Charles & Colvard Ltd.

Good day and welcome to the Charles and Colvard Q4 fiscal year 2023 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. 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. 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 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 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.charlesandcolvard.com slash events. The company will be hosting a Q&A session at the conclusion of the prepared remarks. Should you have any questions you'd like to submit, please email C-T-H-R at lithiumpartners.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.

Good afternoon, everyone, and welcome to our fourth quarter and fiscal 2023 financial results conference call. The challenging macroeconomic backdrop, a weakened consumer outlook, and a softening engagement market greatly impacted our quarter and fiscal year. We're not alone, as these circumstances and heightened downward pricing pressure on both lab-grown and mined diamonds created significant headwinds for the entire jewelry and gemstone industry. Until now, these challenges have not greatly affected our overall business. These trends in the diamond market have now put considerable pricing pressure on moissanite, affecting our overall traditional wholesale business and consumption of raw materials. This has caused us to reevaluate our supply chain and gemstone cost, pricing methodology, and go-to-market strategy as we experience margin erosion in software sales. In addition, late in Q4, we identified a cybersecurity incident that temporarily disrupted the company's IT network and resulted in some limited downtime for certain systems. Our investigation revealed no evidence that any sensitive customer data was compromised as a result of this incident. Our relationship with our customers has not been negatively impacted, and no payments were made to the ransomware threat actors. We have, however, incurred costs in the first quarter of the fiscal year ending June 30, 2024, and expect to continue to incur some additional costs in the future related to enhancements to our cybersecurity measures. Despite these challenges, our balance sheet remains strong. and the company continued to manage cash effectively, closing out the quarter and fiscal year with over $15.6 million. The company remains debt-free, all the while making strategic investments in support of our future growth opportunities and initiatives. Other notable highlights for Q4 include we launched both successful Mother's Day and Father's Day campaigns on charlesandcobar.com, as we look to expand our repeat customer base, highlighting men's and unisex jewelry. We hosted a private invite-only spring preview in New York City in April, with more than 30 editors and influencers from well-known publications and websites, such as The Knot, NBCU, Today, and U.S. Weekly, to showcase our new expanded fine jewelry styles. We launched the company's new-owned B2B web property, Charles and Colvard Direct.com, selling loose... Moissanite Gems, Forever One, and Moissanite by Charles and Colvard to select the retailers. We expanded our assortment of new Forever One Moissanite and Cadia lab-grown diamond fine jewelry styles on charlesandcolvard.com across all categories, including our signature and exotics collections, along with our fashion jewelry assortment in both lab-grown diamonds and Moissanite, and our made-in-color collection and unisex bands in lab-grown diamonds. We launched three new dropship partnerships featuring Moissanite by Charles and Colvard Fine Jewelry. We attended JCK in Las Vegas in June to engage with customers and our vendors in support of growing our customer base and product assortments. We launched an ad campaign promoting the company's signature showroom in the local Midtown magazines. We showcased and highlighted our brand at the Direct Selling Association's annual conference in Scottsdale, Arizona in June to further build our brand awareness and establish non-traditional partnerships. We appeared in 34 brand and product placements in 23 features, including notable outlets such as Marie Claire, The Hollywood Reporter, Brides, JCK, The Knot, and AC Magazine. And revenue on our moissanineoutlet.com owned property increased by 64% for the quarter, which enabled us to capture a greater market share of those consumers seeking lower-priced fine jewelry items. We believe responsible inventory management is crucial for maintaining competitiveness amidst a challenging economic landscape. Given the seismic shifts in the industry, pricing pressures, and constrain consumer demand, we have taken a position to write down $5.9 million of certain lower-grade non-ForeverOne moissanite and lab-grown diamond raw material and gems. The company's inventory level remains solid at $26.75 million, which we deem adequate to support the demand for our ForeverOne product category for the foreseeable future. We are confident that advancements in our technology, our proprietary cutting and faceting methods, and our ability to procure alternative SIC material as needed enable us to navigate the fluid environment more responsibly. As we look ahead, let's take a moment to look at the positives that we believe will better position us for future growth beyond the macroeconomic and industry headwinds in the short term. The holiday season, fast approaching, has historically been our strongest quarter as consumers are predisposed to purchase. Our proprietary signature collection continues to resonate with the consumer as we seek to differentiate the brands and products we have to offer, supported by a 36% increase in revenue for Q4 compared to one year ago. In addition, during the fiscal year and quarter, the company's AOV, or average order value, remains stable. which reflects that we've been able to maintain our price points despite the macroeconomic backdrop. While we believe that lab-grown diamonds have gained significant market penetration and that Arcadia lab-grown diamonds will become the highest growth product category for us, witnessed by more than a 20% increase over the comparable periods, we also believe that Moissanite will remain an integral part of our overall business composition. as it continues to offer an attractive value proposition to the price-conscious consumer looking for quality fine jewelry products. The increased demand for lab-grown diamonds amplifies the need to grow Arcadia lab-grown diamond business in a responsive way as we seek to migrate our diamond products into existing channels to capture a greater share of wallet. We believe that the lab-grown movement plays into our hands And as more consumers come to understand that lab-grown diamonds are identical to their mine counterparts, the only difference being the origin. According to the Knot.com, a wedding planning website, of the 12,000 couples surveyed, more than one-third opted for a lab-grown diamond as their ring center stone, double the number just three years ago. As a result of these trends, sales of lab-grown diamonds are expected to double to $55.5 billion by 2031. As we move forward, we will continue to evaluate the competitive landscape and the value proposition between moissanite and lab-grown diamonds and its overall impact on our business. We will continue to invest responsibly and seek opportunities to make our brand and products top of mind. Look to us to stabilize our current state, amplify our brand, diversify revenue streams, and strategically adapt our technology. Now I'd like to highlight our upcoming strategic initiatives. For fiscal 2024, the company's core focus will be to continue to enhance its global brand awareness campaigns, diversify its product categories, and innovate its technology to stay ahead of the competition to deliver additional products and services, unlocking new revenue streams. More specifically, as it relates to global brand awareness, we plan to continue strengthening the fine jewelry brand we have been building for nearly three decades. As the consumer landscape continues to shift and factors beyond price, craftsmanship, and origin are driving decisions to purchase, brand equity is more important than ever. We believe we will continue to invest in paid media campaigns targeting the trade and consumers as we reinforce our made-not-mine providence. We will also remain steadfast in our quest for sustained top-line organic growth as our brand messaging resonates with new audiences. To diversify our product categories, we will continue to evaluate opportunities for growth with synergistic brands, products, and verticals beyond our current offerings. Emerging consumer trends and data will inform new product lines, collections, partnerships with designers and influencers. We will explore strategic alliances to fuel growth and deliver incremental long-term shareholder value while prioritizing our sustainable practices and our core values. Evolving technology continues to shape how consumers discover, research, and ultimately purchase. We will continue to invest strategically in technology to service customers in existing and new outlets. We believe that our investment in innovative technology and predictive analytics will further maximize our ability to be agile and efficient in our business. We will enhance our consumer experience through immersive virtual selling and fully customizable products driven by actionable data. Additionally, we'll continue to capitalize on our leading-edge streaming broadcast technology to digitally attract new audiences, each with unique characteristics, while broadening our footprint and ability to drive organic growth. Fundamentally, our goal is to find ways to reach consumers more efficiently and cost-effectively while strengthening our moat and overall position in the market. Expanding our business to directly interface with the consumer while controlling the customer experience is critical. As highlighted by the challenges in our wholesale channels, a quick look at the numbers shows that our traditional segment, which is comprised primarily of wholesale loose gemstones, was down 61% during the fourth quarter. This shrinking segment is, in part, by design and a primary reason we will continue to seek and open new channels that enable us to interact directly with the customer at all points along their buying journey. To achieve this, we are building an environment to meet today's consumers with shoppable interactive live streaming on connected TV, linear broadcasting, satellite, and social media platforms. Taking a step back, for those not familiar with it, we believe this is a growth opportunity for the company. This technology is being embraced by industry leaders such as Roku and Shopify's recent announcement of a strategic partnership, Amazon's announcement of Amazon Live, and Pinterest's announcement of PinTV. Fueling these trends is the increased usage of smart TVs, along with the new payment alternatives which make shopping via TV easier and more streamlined. The global TV shopping market size is vast and expected to grow by 6%, annually to $440 billion by 2030. In addition, among the several product categories within the TV shopping market, jewelry is expected to dominate this space and be the largest offering within this selling vertical by 2028. We're excited to introduce this beta phase of our interactive shopping initiative by going live on select cable and satellite TV providers broadcasting our made shopping content. highlighting our made-not-mined Forever One Moissanite and Cadia Lab Grown Diamonds to over 20 million households weekly and streaming via YouTube, Facebook, LinkedIn to potentially millions of households. We believe the holiday season is an ideal time of year to debut. In addition, we believe this will be accretive to our existing business as we view this as a new channel opportunity utilizing our existing infrastructure and resources to enhance our growth opportunity and control our destiny, and perhaps meet consumers in different verticals. While our operations have been negatively affected by the macroelements of the economy and pricing disruptions, we believe our strategic initiatives of enhancing our global brand awareness campaigns Diversifying our product categories and innovating our technology will help drive measurable growth in the years to come. I will now turn the presentation over to Clint Peet, our CFO, to provide detailed insight into Q4's financial performance. Clint, please proceed.

Thanks, Don. Today I'll provide a summary of key financials for the fourth quarter into June 30, 2023. Additional details can be found in our earnings press release that we issued this afternoon in our form 10-K, which we expect to file this evening. Please note that all percentage comparisons are to the fourth quarter ended June 30, 2022, unless specified otherwise. First, we'll start on slide eight with the comparative analysis of the fourth quarter of fiscal 2023 compared to the same period one year ago. In total, Net sales for Q4 2023 totaled $5.6 million versus $9.3 million, a decrease of 40%, due primarily to the factors Don previously mentioned. Net sales for our online channel segment, which is primarily direct-to-consumer and includes CharlesandCobar.com, MoistureNetOutlet.com, CharlesandCobarDirect.com, Marketplaces, Drop Ship Retail, and other pure-play outlets, totaled $4.2 million for the quarter, or a decrease of 27%, but now representing 75% of total net sales, up from 62% one year ago. Net sales for our traditional segment, which consists of wholesale and brick and mortar customers, totaled $1.4 million for the quarter, or a decrease of 61%, representing now 25% of total net sales, down from 38% of net sales in the year-ago quarter. Finished jewelry net sales decreased 23% for the quarter, but represented 84% of total sales in the quarter, up from 65% of sales in the fourth quarter one year ago, as we further positioned ourselves in the fine jewelry market. Loose jewel net sales decreased 73% 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 forecast and overall inventories to the softer economic environment. Looking at sales by geography, nearly all the sales in the fourth quarter were derived in the U.S., while international net sales reported in the quarter were only $100,000. Direct-to-consumer and finished jewelry opportunities, which remained core to the company, were somewhat less impacted. as evidenced by the lesser decline in online channels in finished jewelry net sales than in our traditional segment, in particular, loose jewels net sales. Moving to slide 9 to discuss gross margin, we reported a negative gross margin of 90% versus 41% positive gross margin in the year-ago quarter, or a gross loss of $5 million versus a $3.8 million in gross profit in the year-ago quarter. Primary driver for this negative gross margin in Q4 2023 is a $5.9 million inventory write-down as pricing pressure and constrained consumer demand impacted the net realizable value of certain grades of our non-forever-won moissanite and lab-grown diamond raw material gems falling below the current carrying costs. For Q4 2023, total operating expenses increased 16%. representing 77% of total net sales, compared to 40% in the year-ago quarter. Sales and marketing expenses increased 11% to $3 million in support of our top of funnel brand awareness initiatives, and G&A expenses were $1.4 million for the quarter, compared to $1.1 million in the year-ago quarter, for a 28% increase. For sales and marketing, 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. The primary increase in G&A for Q4 2023 was due in large part to an increase in bad debt expense and legal fees. We reported a net loss for Q4 2023 of $9.3 million, or $0.30 loss per diluted share. compared to a net income of $40,000, or zero cents earnings per diluted share in a year-ago period. The main drivers for our net loss were the $5.9 million inventory write-down noted earlier and increased expenses incurred in support of top-of-funnel marketing. Our weighted average share is outstanding on a diluted basis, used in the calculation of loss per share for the quarter period. were approximately 30.4 million shares for the period ended June 30, 2023, compared to 31.2 million shares for the period ended June 30, 2022. 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 $15.6 million of total cash, compared to $16 million at the end of the third quarter ended March 31, 2023, and $21.2 million as of June 30, 2022. Working capital remained strong at $17.3 million. In addition, the company continues to be debt-free. Our cash flow used in operations was $48,000 during the quarter, compared to $500,000 of cash flow used in operations during 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, which was renewed for another year in June 30, 2023. As of June 30, 2023 and through today, we have not accessed funds through our credit facility agreement. Inventory as of June 30, 2023 totaled $26.8 million, compared to $33.3 million at March 31, 2023, a reduction of nearly $6.9 million due to the inventory write-down previously mentioned. The inventory as of June 30, 2022, was $33.5 million. Luce Jules' inventory was $9.1 million as of June 30, 2023, compared to $15.6 million as of March 31, 2023, again, due to the inventory write-down. which was all related to loose jewels inventory. Loose jewels inventories of June 30, 2022 was $16.2 million. Finished jewelry inventory was $17.3 million as of June 30, 2023, compared to $17.4 million as of March 31, 2023, showing a reduction of $100,000. Demonstrating a solid sell-through of our finished jewelry in our direct-to-consumer online channels, while maintaining a higher percentage of in-stock rates above 90% to meet our service level agreements. We plan to remain focused on prudent inventory management strategies going forward. Finished jewelry as of June 30, 2023 was $17.2 million. Book value per share at the end of the quarter and the year was $1.30 per share. sequentially lowered to Q3 2023 and at June 30, 2022, due to the inventory write-down that I described earlier in my comments, as well as the tax valuation allowance and cumulative losses over the quarters of FY 2023. In summary, we remain steadfast in our cash management while diligently deploying capital and support about our ongoing business and technology advancements towards growth initiatives and further brand awareness. With that, I'll turn it back over to Don.

Thank you, Clint. In conclusion, despite the facing headwinds throughout the full fiscal year, we remain optimistic and excited about the future of our company. While we acknowledge the challenges we've encountered, we have also made significant progress in implementing strategic initiatives that we believe will drive growth and enhance our overall performance. Moving forward, we are committed to leveraging our strengths, refining our strategies, and capitalizing on new opportunities. Our dedicated team, coupled with our innovative approach, positions us well for success in the coming years. We firmly believe that our proactive measures combined with our unwavering determination will enable us to overcome the obstacles we have encountered and pave the way for a brighter future. We are confident in our long-term business strategies. will yield favorable results and create long-term value for our shareholders. We extend our gratitude to our valued investors, employees, and stakeholders for their continued support and trust in our company. Together, we will navigate these challenges and, we believe, emerge stronger than ever. At this time, I will turn the call back over to the operator who will open the lines for any questions.

Thank you. 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're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Please limit yourself to one question and one follow-up. If you have further questions, you may re-enter the queue. At this time, we will pause momentarily to assemble our roster.

Hi, Sarah. This is Adam Lowensteiner from Lithum Partners. I'm going to pose a few questions to the management team.

Hey, Adam.

Go ahead. Hi, Donna Quinn. Where do you see the company streaming made shopping going?

Well, thanks for bringing that up. So basically, we're about a week into made or made shopping, which is our digital streaming, broadcasting, interactive shopping experience. allowing the consumer to shop anywhere they want, whether they want to stream through Facebook, Instagram, YouTube, LinkedIn, wherever they are, we're going to give them the ability to see the products that we offer and be able to click and buy right there. In conjunction with that, we're also spread across in a beta phase with the broadcasting side where we're streaming through direct TV and those type of mediums like satellite and also different cable providers. look to us to gather the data that we've kind of learned and the learnings from where our customers are shopping and where they're located from a demographic standpoint and be able to geotarget them and be able to buy either cable, either direct response type opportunities and be able to target those customers. And also it allows us to be more diverse in the product offerings that we bring. So moving ahead and moving forward, you know, we believe and anticipate that we're broadcasting a really beautiful signal, a really great show. I mean, for those interested right now, we're actually broadcasting maidshopping.com. You can find us. You can find us streaming. So if you just go there, you can look at the quality of the show and what we're putting out. And we believe that it's state-of-the-art. We believe it's probably the best of the best in technology. We're producing 4K HD videos. Also, we're producing and streaming in 1080p, too, as well. And really, we're pretty excited about this new initiative. We think this is another way that we can reach a bigger, broader audience. It's also an answer to this incredibly expensive performance marketing cost per click that's going up and really just enabling us to navigate in a different way to be able to clear the noise of all the other competition out there. and showcase our products and showcase our product brands like we've never been able to do before. For example, Forever One is the premium Moissanite. We innovated it. We created it. We developed it and brought it to market. We need to let the consumers know that that's really what they're looking for, and this enables us to create long-form content that we can actually educate those consumers in a much better way and show the competitive advantage as to why Moissanite They need to be shopping with our brand and all the brand equity that comes along with it. For example, lifetime warranty on our gemstones, certifications, different things like that that will separate us from the Moissanite perspective. And also in a lab-grown diamond market, it's a very crowded space in very short order, and it's very price sensitive, and the pricing is coming down across the board for everyone. So we need to be able to bring our own brand forward, which is Cadia, K means pure in Greek, I think some symbiotic, I can't pronounce that word, so sorry about that, Adam. So we believe in diamond is diamond. So labrum diamonds are pure diamonds as far as we're concerned, same chemical and physical properties. And we're bringing them to market in a beautiful way through our incredible designs. And we believe that In order to be a leader in the lab-grown space, we need to push out our brand where customers are gravitating more to brands. So stay tuned for a bigger footprint. Stay tuned for seeing made in a much different light. And also the shopping network or the shopping made will enable us to bring different brands forward to be able to highlight those brands and be able to offer those brands in this stream. So not just limiting to brands, just primarily fine jewelry, but anything that we believe that's aligned with the brand and aligned with what we stand for as a company and enables us to grow in a much bigger way and we believe brings a lot more value to the shareholders than to Charles and Colbert. I know that was long-winded, but I figured I had to get that out there.

I appreciate the color. Was the decline in wholesale revenue a surprise?

Well, we've kind of been alluding quarter over quarter that we've been pushing more direct-to-consumer. Now, that's not to say that the wholesale brick-and-mortar business is not top of mind for us, and the brick-and-mortar partners are very dear to our heart and part of our strategy moving forward, and we support them. And a matter of fact, we didn't make the press announcement yet, but I can go ahead and make the statement that we did launch lab-grown diamonds, Cadia, in Helzberg stores. So we just launched that – basically a week and a half ago. So brick and mortar in our wholesale segment is still very, very strong. We'll continue to support our brick and mortar partners. On the wholesale side, you know, we've been talking about a declining market on the wholesale, and that could be because the downward pressure on the pricing, you know, it starts from the top, right? So it's no secret that, you know, everybody in the industry has been talking about the downward pressure of natural diamonds and dropping nearly 40%, I believe the number is. I mean, we can get the actual facts on that in the quotes, but I believe it's 40% drop on natural because lab-grown diamonds is pushing downward and becoming also a problem, as I alluded to in my prior remarks, for moissanite, pushing down on the moissanite pricing. So what we need to do is, and what we have been doing, is looking at that very closely over the quarters, focusing more on direct-to-consumer pricing, maintaining our brick and mortar presence and strength with our customers in brick and mortar, supporting them in our brand, all the while looking at our wholesale business and saying, okay, maybe we need to consolidate a little bit here. Maybe we need to kind of key in our strategic partners within the distribution model. And then also we just spoke about Charles and Colvard Direct. So Charles and Colvard Direct we just launched recently here, and that's also in beta. So we have a select amount of independent retailers that we have direct relationships with and that basically we can be more competitive and give them better pricing on certain quality of goods that are outside the Forever One. So we believe this could be a solution to an automated process to be able to support the entire wholesale market. But right now our focus is really pushing more direct-to-consumer and becoming more a brand that's meaningful, that resonates with all consumers and all products in all categories. How do we do that? We do that through this new streaming technology. We do it through analyzing where that customer is located and giving that customer what they're looking for to purchase. Make no mistake, this could be something that's very significant for us, and we believe that it's really important to the business. given the decline on the wholesale side. Now, again, it's difficult because we have to report quarter over quarter and say, okay, wholesale is declining by X number of percent. But the reality is it's going to continue to decline as long as we keep pushing more to direct the consumer. And then we anticipate some strength on the brick-and-mortar side, some strength in additional product brands that we'll introduce to more brick-and-mortar partners as we expand more in the lab-grown diamond, too, as well. Okay. Again, long-winded answer there, but hopefully I covered what you were asking for.

Thank you. Given the move towards lab-grown diamonds, how should investors view the company's inventory? Will you build more lab-grown diamonds and less moissanite going forward?

That's a great question. So in our... history, we've accumulated a pretty solid amount of inventory through a supply agreement that we had with our strategic partner. And if anybody's been tracking or following the company over the years, we've maintained a significant silicon carbide or moissanite inventory. We're pretty comfortable that we have ample inventory to support our overall business. And, you know, as I said earlier, for the has recently come down a little bit through this write-down that we just did. But it's a much different business than the diamond business. So from the lab-grown diamond business, there's so much material that's in the market readily available. With our strategic alliances and partnerships and relationships in the vendor community, we're able to buy more in just-in-time. Now, that's not to say that there wasn't some of that material bundled up in the write-down, And that was large in part due to our early entry to market of getting into lab-grown space, which we believe was a great move for the company, and now we offer the choice to that consumer. But the difficult scenario there was the market really pushed down and the pricing pressure was intense on the lab-grown side from the early days to where it is today. We believe that with this consideration that we just did in the write-down, we're in a great position as far as on the diamond inventory and then purchasing just in time our needs. And then Nemoise and I will continue to kind of look at that and weigh that, but, you know, we have a lot of options there. But if you look at our consumption of material, if anyone wants to look back from our supply agreement, year-to-date, not year-to-date, but for the full year we purchased materials, $1.8 million worth of material, which you can kind of understand what the consumption was. So we didn't feel that we needed any more material. We had plenty of material. We're servicing all of our customers, all of the needs, and we believe that Forever One is the pinnacle, and it will continue to be so for the foreseeable future and beyond.

Again, if you have a question, please press star, then one. Showing no further questions, this concludes our question and answer session. I would like to turn the conference back over to Don O'Connell for any closing remarks.

Thank you, Sarah. I'd like to thank you and everyone else for your attention and continued belief in our company. We look forward to sharing our progress and achievements with you in the future.

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