Charles & Colvard, Ltd. (NASDAQ:CTHR) Q2 2023 Earnings Call Transcript February 2, 2023

Operator: Good afternoon and welcome to the Charles & Colvard, Ltd. Second Quarter Fiscal Year 2023 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. 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.charlesandcolvard.com/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 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. Over the past few years, our focus has been to build a company that can take advantage of the longer term movement in the marketplace towards responsibly sourced gems and jewelry to capture greater market share. A recent Mackenzie report noted that consumer shopping for fine jewelry are increasingly favoring brands that act responsibly value diversity and have a compelling brand presence both online and offline. In years past, when people shot for high-end jewelry, design would be at the forefront of their mind. However, in recent years, research shows that consumers now also search for a brand that resonates with them and is socially and ethically responsible, which we believe is one of our key differentiators.

Millennial customers in particular won't even consider a brand that doesn't prioritize sustainability according to Mackenzie. Since the pandemic began, the consumer buying journey has fundamentally changed, while previously customers would visit a brick and mortar store in order to try on fine jewelry items in person, the pandemic moved consumers online. Research has also shown that sustainability considerations across product categories are growing. Within high-end jewelry, the consumer cares much more about ethics than they did before the pandemic. McKenzie projects that sustainability influence purchases while account for 20% to 30% of all fine jewelry sales by 2025. Perhaps as much as $110 billion, which is more than triple the number of sustainability influence purchases in 2019.

The lab grown jewelry market, which represents one of the hottest growing categories in the jewelry space and as a subset of sustainability influence purchases, is forecasted to exceed $9 billion this year. We believe that Charles & Colvard is ideally positioned with our Manotmine strategy and campaign to benefit from what McKinsey has dubbed the sustainability search, as well as our broader direct-to-consumer initiatives providing us optimism for growth opportunities for the future of the company. In order to take advantage of the movement in the market, we have undertaking key initiatives to drive long-term value in the company. This includes focusing on finished jewelry products, the utilization of one of our long-standing core strengths in the production and faceting of loose gemstones to now include lab grown diamonds.

Diversifying our product offering beyond created moissanite to include lab grown diamonds and colored gemstones. Expanding our direct-to-consumer footprint, which includes our online focus, our signature showroom initiative, and some exciting opportunities we will be exploring in the coming quarters and building up branded distribution assets of our owned properties to become more self-sustaining while allowing us to leverage our infrastructure in the future. While the macroeconomic environment is certainly providing some near-term pressure to the industry right now, we have begun to take steps to diligently manage our expenses when possible, and overall inventory position. We believe the underlying results of the quarter are an indication that we are executing against our long-term initiatives while maintaining the strength of our balance sheet, positioning us well within the growing transformation that is taking place within the jewelry industry.

So when I talk about execution against our key initiatives, what does that mean? First, as I mentioned, we are expanding our focus on enhancing our finished jewelry assortment and showcasing our value proposition with its core and original designs. Featuring moissanite gemstones in premium quality. In fiscal year 2021, approximately 62% of our total revenue was attributed to finished jewelry. That number was 68% in fiscal 2022, and during the most recent quarter end of December 31, 2022, it comprised 81%. Why the added focused on finished jewelry versus loose gemstones. For several years, we've worked diligently to become a globally recognized fine jewelry destination, rather than simply a single gemstone supplier in the wholesale capacity, which we believe limited our future growth opportunities and overall total achievable market or tam.

Our second key focus area is broadening our footprint to capture a greater share of the lab grown diamond market. Data shows the number of engagement rings sold that featured a lab grown diamond jumped 63% from March 2021, to March of last year. While the number of engager rings sold with a mine diamond declined 25% in the same period. Lab grown diamonds comprised about 3% of the specialty diamond jewelry market in 2020, and that figure grew 7% in 2021. This is a growing market and we intend to be a major voice within the industry. In September of 2020, we launched Arcadia Lab Grown diamonds. While still a fraction of overall sales, it is clearly the fastest growing product category for us, with sales of 19% compared to last year's second quarter and year to date, we are up over 600% compared to the same period in fiscal 2021.

Moissanite will continue to be a huge focus and key differentiator for us, but we intend decimally compete in the diamond space, adding to our incredible line-up of Manotmine gems and jewelry. As mentioned, another key focus for us is on expanding our direct-to-consumer focus, thereby broadening our footprint and providing the ability for our consumers to experience our product firsthand. As a report I mentioned at the beginning discussed there is increasing movement towards online and non-brick and mortar purchases. Clearly brick and mortar is not going away. In fact, we recently opened a flagship store in Research Triangle Park, North Carolina to expand our reach, but the growth especially amongst younger individuals is moving towards online.

We have expanded our capabilities online over the last number of years to enhance the customer experience, while also looking to improve our advertising and marketing focus to build greater brand awareness. That said, the investment to capture the direct-to-consumer and online sales do come to cost. Digital advertising costs have increased substantially in the ROI fluctuates. Like many in the industry, we have refocused efforts to find ways to reach the consumer more effectively, strategically focusing our marketing efforts to find customers predisposed to our Manotmine product assortment. At a high level, online channels comprised 76% of our second quarter sales in fiscal 2023 compared to 66% during Q1 of fiscal 2023 and just 62% for full fiscal year 2022.

Our strategic focus remains continuing to drive and elevate our direct-to-consumer presence and brand strategy, which we believe will better position us from long-term growth and help bolster against the current macroeconomic uncertainty and geopolitical unrest. We continue to make strategic investments in our direct-to-consumer initiatives, which we believe will further strengthen our moat and overall position in the market. Our goal is to leverage our assets in order to make Charles & Colvard synonymous with responsible moissanite fine jewelry and gemstones for the conscious consumer, which we believe is the largest growing category and opportunity in the jewelry space. We want to own more of our destiny and become a top destination of choice where our customers can satisfy all of their jewelry needs.

Our web properties and flagship stores are examples of this. With a large portion of our capital investments funded and key personnel added in support of these strategies, we can now focus on ways to monetize these initiatives in a meaningful way. This will take some time to bear fruit, but we believe we have strengthen our resources and capabilities building upon our past successes infrastructure and brand equity to take the company to the next level. Clearly, the challenges in the economy are playing a part in our results. Domestic and global inflation and rising interest rates, coupled with ongoing fears of recession continue to erode consumer confidence and present major challenges for the global retail and jewelry industry. While American consumers spent more this holiday season to keep up with higher prices, we experience lulls during the calendar year end holiday season, and we expect that consumers will continue to feel pressured financially, particularly during the second half of fiscal 2023.

This is not unique to Charles & Colvard and we are facing similar challenges of retailers in the fine jewelry space. At the same time however, these same challenges are providing us the opportunity to continue reevaluating technologies and strategies to better position us in the future. Some of these I've discussed already on this call, but another important aspect has been our ability to manage our inventory and cash flow. As you will see in the results, our cash position increased during the quarter, despite the net loss. Cash increased from $16.6 million last quarter to $17 million this quarter. Further, our cash flows from operations were also positive this quarter. We expect that our inventory levels, which were down $1.6 million from the most recent quarter, should continue to decrease in the quarters to come.

Photo by Cornelia Ng on Unsplash

We feel confident that we have taken decisive actions to align our go-forward growth and profitability strategies with the near term economic backdrop, to help maintain a strong balance sheet going forward. I would like to highlight again to everyone that we currently have $17 million cash and cash equivalents and inventory valued at $35 million, for a combined total of $52 million with only $10 million in total liabilities, including zero debt. So even if you ignore all the other assets we have, including net fixed assets and equipment, intangible assets such as our intellectual property, receivables and excluding any value for our brand equity, etcetera, and only account for cash, cash equivalents and inventory, less all liabilities. it comes to approximately $42 million compared to a current market cap of approximately $29 million.

We believe this showcases our demonstrated value. As I turn it over to Clint to review our financial statement in more detail, let me just quickly summarize. Despite the challenges in the industry, we still deliver $10.4 million in revenue, a level that's only been achieved a handful of times in the company's history. We generated positive cash flow from operations this quarter. We are transitioning the business to focus on areas that create long-term value, such as focusing on finished jewelry products and allow us to capitalize on key consumer opportunities such as diversifying our offering to include lab grown diamonds and colored gemstones, while expanding our direct-to-consumer footprint. These key areas of focus outperformed the larger top line number during the quarter, which was largely impacted by non-direct consumer sales and our wholesale loose gemstone business.

Clint will expand more on this shortly. We are building value in our distribution capabilities and brand equity to better control our own destiny, meeting the consumer directly where they're shopping. And finally, our balance sheet remains strong, affording us the ability to invest in areas to enact these strategic initiatives and take advantage of key opportunities in the marketplace. At this time, I'd like to turn the call over to Clint Pete, our CFO for an overview of our Q2 financials. I'll return to wrap things up after. Clint?

Clint Pete: Thanks Don. Today I'll provide a summary of key financials for the second quarter ended December 31, 2022. 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 second quarter end December 31, 2021 unless specified otherwise. First, we'll start on Slide 11 with comparative analysis of the second quarter of fiscal 2023 compared to the same period one year ago. In total net sell for Q2 2023, total $10.4 million versus $13.8 million, a decrease of 25%, due primarily to the economic factors Don alluded to. While revenues were lowered in a quarter, the decline was slightly less than what we experienced in the first quarter when compared to the comparable prior year period.

Net sales for online channel segment, which is primarily direct-to-consumer and includes charlesandcolvard.com, moissaniteoutlet.com, marketplaces, drop ship retail, another pure play outlet totaled $7.8 million for the quarter or a decrease of 16%, but now representing 76% of total net sales up from 68% one year ago. Net sales for our traditional segment, which consist of wholesale and brick and mortar customers, totaled $2.5 million for the quarter or a decrease of 43%, representing now approximately 24% of total net sales. Finished jewelry net sales decreased 20% for the quarter, but represented 81% of total sales in the quarter up from 77% of sales in the second quarter one year ago. Loose jewel net sales decreased 40% for the quarter. As we mentioned above, due impart to our shift towards finished jury and directing consumer strategies while many domestic and international distributors reduced third calendar year forecast in overall inventory due the softer economic environment.

International net sales decreased 49% as certain of our distribution partners continue to face ongoing COVID-19 restrictions and closures as well as lower calendar year end holiday demand due to consumer inflation and 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. We want to point out changes in our online channel segment as well as in the finished jewelry as they relate to the percentage increases of these two total revenue. We have seen increases not only in the current quarters as discussed above compared to year ago quarter, but also comparable to the trends we saw in Q1 of fiscal 2023 that had similar increases when compared to the prior year period.

We are also seeing these same increases when comparing Q2 2023 to Q1 2023. Accordingly, we are becoming less dependent on the distribution network in our traditional segment as we continue to shift to a more of a direct and consumer focus in which Don alluded to earlier and is by design. Moving to Slide 12 to discuss gross margin and profit, we delivered a gross margin of 41% versus 49% in the year ago quarter, delivering 4.3 million in gross profit versus $6.7 million in a year ago quarter. Most notably, the decrease in the gross margin during the quarter was related to an approximately seven percentage point impact due to our applied labor cost that are capitalized to inventory with an additional approximately three percentage point impact due to the shift and our product makes towards Lab Grove Diamond accordingly, most of the decrease in our gross margin was due to the adverse change in applied labor cost and not the result of any large scale discounting.

During the period for Q2 2023, total operating expenses increased 5%, representing 53% of total net sales compared to 38% in a year ago quarter. Sales and marketing expenses increased 6% to $4.3 million in support of our growth and brand awareness initiatives and G&A expenses remained flat at $1.2 million for the quarter. We explored alternative marketing efforts to reach a broader audio with some initiatives admitted Italy falling flat of expectations. We reported in net loss for Q2 2023 of $1 million or 3 cents loss per diluted share compared with a net income of 1.2 million or 4 cents earnings per diluted share in a year ago period. Included in our net loss per Q2, 2023 is an income tax benefit of $132,000 compared to an income tax expense to $283,000 in a year ago period.

Our weighted average diluted shares outstanding used in the calculation of diluted loss per share for the quarter were approximately 30.3 million shares for the period ended December 31st, 2022 compared to 31.3 million shares for the period ended December 31st, 2021. The decrease in shares outstanding is partially driven by the impact of the company's share repurchase program. Now let's move on to a snapshot of our balance sheet. As Don alluded to the liquidity and capital position remained strong as we ended the quarter with 17 million of total cash compared to 16.6 million at the end of the first quarter that ended September 30th, 2022 or can capos also strong ending at 26.3 million up from approximately $25 million at the end of the first quarter of fiscal 2023.

In addition, the company continues to be debt free. We believe our capo structure remains strong and able to weather inflationary and geopolitical factors in the near term. Our cash flow provided by operations was $617,000 during the quarter compared to $3.1 million used in operating activities during the first six months of fiscal 2023 and $121,000 provided by operations in the year ago period. The improvement and the current quarter primary reflex are continued inventory management efforts. In terms of other sources of liquidity, we have access to our $5 million cash secured credit facility with JPMorgan Chase Bank, which we renewed on July 29, 2022 for one year as of December 31, 2022 and through today, we have not access funds to our credit facility agreement as Don discussed inventory as December 31, 2022, total $35 million compared to $36.6 million as of September 30, 2022, a reduction of $1.6 million whose jewels inventory was $15.9 million as of December 31, 2022 and compares to $16.6 million as of September 30, 2022, a reduction of approximately $700,000 finished jury inventory was $18.8 million compared to $19.9 million as of September 30, 2022, a reduction of $1.1 million demonstrating a solid sell through of our finished jury in the direct-to-consumer online channels, while still maintaining a high percentage of in-stock rates to meet our SLAs. As Don discussed, we plan to remain focused on prudent inventory management strategies going forward.

In summary, we remain confident in our financial strength and our continued efforts to increase shareholder of value. With that, I'll turn the call back over to Don.

Don O'Connell: Thanks, Clint. To wrap things up, the jewelry industry is undergoing an incredible transformation, one that I believe we are in the strong position to capitalize on in the years to come. The results of the quarter, despite the macroeconomic backdrop show that we are executing on our key initiatives that we believe are driving long-term value in the company initiatives that we believe allow us to take advantage of our branding and distribution capabilities to enable customers to find, engage and transact with us on a greater scale. And finally, I'm appreciative of the hard work and dedication of our employees and the continued support from our shareholders. With that, I would be happy to now take any questions you might have.

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