This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Statements expressing expectations regarding our future and projections relating to products, sales, revenues and earnings are typical of such statements and are made under the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, representations and contentions and are not historical facts and typically are identified by use of terms such as "may," "will," "should," "could," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," "continue" and similar words, although some forward-looking statements are expressed differently.

All forward-looking statements are subject to the risks and uncertainties inherent in predicting the future. You should be aware that although the forward-looking statements included herein represent management's current judgment and expectations, our actual results may differ materially from those projected, stated or implied in these forward-looking statements as a result of many factors, including, but not limited to any trends in the general economy that would adversely affect consumer spending, a further decline in our sales, dependence on Cree, Inc as the current supplier of most of the raw material, ability to develop a material second source of supply, dependence on a limited number of customers, dependence on consumer acceptance of the Company's products, risks of conducting operations in foreign countries, dependence on third parties, in addition to the other risks and uncertainties described in more detail in our most recent annual report on Form 10-K filed with the Securities and Exchange Commission. Forward-looking statements speak only as of the date they are made. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur except as required by the federal securities laws, and you are urged to review and consider disclosures that we make in the reports that we file with the Securities and Exchange Commission that discuss other factors relevant to our business.

Overview

We manufacture, market and distribute Charles & Colvard created moissanite jewels (also called moissanite) for sale in the worldwide jewelry market. Moissanite, also known by its chemical name, silicon carbide (SiC), is a rare, naturally occurring mineral found primarily in meteors. As the sole manufacturer of scientifically-made moissanite jewels, our strategy is to establish Charles & Colvard as a reputable, high-quality and sophisticated brand and position moissanite as a unique jewel, distinct from all others based on its exceptional fire, brilliance, luster, durability and rarity. While we acknowledge that moissanite jewelry is sold as a gift and into the bridal and men's jewelry markets, moissanite is primarily marketed to the self-purchasing woman as the perfect reward or indulgence for a woman celebrating her achievements or milestones in her life. Moissanite is also marketed to the jewelry trade as a new jewelry category with a unique business opportunity.

Sales for the first quarter of 2008 were 41% less than sales during the first quarter of 2007, primarily due to the actions by retailers to effectively reduce inventory on hand, partially due to the overall weakness in the general economy. Also negatively impacting revenue during the first quarter was the time and effort necessary for several retailers to transition to new moissanite jewelry suppliers to replace the jewelry previously sourced through K&G Creations. Management expects that much of this process will conclude in the second quarter and we expect to see revenue contributions from those retailers through other manufacturers in the second half of the year.

While we were disappointed with our first quarter financial results as sales trends at retail continue to be soft, we remain intently focused on addressing both the short-term and long-term challenges our company is facing. We have begun several initiatives to address the issues we are facing.

• One of these initiatives was to engage an independent consulting firm, Kanter International, to conduct a strategic review of the Company. This review has been completed and we are in the process of evaluating the recommendations, which focus on organizational structure, brand building and sales growth strategies as well as expense controls and inventory management. The report and recommendations received from Kanter are currently being studied and evaluated by the Board of Directors and a complete action plan is being developed. At the appropriate time, we will report actions we are taking.

• A second initiative is to make significant changes in the composition of the Board of Directors. Three of our current directors will not stand for re-election to the Board, primarily because of the time commitment we envision for our Directors in 2008-2009 as we deal with the issues and opportunities facing the Company.

• A third initiative is to begin the planning to attract new talent to our organization, including separating the positions of Chairman and CEO, as we work to improve our performance and realize the opportunity that each of us recognizes and embraces.

• A fourth initiative is an aggressive review of our planned spending for 2008 given the weakness in the economy and our revenue outlook over the near-term. As a result, we have reduced our staff levels, as well as other planned expenditures. In particular, those staff reductions will cause us to incur severance expense of approximately $185,000 in the second quarter, but will result in an annualized savings of approximately $550,000.

• A fifth initiative is the development of a more aggressive e-commerce presence. You can expect progress on this initiative beginning in May 2008.

Results of Operations

The following table is intended to illustrate a tabular analysis of certain
Condensed Consolidated Statement of Operations data as a percentage of sales for
both periods presented. A detailed explanation of our results of operations
follows this table:



                                                   Three Months Ended March 31
                                                   2008                    2007
     Sales                                 100 %   $  3,403,883     100 %   $ 5,780,666
     Gross profit                           66 %      2,246,796      77 %     4,431,046
     Marketing and sales expenses           56 %      1,917,912      46 %     2,676,167
     General and administrative expenses    42 %      1,424,378      20 %     1,151,957
     Operating income (loss)                -        (1,109,586 )    10 %       587,284
     Net income (loss)                      -          (698,085 )     6 %       339,284

Three Months ended March 31, 2008 compared with Three Months ended March 31, 2007

Net sales were $3,403,883 for the three months ended March 31, 2008 compared to $5,780,666 for the three months ended March 31, 2007, a decrease of $2,376,783 or 41%. Shipments of moissanite jewels, excluding consigned jewels, decreased 48% to approximately 18,000 carats from 35,000 carats. The average selling price per carat increased by 12% due to a product mix in which a greater percentage of larger size jewels, which have a higher price per carat, were sold. U.S. sales accounted for approximately 72% and 79% of sales during the three months ended March 31, 2008 and 2007, respectively.

U.S. net sales and carat shipments, excluding consigned jewels, decreased by 47% and 53%, respectively, for the three months ended March 31, 2008 as compared to the three months ended March 31, 2007. U.S. sales decreased primarily due to the actions by retailers to effectively reduce inventory on hand, partially due to the overall weakness in the general economy. Another factor that negatively impacted our sales results was the time and effort necessary for several retailers to transition to new moissanite jewelry suppliers to replace the jewelry previously sourced through K&G Creations. Effective January 1, 2008, we terminated our relationship with K&G Creations. We had no sales to K&G during the three months ended March 31, 2008 and they accounted for 13% of our sales during the same period of 2007. We continue to work with the retailers previously supplied by K&G Creations to establish relationships with other moissanite jewelry manufacturers. We will likely see a negative impact on our results of operations in the second quarter as much of this process should be completed by then. We expect to begin seeing revenue contributions from those retailers through other manufacturers in the second half of the year. Our three largest customers during the three months ended March 31, 2008, Samuel Aaron International ("SAI"), Reeves Park, and Stuller accounted for 20%, 19% and 9%, respectively, of our sales during the period as compared to 14%, 24% and 14%, respectively, for the same period of 2007. We expect that we will remain dependent on our ability and that of our largest customers to maintain and enhance their retail programs. A loss of any of these customer or retailer relationships could have a material adverse effect on our results of operations.

International net sales and carat shipments decreased by 20% and 28%, respectively, for the three months ended March 31, 2008 as compared to the same period of 2007. International sales decreased primarily due to decreased sales to the United Kingdom, Thailand and Canada, partially offset by higher sales to Hong Kong. A portion of our international sales is due to jewels sold internationally that will be re-imported to North American retailers. Our top three international distributors during the three months ended March 31, 2008 were located in Italy, Hong Kong, and India.

Our gross profit margin was 66.0% for the three months ended March 31, 2008 compared to 76.7% for the three months ended March 31, 2007. The decreased gross profit margin percentage was primarily caused by the write-off of a portion of the consigned jewels returned to us by K&G Creations. Most of the consigned jewels returned to us by K&G Creations were removed from jewelry by K&G Creations. This process resulted in damage to approximately 50% of the jewels, which we wrote off and invoiced to K&G per our standard policy on this type of return. This write-off resulted in approximately a 5% point reduction in our gross profit percentage during the three months ended March 31, 2008. Since we are working on a settlement of the amounts we are owed by K&G Creations, we conservatively did not record the revenue associated with the billings on these damaged jewels. We will aggressively pursue collection on all amounts rightfully and contractually owed to us by K&G. Our gross margin percentage was also negatively affected during the three months ended March 31, 2008 by approximately 3% points due to the establishment of an additional $115,000 damaged stone reserve in anticipation of future damaged jewels returned by K&G Creations being in the same percentage as realized in the first quarter. Other factors affecting our gross margin percentage during the three months ended March 31, 2008 were higher production costs in the first-in, first-out accounting period relieved from inventory, partially offset by a 12% increase in our average selling price per carat.

Marketing and sales expenses were $1,917,912 for the three months ended March 31, 2008 compared to $2,676,167 for the three months ended March 31, 2007, a decrease of $758,255 or 28%. As a percentage of sales, these expenses increased to 56% from 46% in the same period of 2007. The primary reasons for the decrease in expenses were a $631,000 decrease in advertising expenses and $122,000 of decreased travel costs. Our direct advertising costs decreased by $391,000 primarily due to decreased print advertising and our co-op advertising expense decreased by $240,000 due to lower sales. Our co-op advertising program reimburses a portion of our customers' marketing costs based on the amount of their purchases from us, and is subject to the customer providing us documentation of all advertising copy that includes our products. The decreased travel costs are consistent with our efforts to cut back on expenses in an effort to get back to profitability.

General and administrative expenses were $1,424,378 for the three months ended March 31, 2008 compared to $1,151,957 for the three months ended March 31, 2007, an increase of $272,421 or 24%. As a percentage of sales these expenses increased to 42% from 20% in the same period of 2007. The increase in expenses is primarily due to $244,000 of increased fees for professional services. Professional services increased mostly due to $187,000 of fees associated with the services provided by Kanter International, who was engaged by our Board of Directors to provide a thorough review of our business strategy and model.

Interest income was $48,559 for the three months ended March 31, 2008 compared to $171,628 for the three months ended March 31, 2007, a decrease of $123,069 or 72%. This decrease resulted from lower cash balances and a lower interest rate earned on our cash balances.

Our effective income tax benefit rate for the three months ended March 31, 2008 was 34% compared to an effective income tax rate of 55% for the three months ended March 31, 2007. Our statutory tax rate is 38.5% and consists of the Federal income tax rate of 34% and the North Carolina state income tax rate of 4.5%, net of the federal benefit. In periods when we have taxable income, our effective income tax rate is higher than our statutory rate primarily due to our inability to currently recognize an income tax benefit for our operating losses in Hong Kong and China. We cannot recognize the income tax benefit of our losses in Hong Kong and China due to the uncertainty of generating sufficient future taxable income in these tax jurisdictions to offset the existing losses. As a result of our loss position in the U.S. during the three months ended March 31, 2008, the effect of losses at our non-U.S. operations caused our effective tax benefit rate to be lower when compared to the effective tax rate in 2007 when we had taxable income. In addition, during a review of North Carolina tax returns filed in prior years, we filed amended returns that resulted in a $42,000 credit to tax expense during the three months ended March 31, 2008 as we were able to amend these returns and increase our state NEL tax position.

Liquidity and Capital Resources

At March 31, 2008, we had approximately $5.3 million of cash and cash equivalents and $26.1 million of working capital as compared to $7.0 million of cash and cash equivalents and $30.5 million of working capital at December 31, 2007. As further described below, cash and cash equivalents decreased during the three months ended March 31, 2008 primarily as a result of $1.7 million of cash used in operations. The decrease in working capital is primarily attributable to the classification of inventory between current and long-term assets.

Our principal sources of liquidity are cash on hand and cash expected to be generated by operations in future periods. During the three months ended March 31, 2008, $1.7 million of cash was used in operations primarily as a result of a $1.6 million decrease in accounts payable, a $0.9 million increase in inventory and a $0.7 million net loss, partially offset by a $1.7 million decrease in accounts receivable. Our accounts payable are typically at their highest level at December 31 of each year due to our increased expenses for sales and marketing during the fourth quarter holiday season and our decrease in accounts payable is due to payments made on these expenses. We have significantly reduced our inventory purchase commitments in 2008 over prior years to improve cash flow from operations. We also worked during the first quarter of 2008 to reduce all aspects of our manufacturing activities. As we continue to ramp down manufacturing levels during 2008, we expect to see inventory decrease in future quarters. Accounts receivable is down due to decreased sales, as well as collection of open receivables from our customers.

We purchased $850,000 of raw material during the three months ended March 31, 2008. Our raw material inventories of SiC crystals are purchased under exclusive supply agreements with a limited number of suppliers. Because the supply agreements restrict the sale of these crystals to only us, the suppliers negotiate minimum purchase commitments with us that may result in periodic levels of inventories that are higher than we might otherwise maintain. These agreements coupled with lower than expected sales resulted in $30.5 million of our inventories being classified as long-term assets at March 31, 2008.

On June 6, 1997, we entered into an Amended and Restated Exclusive Supply Agreement with Cree. The exclusive supply agreement had an initial term of ten years that was extended in January 2005 to July 2015. In connection with the exclusive supply agreement, we have committed to purchase a minimum of 50% (by dollar volume) of our requirements for SiC crystals from Cree. If our orders require Cree to expand beyond specified production levels, we must commit to purchase certain minimum quantities. In November 2007, we agreed with Cree on a framework for purchases for 2008. Under the agreement, we agreed to purchase approximately $710,000 of usable material for each quarter during 2008 at a price per gram that is approximately 22% over what we paid per gram during the fourth quarter of 2007 and 33% over what we paid during the first nine months of 2007. We purchased $710,000 from Cree during the three months ended March 31, 2008.

In February 2005, we entered into an Exclusive Supply Agreement with Norstel (formerly Jesperator AB) for the supply of SiC crystals for use in the manufacturing of moissanite jewels. In April 2008, we signed an amended agreement with Norstel that extended the term to September 26, 2011. The Company's minimum purchase commitment to Norstel continues until (i) the Company has purchased an aggregate amount of approximately $7.9 million of SiC crystals, or (ii) September 26, 2011, whichever occurs first. The Company's minimum purchase commitment during 2008 is $1,200,000. We purchased $112,000 from Norstel during the three months ended March 31, 2008. In addition, we advanced $400,000 to Norstel in 2005 for the purchase of certain equipment. This advance began to be repaid in January 2007 through a 20% reduction on the invoice for subsequent purchases of SiC crystals. Effective March 1, 2008, pursuant to the amended agreement with Norstel, we began receiving a 30% reduction on the invoice for subsequent purchases of SiC crystals, and will continue to receive this reduction until the advance is repaid. The balance on the advance as of March 31, 2008 was $326,900.

As of March 31, 2008, we had trade accounts receivable from Reeves Park of $5.7 million. Of this amount, $5.0 million was past due. We will continue shipping orders to this customer as long as they pay a specified amount higher than the amount of their new orders to us. There is also a minimum payment amount that must be made quarterly. We believe this will enable us to continue reducing the past due balance from this customer in an orderly manner over the long-term while preserving its relationships with its retail customers.

We did not make any income tax payments during the three months ended March 31, 2008. During the year ended December 31, 2006, we fully utilized our U.S. Net Operating Loss ("NOL") carryforward. The 2007 tax year was the first full year that we made federal income tax payments. As of March 31, 2008 we have an income tax receivable amount of $315,023 primarily due to our loss position during the first quarter of 2008 and also due to an $82,000 overpayment for the 2007 tax year based on our current estimates on our 2007 tax liability. As of December 31, 2007, we also had a North Carolina NOL carryforward of approximately $3.7 million, which expires between 2012 and 2015. As of December 31, 2007, we also had a $4.9 million NOL carryforward in Hong Kong that can be carried forward indefinitely and $567,000 of a NOL carryforward in China that begins expiring in 2008.

Periodically, we ship jewels to customers on "memo" terms. For shipments on "memo" terms, the customer assumes the risk of loss and has an absolute right of return for a specified period. We do not recognize revenue on these transactions until the earlier of (1) the customer informing us that they will keep the jewels or (2) the expiration of the memo period. Any jewels shipped to our customers on "memo" terms are classified as inventory on consignment on our consolidated balance sheets. Of the $1,564,000 of inventory on consignment at March 31, 2008, the Company expects $219,000 (net of the $215,000 damage reserve) on consignment with K&G Creations to be returned. The remaining $1,345,000 is on consignment primarily with three customers and represents potential revenue of $4,155,000 and potential gross profit of $2,810,000 based on the average cost per carat of inventory at March 31, 2008.

In April 2007, the Board of Directors authorized a repurchase program for up to 1,000,000 shares of the Company's common stock. Repurchases could be made in the open market at prevailing prices or in privately negotiated transactions at prices at or below prevailing open market prices. This program expired in April 2008. There were no shares repurchased under this program.

Based on our cash and cash equivalents and other working capital, management believes that our existing capital resources are adequate to satisfy our capital requirements under our current business strategy for at least the next 12 months; however, depending upon the results of our board's strategic planning process, we may need additional cash to implement new initiatives.

Newly Adopted Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements ("FAS 157"). This standard defines fair value, establishes a methodology for measuring fair value, and expands the required disclosure for fair value measurements. FAS 157 was effective for us beginning January 1, 2008. The adoption of FAS 157 did not have an effect on our consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No. 115 ("FAS No. 159"). FAS 159 permits entities to measure eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other generally accepted accounting principles. The fair value measurement election is irrevocable and subsequent changes in fair value must be recorded in earnings. FAS 159 was effective for us beginning January 1, 2008. The adoption of FAS 159 did not have an effect on our consolidated financial statements.

Newly Issued Accounting Pronouncements

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations ("FAS 141R"). FAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. FAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This statement is effective for us beginning January 1, 2009. We do not expect the adoption of FAS 141R to have an effect on our consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements-an amendment of Accounting Research Bulletin No. 51 ("FAS 160"). FAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent's ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. FAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This statement is effective for us beginning January 1, 2009. We do not expect the adoption of FAS 160 to have an effect on our consolidated financial statements.