, that's as specific as I can get. And we're very pleased with our Forever One Moissanite and the growth trajectory of our Moissanite. And we're also very pleased of our KDLA grown diamond growth. So we basically don't disclose that in the can at this time.

Okay. And how about this? Did you sense that there was any type of cannibalization in the quarter?

No, it actually was the reverse. It actually elevated our Forever One Moissanite or Moissanite sales across the board. Also, our merchandising and product development team did a great job of making sure that there's a clear delineation between the two products. For example, two carats and below is really catered to the diamond business or the lab-grown diamond price point. whereas the moissanite benefits are two carat above. Also, in the moissanites, we offer many, many shapes and sizes that would be cost prohibitive in the diamond world or lab-grown diamond space. So it's really a clear delineation from the two. We did a really good job in coming to market. We are not experiencing cannibalization by any means. So both are growing very nicely. The business is growing very nicely. you know, as it has reflected in our earnings.

Yeah. Yeah, you guys are doing a great job. Fantastic work. Thank you for taking the question.

Appreciate it, Eric. Thanks, Eric.

This concludes our question and answer session. I would now like to turn the conference back over to Don O'Connell, President and Chief Executive Officer, for any closing remarks.

So all I can say is I'm very proud of our team and what we've accomplished through the quarter, and we appreciate all your time and continued interest in Charles and Cobard. We look forward to delivering more results like this in the future quarters to come.

All be safe and be well.

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