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CTHR > SEC Filings for CTHR > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for CHARLES & COLVARD LTD

Form 10-Q for CHARLES & COLVARD LTD


13-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. 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," "continue," and similar words, although some forward-looking statements are expressed differently.


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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 following:

· Our future financial performance depends upon increased consumer acceptance and growth of sales of our products resulting from our strategic initiatives.

· We are currently substantially dependent on a limited number of distributors, jewelry manufacturers, and retailers for the sale of our products.

· Though we have openly communicated our intentions with our current customers regarding our finished jewelry business, some of our wholesale customers may potentially perceive us as a competitor.

· Our business and our results of operations could be materially adversely affected as a result of general economic and market conditions, including the current economic environment.

· We expect to remain dependent upon Cree, Inc., or Cree, for the supply of our silicon carbide, or SiC, crystals for the foreseeable future.

· We face intense competition in the worldwide jewelry industry.

· The financial difficulties or insolvency of one or more of our major customers could adversely affect results.

· We are subject to certain risks due to our international distribution channels and vendors.

· Sales of moissanite jewelry could be dependent upon the pricing of precious metals, which is beyond our control.

· Seasonality of our business may adversely affect results.

· We rely upon our ability to protect our intellectual property.

· A failure of our information technology infrastructure or a failure to protect confidential information of our customers and our network against security breaches could adversely affect our business and operations.

· Governmental regulation and oversight might adversely impact our operations.

· Some anti-takeover provisions of our charter documents and agreements may delay or prevent a takeover of our company.

· If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer.

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, or SEC, that discuss other factors relevant to our business.

The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. This information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2011. Historical results and percentage relationships among any amounts in the consolidated financial statements are not necessarily indicative of trends in operating results for future periods.

Overview

We manufacture, market, and distribute Charles & Colvard Created Moissanite® jewels (which we refer to as moissanite or moissanite jewels) and finished jewelry featuring moissanite for sale in the worldwide jewelry market. Moissanite, also known by its chemical name of silicon carbide, or SiC, is a rare mineral first discovered in a meteor crater. Because naturally occurring SiC crystals are too small for commercial use, larger crystals must be grown in a laboratory. Leveraging our advantage of being the sole source worldwide of created moissanite jewels, our strategy is to establish Charles & Colvard with reputable, high-quality, and sophisticated brands and to position moissanite as an affordable, luxurious alternative to other gemstones, such as diamond. We believe this is possible due to moissanite's exceptional brilliance, fire, luster, durability, and rarity like no other jewel available on the market.

We sell our loose moissanite jewels at wholesale to some of the largest distributors and manufacturers in the world, which mount them into fine jewelry to be sold at retail outlets and via the Internet. We also sell loose moissanite


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jewels and finished jewelry at wholesale to retailers to be sold to end consumers and, in the third quarter of 2011, we established a direct-to-consumer e-commerce sales channel through our wholly owned operating subsidiary Moissanite.com, LLC that sells both loose moissanite jewels and finished jewelry. Additionally, in April 2012 we officially launched a direct-to-consumer home party sales channel through our wholly owned operating subsidiary Charles & Colvard Direct, LLC, or Charles & Colvard Direct, that sells finished jewelry. We believe the expansion of our sales channels to the jewelry trade and the end consumer with branded finished moissanite jewelry creates a more compelling consumer value proposition to drive increased demand.

We are continuing to focus on our core business of manufacturing and distributing the moissanite loose jewel and finished jewelry featuring moissanite through wholesale sales channels, because this is currently the primary way we reach consumers. We believe there is substantial opportunity to grow our wholesale business and to capture a larger share of the jewelry market as we execute our strategy to increase consumer awareness of moissanite.

The wholesale finished jewelry business that we launched in 2010 is currently expanding through select retailers and television shopping networks, and we believe there is significant opportunity to expand these sales channels. We believe our finished jewelry business, including finished jewelry sold through our direct-to-consumer e-commerce and home party sales channels, allows us to have more control over the end product and enhance our relationships with consumers, as well as provide incremental sales and gross profit dollars due to the higher price points of finished jewelry containing moissanite relative to loose jewels. To that end, we are focusing on the following critical aspects of our strategic plan during 2012:

· Developing brand strategies - Our goal is to build multiple brands around the moissanite jewel and finished jewelry collections in attractive and desirable jewelry designs, especially those featuring larger center stones that leverage moissanite's point of differentiation. We believe branding will allow us to increase consumer awareness, which we expect to help drive sales and develop consumer brand recognition and loyalty. In January 2012, we entered into an exclusive partnership with Serenity Technologies, Inc., or Serenity, one of the world's notable laboratories for gemstone enhancements, to create moissanite jewels with optical properties that are significantly whiter than our standard VG grade jewels. We are positioning Forever Brilliant® as a premier brand to differentiate these color-enhanced jewels from other grades of our moissanite as well as moissanite sold by potential competitors in the future, and we launched the brand in June 2012 at the JCK jewelry show in Las Vegas, which is the largest jewelry industry trade show in the United States, or U.S. The industry response was strong, and we ended the second quarter with a backlog of orders that we continued to fulfill throughout the third quarter resulting in Forever Brilliant® comprising over 25% of our third quarter loose jewel sales. We expect demand for our Forever Brilliant® loose jewel and finished jewelry featuring the Forever Brilliant® jewel to grow, both in our wholesale channel and on our Moissanite.com e-commerce website, as production accelerates, more finished jewelry styles are featured in the various sales channels, and awareness increases. We also believe that Forever Brilliant® will become an increasingly important brand for Charles & Colvard as we execute future branding initiatives of our strategic business plan. Serenity has also developed proprietary technologies for treating moissanite to produce such colors as pink, blue, and yellow, among others, around which we continue to explore additional product lines and branding strategies.

In October 2012, Charles & Colvard Direct entered into an exclusive services and licensing agreement with JudeFrances Jewelry, Inc., or JudeFrances, a well-known designer jewelry brand. Under the agreement, JudeFrances will custom design fashion and moissanite jewelry for Lulu AvenueTM, the home party direct sales brand of Charles & Colvard Direct. JudeFrances' fashion jewelry and moissanite designs for Lulu AvenueTM are targeted to add a unique, trendsetting, and style-defining element differing from any other designs on the market today. We believe the exclusive agreement with JudeFrances is the point of differentiation that positions Lulu AvenueTM ahead of other jewelry home party direct sales companies and will excite both consumers and women searching for unique business ownership opportunities. We continue to seek additional opportunities to partner with recognized finished jewelry designers for Lulu AvenueTM as well as our wholesale and retail sales channels to create exclusive, branded pieces.

We believe our efforts to position Forever Brilliant® as the whitest and brightest moissanite jewel available anywhere in the world and the introduction of designer finished jewelry brands will help us to build brand recognition and increase consumer awareness of our products. We also expect that this strategy of building brand recognition will help to support revenue streams as our intellectual property rights expire in the future.


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· Launching our direct-to-consumer e-commerce website - Our direct-to-consumer e-commerce website, Moissanite.com, went live to the public in August 2011. Our focus in the latter part of 2011 was to improve site functionality, add new features, and increase product assortment. In May 2012, we partnered with a preeminent Chicago-based web design firm to develop a new lifestyle look as well as technologies to personalize the content of our website based on how the site is accessed. The newly redesigned website went live in October 2012 and features a more intuitive web presence designed to enhance the customer experience and convert more traffic into sales with over 100 new features to be included when all phases are complete. Additionally, we are continuing to expand the website's jewelry assortment through an exclusive agreement with one of the top jewelry manufacturers in the U.S. To complement our improved functionality and assortment on the website, we also began in the first quarter of 2012 to invest resources in online marketing campaigns, email marketing, and social marketing designed to increase traffic and sales conversion ratios, and we expect this investment to increase in the fourth quarter during the holiday season. We believe our direct-to-consumer e-commerce sales channel will not only add to our top-line revenues in a significant manner, but will also play a key role in our campaign to increase overall consumer awareness of moissanite. We also envision e-commerce as a part of a broader effort to establish online connections with consumers that build our brands and our business with retail partners.

· Launching our direct-to-consumer home party business - Our direct-to-consumer home party business, Lulu AvenueTM, officially launched in April 2012 concurrently with our direct sales front-end and back-office system's go-live date, our 58-page spring/summer catalog, and a series of nationwide launch events designed to introduce Lulu AvenueTM jewelry products and the direct sales business opportunity. As a result of our services and licensing agreement with JudeFrances discussed above, we target to include new, exclusive fashion and moissanite jewelry designs by JudeFrances beginning with the Lulu AvenueTM Spring 2013 catalog. In a separate transaction, we also entered into an asset purchase agreement in October 2012 with Bamboo Pink, Inc., or Bamboo Pink, a jewelry home party direct sales company affiliated with the owners of JudeFrances, that included, among other assets, all of Bamboo Pink's JudeFrances-designed finished jewelry. We plan to feature this inventory in a special Lulu AvenueTM 2012 holiday supplement to complement our recently issued Fall 2012 catalog. As we continue in 2012, our other initiatives include the ongoing recruitment of independent sales representatives, including former Bamboo Pink representatives; targeted marketing and advertising campaigns; and product merchandising for future catalog seasons. We believe our direct-to-consumer home party sales channel will provide future sales growth and play a key role in our campaign to increase overall consumer awareness of moissanite.

As we execute our strategy to build and reinvest in the business, expenses and investment of cash will be required ahead of the revenue streams we expect in the future, and this may result in some unprofitable quarters as we experienced in the first quarter of 2012. However, one of our primary goals is to maintain positive cash flow each quarter to protect our cash position, and we were successful in generating $2.11 million in cash flow from operations during the nine months ended September 30, 2012. We will continue to diligently focus on cost containment and monitor our cash burn rate as we grow the business.

Our total net sales for the nine months ended September 30, 2012 of $14.31 million were 61% greater than total net sales during the same period of 2011. Loose jewel sales comprised 72% of our total net sales and increased 43% to $10.33 million, compared with $7.25 million in the same period of 2011. Finished jewelry sales comprised 28% of our total net sales and increased 147% to $3.98 million, compared with $1.61 million in the same period of 2011. These increases in sales by product mix are primarily the result of the ongoing execution of our growth strategies, including initiatives to increase consumer awareness of moissanite through marketing support of our customer base; the addition of several new customers and the expansion of existing customer relationships; the introduction of our Forever Brilliant® color-enhanced moissanite jewel; and increased sales of our finished jewelry featuring moissanite to both our wholesale customer base and through our direct-to-consumer retail channels, Moissanite.com and Lulu AvenueTM. We expect these increases in sales by product mix to continue as we execute our strategy of developing new wholesale and direct-to-consumer sales channels and expanding our finished jewelry business.

Operating expenses increased $2.70 million, or 46%, to $8.62 million for the nine months ended September 30, 2012, compared with $5.92 million in the same period of 2011. Of this increase, sales and marketing expenses increased $2.53 million, or 113%, to $4.76 million, primarily as a result of personnel additions and advertising and marketing initiatives incurred to position us for future growth, especially with respect to our e-commerce and home party direct sales businesses. As we grow our business, we continue to focus on closely managing our operating expenses by seeking the most cost effective and efficient solutions to our operating requirements. We recorded net income of $296,000, or $0.01 per diluted share, for the nine months ended September 30, 2012, primarily due to our


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higher sales and an income tax net benefit, offset in part by our increased operating expenses.

The execution of our strategy to grow our company, with the ultimate goal of increasing consumer awareness and clearly communicating the value proposition of moissanite, is challenging and not without risk. As such, there can be no assurance that future results for each reporting period will exceed past results in sales, operating cash flow, and/or net income due to the challenging business environment in which we operate, our changing business model, and our investment in various initiatives to support our growth strategies. However, we remain committed to our current priorities of generating positive cash flow and strengthening our financial position through cost-management efforts and selling down our inventory while we execute and refine our strategy and messaging initiatives. We believe the results of these efforts will propel our revenue growth and profitability and further enhance shareholder value in coming years, but we fully recognize the business and economic challenges in which we operate.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which we prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosures of contingent assets and liabilities. "Critical accounting policies and estimates" are defined as those most important to the financial statement presentation and that require the most difficult, subjective, or complex judgments. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Under different assumptions and/or conditions, actual results of operations may materially differ. We have disclosed our critical accounting policies and estimates in our Annual Report on Form 10-K for the year ended December 31, 2011, and that disclosure should be read in conjunction with this Quarterly Report on Form 10-Q.

Results of Operations

The following table sets forth certain consolidated statements of operations
data for the three and nine months ended September 30, 2012 and 2011:

                                              Three Months Ended September 30,            Nine Months Ended September 30,
                                                2012                    2011                  2012                  2011
Net sales                                 $       5,076,364       $       2,891,109     $      14,312,976       $  8,862,945
Costs and expenses:
Cost of goods sold                                2,092,734                 819,309             5,763,179          3,444,465
Sales and marketing                               1,678,779               1,005,600             4,764,595          2,238,866
General and administrative                        1,192,278               1,191,857             3,834,744          3,510,232
Research and development                              1,490                  28,476                18,279             71,982
Loss on abandonment of assets                             -                       -                     -             94,408
Total costs and expenses                          4,965,281               3,045,242            14,380,797          9,359,953
Income (loss) from operations                       111,083                (154,133 )             (67,821 )         (497,008 )
Other income (expense):
Interest income                                      16,002                  21,062                57,690             62,320
Interest expense                                       (335 )                  (456 )                (939 )             (718 )
Loss on call of long-term investments                     -                       -                     -             (2,913 )
Total other income                                   15,667                  20,606                56,751             58,689
Income (loss) before income taxes                   126,750                (133,527 )             (11,070 )         (438,319 )
Income tax net (expense) benefit                     (3,125 )               243,182               307,421            208,272
Net income (loss)                         $         123,625       $         109,655     $         296,351       $   (230,047 )


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Net Sales

Net sales for the three and nine months ended September 30, 2012 and 2011
comprise the following:

                        Three Months Ended September 30,                  Change                Nine Months Ended September 30,                Change
                          2012                    2011              Dollars       Percent           2012                  2011           Dollars       Percent
Loose jewels        $       3,782,105       $       2,209,049     $ 1,573,056          71 %   $      10,330,161       $  7,249,173     $ 3,080,988          43 %
Finished jewelry            1,294,259                 682,060         612,199          90 %           3,982,815          1,613,772       2,369,043         147 %
Total net sales     $       5,076,364       $       2,891,109     $ 2,185,255          76 %   $      14,312,976       $  8,862,945     $ 5,450,031          61 %

Net sales were $5.08 million for the three months ended September 30, 2012 compared to $2.89 million for the three months ended September 30, 2011, an increase of $2.19 million, or 76%. Net sales were $14.31 million for the nine months ended September 30, 2012 compared to $8.86 million for the nine months ended September 30, 2011, an increase of $5.45 million, or 61%. The improvement in net sales for the three and nine months ended September 30, 2012 was due primarily to an increase in loose jewel sales to our wholesale customer base resulting from the June 2012 launch of our new Forever Brilliant® color-enhanced moissanite jewel and the growth of our customers' moissanite finished jewelry lines with styles that include both Forever Brilliant® and our standard Very Good, or VG, grade loose jewels. The improvement in net sales for the three and nine months ended September 30, 2012 was also attributable to a significant increase in finished jewelry sales to a major home shopping network customer. We anticipate orders and related sales of both loose moissanite jewels and finished jewelry featuring moissanite will improve as we continue to execute our growth strategies.

Sales of loose jewels represented 75% and 72% of total net sales for the three and nine months ended September 30, 2012, respectively, compared to 76% and 82% of total net sales for the corresponding periods of the prior year. For the three months ended September 30, 2012, loose jewel sales were $3.78 million compared to $2.21 million for the three months ended September 30, 2011, an increase of $1.57 million, or 71%. For the nine months ended September 30, 2012, loose jewel sales were $10.33 million compared to $7.25 million for the nine months ended September 30, 2011, an increase of $3.08 million, or 43%. These increases were primarily attributable to robust orders received from our wholesale customer base upon the June 2012 launch of our new Forever Brilliant® color-enhanced moissanite jewel as well as increased Forever Brilliant® and VG grade loose jewel orders resulting from the growth of our customers' moissanite finished jewelry lines.

Sales of finished jewelry represented 25% and 28% of total net sales for the three and nine months ended September 30, 2012, respectively, compared to 24% and 18% of total net sales for the corresponding periods of the prior year. For the three months ended September 30, 2012, finished jewelry sales were $1.29 million compared to $682,000 for the three months ended September 30, 2011, an increase of $612,000, or 90%. For the nine months ended September 30, 2012, finished jewelry sales were $3.98 million compared to $1.61 million for the nine months ended September 30, 2011, an increase of $2.37 million, or 147%. These increases were attributable to our ongoing expansion into the finished jewelry business through the creation of new sales channels, including televised home shopping networks and our direct-to-consumer e-commerce website, Moissanite.com.

U.S. net sales accounted for 80% and 63% of total net sales during the three months ended September 30, 2012 and 2011, respectively, and 80% and 58% of total net sales during the nine months ended September 30, 2012 and 2011, respectively. U.S. sales increased 124% and 122% during the three and nine months ended September 30, 2012, respectively, from the corresponding periods of the previous year primarily due to an increase in loose jewel sales to our wholesale customer base resulting from the launch of our new Forever Brilliant® color-enhanced moissanite jewel and the growth of our customers' moissanite finished jewelry lines. The increase in U.S. sales was also attributable to a significant increase in finished jewelry sales to a major home shopping network customer.

Our largest U.S. customer during the three months ended September 30, 2012 accounted for 16% of our total sales compared to 4% during the same period of 2011. One U.S. customer accounted for 17% of our total sales in the same period of 2011 but did not account for a significant percentage of our total sales during the three months ended September 30, 2012. Our two largest U.S. customers during the nine months ended September 30, 2012 accounted for 25% and 11%, respectively, of our total sales compared to 6% and 17% during the same period of 2011. No additional U.S. customers accounted for more than 10% of total sales during the nine months ended September 30, 2012 or 2011. We expect that we will remain dependent on our ability, and that of our largest customers, to maintain and enhance 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.


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International net sales accounted for 20% and 37% of total net sales during the three months ended September 30, 2012 and 2011, respectively, and 20% and 42% of . . .

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