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 the recent downturn in the worldwide economy and its ongoing impact on our business and the business of our customers and suppliers, any continued trends in the general economy that would adversely affect consumer spending, a further decline in our sales, dependence on consumer acceptance of the Company's products, 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, risks of conducting operations in foreign countries, dependence on third parties, continued listing of our common stock on the NASDAQ Global Select Market, the impact of significant changes in our management on our ability to execute our business strategy in the near-term, and the impact of adverse resolution of legal proceedings on our operating results or financial condition, 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. We primarily sell loose moissanite jewels, although we have begun to sell a limited amount of moissanite jewelry. Moissanite has primarily been marketed to the self-purchasing woman as the perfect reward or indulgence for a woman celebrating her achievements or milestones in her life. Beginning in 2008 and continuing in to 2009, Charles & Colvard has expanded its marketing message beyond the self-purchasing woman to include a larger marketplace such as, bridal, anniversary and gift-giving. Moissanite is also marketed to the jewelry trade as a new jewelry category with a unique business opportunity.

Sales for the first quarter of 2009 were 27% less than sales during the same period of 2008 primarily due to a significant slowdown in the retail environment and reduced purchases from jewelry manufacturers serving major retailers that sell moissanite jewelry. A $0.7 million reduction in operating expenses resulted from very tight cost control and decreased expenses for sales and marketing programs. Net loss for the first quarter was $1.3 million, or $0.07 per diluted share, compared with a net loss of $0.7 million, or $0.04 per diluted share, for the first quarter of 2008. The 2008 first quarter net loss benefited from a $0.4 million income tax benefit. We did not recognize an income tax benefit for our operating losses during the first quarter of 2009 due to the uncertainty of sufficient future taxable income to utilize our deferred tax assets.

On February 3, 2009, the Company elected George R. Cattermole as Chairman of the Board of Directors and entered into a Management Services Agreement with Bird Capital Group, Inc. ("BCG") under which BCG provides management services to the Company, including the services of Richard A. Bird as the Company's full-time non-employee Chief Executive Officer. On February 5, 2009, the Company ended its employment relationship with three executive officers: the President and Chief Marketing Officer; the Senior Vice President of Sales and its Vice President of Operations.

In accordance with the terms of the Management Services Agreement, BCG delivered its strategy report to the Company on April 15, 2009 and presented the report to the Board of Directors on April 20, 2009. The report recognizes the distinctions between the jewel business and the jewelry business. Our primary business is the moissanite jewel business in which we have the advantages of being the sole-source worldwide. Strategically, we are seeking to expand moissanite's market reach globally, increase market awareness of our jewel, develop additional marketing channels to the consumer and help create a more compelling consumer value proposition that will drive increased demand.

Due to the difficult economic environment, our current priority is to generate positive cash flow and to stabilize the Company's financial position through cost cutting initiatives and selling down our inventory. We plan to continue the support of our current customers and retailer channels to attempt to gain more sales opportunities. We have also broadened the marketing opportunity for our current customers to have more flexibility in marketing and selling to different segments of the market including bridal and gift-giving. We fully recognize the challenges of our current business in the current economy, and our legacy issues do divert resources from our strategic initiatives. It will take time to accomplish the improvements we seek. However, we believe we have a strategic direction that can ultimately improve our business significantly.

Results of Operations

The following table shows certain Consolidated Statement of Operations data as a
percentage of sales for the periods presented. A detailed explanation of our
results of operations follows this table:



                                                 Three Months Ended March 31,
                                                 2009                     2008
     Net Sales                           100 %   $  2,485,188     100 %   $  3,403,883
     Gross profit                         56 %      1,402,879      66 %      2,246,796
     Marketing & sales expenses           13 %        333,966      56 %      1,917,912
     General & administrative expenses    85 %      2,108,392      42 %      1,424,378
     Operating loss                       -        (1,249,659 )    -        (1,109,586 )
     Net loss                             -        (1,266,500 )    -          (698,085 )

Three Months ended March 31, 2009 compared with Three Months ended March 31, 2008

Net sales were $2,485,188 for the three months ended March 31, 2009 compared to $3,403,883 for the three months ended March 31, 2008, a decrease of $918,695 or 27%. Carat sales of moissanite jewels and jewelry decreased 29% to approximately 13,000 carats from 18,000 carats. Sales of moissanite jewelry represented 18% of total sales (remaining amount is loose jewels) compared to 1% of total sales in the same period of 2008. The majority of our moissanite jewelry sales in 2009 were to a certain customer for sales at trunk show events. The average selling price per carat for our sales of loose jewels decreased 13% primarily due to a special pricing promotion offered to our customers during the three months ended March 31, 2009. U.S. sales accounted for approximately 70% and 72% of sales during the three months ended March 31, 2009 and 2008, respectively.

U.S. net sales and carat shipments, excluding consigned inventory, decreased by 29% and 42%, respectively, for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. U.S. sales decreased primarily due to a significant slowdown in the retail environment and reduced purchases from jewelry manufacturers serving major retailers that sell moissanite jewelry. Some of our retailers have indicated they are experiencing less than desired inventory turn for their moissanite jewelry. There has been a pullback in consumer spending that has negatively affected the jewelry industry and exacerbated the moissanite jewelry retail inventory turn issue. We saw no significant orders during the three months ended March 31, 2009 from our manufacturing customers to support in-case business at the largest retailers selling moissanite jewelry. Further, we do not expect significant orders from our manufacturing customers to service these larger retailers in the near-term. As retailers evaluate their business, we are at risk that some retailers may not be able to achieve acceptable financial performance and may choose not to continue selling moissanite jewelry.

Also negatively impacting revenue during the three months ended March 31, 2009 was the termination of our manufacturing agreement with Reeves Park. Our manufacturing agreement with Reeves Park was terminated during the fourth quarter of 2008 due to repeated failure by Reeves Park to make timely payments on their open payables to us. We are currently in the process of reviewing the retailers supplied by Reeves Park in an attempt to ensure these

retailers can find a supplier of moissanite jewelry if they choose to stay in the moissanite jewelry business. A few of these retailers have decided not to continue carrying moissanite jewelry. As other former retailers of Reeves Park potentially transition to new manufacturers, we will likely see a negative impact on our results of operations, at least in the near term. One of these retailers returned to us a consignment of Reeves Park jewelry which we assumed from Reeves Park as part of our settlement agreement with Reeves Park. This retailer is still currently selling moissanite jewelry, but has consolidated its inventory into fewer stores in an attempt to achieve better inventory turn. We did not have any sales to Reeves Park during the three months ended March 31, 2009, and they accounted for 19% of our sales during the same period of 2008.

Our two largest customers during the three months ended March 31, 2009 accounted for 11% and 10%, respectively, of our sales compared to 0% and 9%, respectively, for the same period of 2008. We expect that we will remain dependent on our ability and that of our largest customers to maintain and enhance their retail programs. A change in or loss of any of these customer or retailer relationships could have a material adverse effect on our results of operations. One of the retailers carrying moissanite jewelry filed for Chapter 11 bankruptcy protection in March 2009 and may not continue selling moissanite jewelry.

International net sales decreased by 21% while carat shipments increased by 5% for the three months ended March 31, 2009 as compared to the same period of 2008. International sales decreased primarily due to decreased sales to Italy and Mexico. 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, 2009 were located in Hong Kong, India and Italy.

Our gross profit margin was 56.4% for the three months ended March 31, 2009 compared to 66.0% for the three months ended March 31, 2008. The decreased gross profit margin percentage was primarily caused by higher production costs in the first-in, first-out accounting period relieved from inventory, a 13% decrease in our average selling price per carat for loose jewels, and the establishment of a $132,000 lower of cost or market reserve against certain jewelry on consignment. This reserve was required due to an assessment of the amount we expect to recover on certain jewelry on consignment with a retailer who recently filed for Chapter 11 bankruptcy protection. The effect of the factors discussed above on our gross profit margin percentage was partially offset by activities that took place during the three months ended March 31, 2008 related to K&G Creations, including the write-off of a portion of the consigned jewels returned to us damaged by K&G Creations and the establishment of a $115,000 damaged stone reserve in anticipation of future damaged jewels returned by K&G Creations. These events decreased the gross profit percentage for the three months ended March 31, 2008 by 8 percentage points.

Marketing and sales expenses were $333,966 for the three months ended March 31, 2009 compared to $1,917,912 for the three months ended March 31, 2008, a decrease of $1,583,946 or 83%. As a percentage of sales, these expenses decreased to 13% from 56% in the same period of 2008. The primary reasons for the decrease in expenses were a $723,000 decrease in advertising expenses and a $539,000 decrease in compensation costs. Our direct advertising costs decreased by $457,000 and our co-op advertising expense decreased by $266,000. We reduced marketing activities as we assessed the effectiveness of our marketing and sales strategies. 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. Our co-op advertising expense decreased due to lower sales and due to our customers using less of their earned 2008 co-op than we estimated at 2008 year end. The decrease in compensation costs can be attributed to decreased salary expense and $180,000 of previously recorded share-based compensation that was reversed during the three months ended March 31, 2009 due to certain stock options not vesting for two terminated executive officers.

General and administrative expenses were $2,108,392 for the three months ended March 31, 2009 compared to $1,424,378 for the three months ended March 31, 2008, an increase of $684,014 or 48%. As a percentage of sales these expenses increased to 85% from 42% in the same period of 2008. The increase in expenses is primarily due to $306,000 of increased fees for professional services and $250,000 of accrued expenses for the estimated liability due to a dispute with three former executive officers. Professional services increased mostly due to $350,000 of fees paid to Bird Capital Group under the February 2009 Management Services Agreement and $149,000 of increased legal fees, partially offset by $187,000 of fees incurred during the three months ended March 31, 2008 associated with the services rendered in conjunction with a review of our business strategy. On February 5, 2009, the Company ended its employment relationship with three executive officers. The former executive officers have individually disputed the Company's belief that no severance obligations are due under the terms of their respective employment agreements. The Company has negotiated in good faith with each of the executive officers to resolve

their individual claims and estimates future costs of $250,000, in the aggregate, for legal and administrative fees and settlement of these claims.

General and administrative expenses are $250,000 higher than the amount originally announced in our quarterly earnings release dated May 5, 2009 to reflect a reserve provided for continuing legal and administrative costs and estimated settlement amounts related to developments on the claims with the three former executive officers.

Research and development expenses were $210,180 for the three months ended March 31, 2009 compared to $14,092 for the three months ended March 31, 2008, an increase of $196,088. As a percentage of sales these expenses increased to 8% from less than 1% in the same period of 2008. Of the increase in expenses, $150,000 is attributable to the December 2008 research and development agreement that requires us to pay $50,000 per month for six months beginning in January 2009.

Interest income was $10,261 for the three months ended March 31, 2009 compared to $48,559 for the three months ended March 31, 2008, a decrease of $38,298 or 79%. This decrease resulted primarily from a lower interest rate earned on our cash balances.

During 2008, we recorded a valuation allowance against certain deferred tax assets. Due to continued uncertainty over sufficient future taxable income to fully use these deferred tax assets, we did not record an income tax benefit for the losses incurred during the three months ended March 31, 2009. There was $27,102 of income tax expense during the three months ended March 31, 2009 due to interest and penalties accrued under the provisions of FIN 48 for uncertain tax positions. We did record an income tax benefit for the losses incurred during the three months ended March 31, 2008. Our effective income tax benefit rate for the three months ended March 31, 2008 was 34%. 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. Our effective income tax benefit rate is lower than the statutory rate during the three months ended March 31, 2008 primarily due to the effect of losses at our non-U.S. operations as we did not record a benefit for these non-U.S. losses due to the uncertainty of generating sufficient future taxable income in these tax jurisdictions to offset the losses. In August 2008, we closed operations in these jurisdictions.

Liquidity and Capital Resources

At March 31, 2009, we had approximately $5.8 million of cash and equivalents and $16.7 million of working capital as compared to $5.6 million of cash and equivalents and $18.8 million of working capital at December 31, 2008. As further described below, cash and equivalents increased during the three months ended March 31, 2009 primarily as a result of $0.2 million of cash provided by operations. The decrease in working capital is primarily attributable to the decrease in accounts receivable and the reclassification of inventory between current and long-term assets, partially offset by the decrease in accounts payable.

Our principal sources of liquidity are cash on-hand and cash expected to be generated by operations in future periods. In April 2009, we received the $2.1 million income tax receivable from the IRS. During the three months ended March 31, 2009, $0.2 million of cash was provided by operations primarily as a result of a $1.8 million decrease in accounts receivable (excluding the impact of the change in reserves), a $0.9 million decrease in inventory, partially offset by a $1.1 million decrease in accounts payable and our $1.3 million net loss. Accounts receivable were down primarily due to cash collections and the impact of our settlement with Reeves Park. While total inventory increased by $0.3 million, there was a $1.2 million non-cash purchase of jewelry inventory under the terms of our settlement agreement with Reeves Park. 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 as well as due to the overall reduction in expenses and inventory purchase commitments consistent with our efforts to reduce costs and inventory while conserving cash.

We did not make any purchases of raw material inventory during the three months ended March 31, 2009. During 2008, we significantly reduced our raw material inventory purchase commitments over prior years to improve cash flow from operations. Further, we were able to negotiate with our two leading raw material suppliers to defer purchases during the three months ended December 31, 2008 into 2009, while keeping in place our long-term supply agreements. We expect our reduced and deferred purchase commitments to help us convert inventory into cash at a faster rate. 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, combined with our reduced sales, have resulted in levels of inventories that are higher than we might otherwise maintain. Our current rate of sales and the high level of inventory resulted in $35.8 million of our inventories being classified as long-term assets at March 31, 2009.

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 September 2008, the Company entered into an agreement with Cree to suspend the Company's commitment to purchase $710,000 of silicon carbide inventory from Cree during the fourth quarter of 2008. This purchase commitment will be included in the Company's yet to be established 2009 purchase commitment with Cree.

In February 2005, we entered into an exclusive supply agreement with Norstel AB ("Norstel") for the supply of SiC crystals for use in the manufacturing of moissanite jewels. In April 2008, we entered into an amendment to the exclusive supply agreement with Norstel due to an update of Norstel's delivery schedule and also due to our desire to limit our purchase of raw materials. Under the amendment, the Company's minimum purchase commitment from 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. We purchased $550,000 since inception of the exclusive supply agreement. In October 2008, the Company entered into a new letter agreement with Norstel which amended and supplemented the April 2008 amendment. Pursuant to the new letter agreement, the Company's commitment to purchase silicon carbide inventory from Norstel during the fourth quarter of 2008 was suspended. It is not yet determined what the Company's total commitment from Norstel will be for 2009, although we have committed to purchase a minimum of 40% of our quarterly SiC requirements from Norstel. In addition, we advanced $400,000 to Norstel in 2005 for the purchase of certain equipment. This advance, which is in the form of a note receivable, 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 April 2008 amendment, we began receiving a 30% reduction on the invoice for subsequent purchases of SiC crystals from Norstel, and will continue to receive this reduction until the advance is repaid. The balance on the advance as of March 31, 2009 was $224,627. Due to the suspension of purchases with Norstel, the Company classified $82,627 of this note receivable as long-term on the Company's condensed consolidated balance sheets as of March 31, 2009.

As of March 31, 2009, we had trade accounts receivable from Reeves Park of $0.7 million, or 25% of receivables (not considering our allowances for uncollectible accounts or returns). As of December 31, 2008, we had trade accounts receivable from Reeves Park of $4.9 million, or 62% of receivables (not considering our allowances for uncollectible accounts or returns). In January 2009, we entered into a settlement agreement with Reeves Park to settle the outstanding balance by accepting a return of inventory, the receipt of certain cash payments due to Reeves Park from its customers, and the payment of a settlement fee to the Company by Reeves Park. Based on the $2.3 million estimated net realizable value of the transactions under the settlement agreement, the Company increased its allowance for uncollectible accounts at December 31, 2008 for Reeves Park to $2.6 million. The transactions under the settlement agreement are substantially complete as of March 31, 2009. The allowance for uncollectible accounts at March 31, 2009 attributable to Reeves Park is $0.6 million. As of March 31, 2009, trade accounts receivable from Reeves Park, net of the allowances for uncollectible accounts is $0.1 million, or 17% of net receivables compared to $2.3 million, or 61% of net receivables at December 31, 2008.

On February 3, 2009, we entered into a Management Services Agreement (the "Agreement") with Bird Capital Group, Inc. ("BCG") under which BCG provides management services to the Company, including the services of Richard A. Bird, a current director of the Company, as the Company's full-time non-employee Chief Executive Officer. The services to be provided by BCG include the development of a new strategy of the Company for growth and competitive success. The initial term of the Agreement is scheduled to end on December 31, 2010. After the initial term, the Agreement would automatically renew for three successive one-year terms unless terminated by the Company within 30 days of the receipt of audited year-end financial statements if the Company has not met certain annual sales and operating income thresholds. The Agreement is terminable "for cause" (as defined in the Agreement) or upon the death or incapacitation of Mr. Bird. BCG also may terminate the Agreement if there is a Change of Control (as defined in the Agreement) of the Company at any time prior to February 1, 2014. Upon such termination, BCG would receive all money and bonuses due under the Agreement plus an early termination payment equal to $1,400,000 if the Change of Control occurs before February 1, 2011 and $900,000 if the Change of Control occurs on or after February 1, 2011, provided that the early termination payment for a Change

of Control on or after February 1, 2011 would be payable only if the annual sales or operating income threshold referred to above is met for the calendar year immediately preceding the Change of Control.

The Agreement provides for monthly management fees payable to BCG. BCG will receive $75,000 per month during 2009, except the monthly fee was $175,000 per month for each of the first two months of the Agreement to compensate BCG for additional work with respect to the new strategy. All fees paid under this Agreement are included in general and administrative expenses on our statement of operations. Beginning on January 1, 2010 and on January 1 of each succeeding . . .