Charles & Colvard Ltd (CTHR) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Charles & Colvard Ltd. third-quarter 2006 earnings conference call. Today's call is being recorded.

At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference is being recorded.

I would now like to turn the conference over to Bill Zima of Integrated Corporate Relations. Please go ahead, sir.

Good afternoon, everyone. Thank you for participating in the Charles & Colvard third-quarter 2006 conference call. Joining us from management are Bob Thomas, President and Chief Executive Officer; Jim Braun, Chief Financial Officer; and Dennis Reed, Executive Vice President and Chief Marketing Officer.

Before we begin, I would like to remind everyone that except for the historical information presented, the matters disclosed in this conference call include forward-looking statements. These statements represent the Company's current judgment on the future and are subject to risk factors and uncertainties that could cause actual results to differ materially. To the extent that there are any statements that could be construed as forward-looking, they should be considered in the context of all of our previous releases and federal filings.

With that said, I would now like to turn the call over to Bob Thomas.

Thank you, Bill. Good afternoon, ladies and gentlemen. Thank you for being let us today. We are pleased to announce that the quarter we are reporting today was the most successful in our history in terms of revenue and operating income. Third-quarter sales increased 7% to $12.1 million compared to $11.3 million in the prior year period. This year-over-year increase was primarily the result of increased sales to our manufacturing customers in anticipation of the holiday buying season.

Operating income increased 12% to $3.5 million compared to $3.1 million in the prior year period. Net income for the third quarter was $2.2 million or $0.12 per diluted share, which approximates the $2.2 million or $0.11 per diluted share last year.

We would like to provide the investment community with more clarity in the makeup of our sales in any given quarterly period. However, our business model is designed to sell our moissanite jewel to jewelry manufacturers and distributors who produce moissanite jewelry that is then sold to retailers.

Those manufacturers and distributors - our direct customers - continue to resist sharing specific sales information about their individual retail customers. This difficulty is further compounded by not having clear visibility to specific inventory levels held by our direct customers on any particular day, including at quarter end.

We are working to gain more transparency from our direct customers, but this is a work in progress; and we currently do not have the methodology in place that allows us to provide you with reliable retail sales data.

With this being said, we will attempt to provide you with some understanding of the various components of our revenue stream. Broadly, our sales consist of sales for initial distribution defined as sell-in; sales for special events such as truck shows; sales for replenishment of sold inventory at previously existing points of retail distribution, defined as sell-through; and we also utilize a sales strategy common in the jewelry industry referred to as memo shipments.

Those shipments are made to creditworthy customers who then manufacture moissanite jewelry and in turn ship that jewelry to creditworthy rails retailers - again on memo. This form of consignment selling -- excuse me. This is a form of consignment selling, and we do not recognize or report those shipments as revenue unless and until the retailer and our direct manufacturer report to us that those goods have been sold or other conditions of a specific memo agreement have been met.

At that point, and only at that point, we recognize the revenue. The value of our inventory shipped under this arrangement can be found on our balance sheet, properly identified. This practice has been beneficial for our business as it allows us to occupy more counter space in specific and highly desirable retail locations, placing the moissanite jewelry much closer to the end consumer than would otherwise be possible.

In the past, and currently, it is not uncommon for a specific retailer to showcase moissanite jewelry that is both owned by that retailer and moissanite jewelry that they have been provided on memo. As we have attempted to develop a method of internally defining our revenue stream from those listed activities, it has become difficult for us to arrive at an estimate for any of the preceding four sources of revenue.

Further, without having access to the inventory position of our direct customers or to the inventory levels held by the retailers at both the beginning and end in any specific time period, any conclusions we might reach by the close examination of each revenue stream is at best, a guess, and thus useless.

In short, we will work to develop a methodology to better determine the overall demand and sales results from each of our direct customers. But until that point, we will limit our disclosure of revenue to domestic and foreign shipping points.

Sales to our international customers increased 59% to $1.3 million, or 11% of the total revenue. We saw strong sales results from each key geographic region. U.S. domestic sales in the third quarter increased 3% to $10.8 million. You should note that some volume of the jewels we sell internationally will be re-imported to North American retailers. This occurs because the cost of jewelry production, like many other consumer goods, is lower in Asia than in North America. Most if not all major retailers source jewelry from Asian manufacturers or from domestic manufacturers who subcontract work to Asia manufacturers.

Our fulltime presence in Hong Kong, we believe, will continue to be a valuable resource for those manufacturers and provide ongoing benefits to our direct customers and to our Company.

In the third quarter, we shipped 77,300 carats, which was a 15% increase from the 67,200 carats we shipped in the prior year period. Shipments of carats to the U.S. increased 12%, while international shipments of carats increased 57%. The average selling price per carat for the third quarter was approximately 4% below the third quarter of 2005.

The decrease in average selling price was a result of a higher percentage of smaller sized jewels that were sold. We remain confident with our mix of stones between larger and smaller jewels and remain comfortable with gross margin levels of between 65 and 75% during any given quarter.

Also, during the most recent quarter, inventory in our manufacturers under memo terms, increased by approximately $400,000. Upon sale, as defined in the consignment agreements, we will record approximately $1.5 million of revenue from this increase. Jewels shipped to customers on memo are classified as inventory on consignment on the Company's consolidated balance sheets. At September 30, 2006, the total value of inventory on consignment was $2,597,000. And that represents potential revenue of $10,661,000 and potential gross profit of $8,064,000 based on the average cost per carat of inventory at September 30, 2006.

Based on our past experience, we expect a very large percentage of this potential revenue and gross profit to be recognized in coming periods.

We continue to work diligently to broaden our customer base through our various channels of distribution. During the quarter, Samuel Aaron International and [Allarama], two domestic jewelry manufacturers, became much more significant direct customers of Charles & Colvard. Both are large, well established suppliers to the North American jewelry market and both sell to a majority of the major jewelry retailers domestically.

Retailers typically want more than one supplier for a category of fine jewelry in order to have a broad array of design choices. Each of our jewelry manufacturers is supplying moissanite jewelry to more than one and perhaps more than a few retail groups.

To update you on the previously announced tests at the approximate 700 door chain Kohls, it is expected that the jewelry will arrive at the store level next week, and the sales and promotional activities will commence the last weekend of this month. The total number of locations involved in this test is 208 - up from the previously disclosed 170. Our sales and marketing team along with the professional staffs at Samuel Aaron International and Kohls, have done an outstanding job in preparing for this launch.

The test at approximately 20 locations of the 900 door chain we announced last quarter will be executed later in this quarter and we are cautiously optimistic about its outcome, but we do not (indiscernible) to expect to recognize any significant revenue from this test in 2006. (audio skip) K&G Creation reports that Her Highness, the Duchess of York, Sarah Ferguson, will be making two public appearances at retail locations to promote her vintage-inspired creations line of moissanite jewelry during the current quarter. This K&G initiative with Finlay has contributed some incremental to date, and we are hopeful that Finlay and K&G will enjoy greater success with this effort as more promotional events occur.

As we continue to add new distribution points at retail we continue to spend more aggressively to build awareness and demand for moissanite jewelry in coming periods.

In the current quarter, we will advertise in newspapers, via direct mail, on the Internet and in major fashion magazines. Those include Allure, Elle, InStyle, Self, More, Vanity Fair and Vogue. Each will be tagged to a specific retailer. The retailers included in those magazine placements are - in no particular order JC Penney, Lord & Taylor, Belk, BoMoscow's, Boscov's, Zales Outlet, HSN.com, Carson's, Macy's, Helzberg, Bon Mar, Parisian, Ross-Simons, and Dillard's.

The magazines are tagged, based on geographic designations.

We are proud of our accomplishments in the third quarter and believe our momentum will continue. Our unique position in the jewelry marketplace is the sole source of moissanite jewels allows us a tremendous opportunity to increase our market position. We believe the money spent on building consumer awareness will lead to increased demand for our jewel in coming periods.

As an example of those efforts, at the beginning of this month, National Jeweler - a leading jewelry trade publication - showcased the moissanite category in a 32 page insert into their October 1 addition. The editorial coverage highlighted the moissanite story and also included stories on several successful moissanite retailers, including JCPenney, Kings, Days, and (indiscernible) Jewelers. (technical difficulty) Our direct customers with our assistance sponsored that effort. If you would like to see a copy of that publication, please fax or e-mail our offices or ICR and one will be supplied.

As we maintain the discipline that has allowed us to grow profitably, we intend to establish an entirely new category of fine jewelry - the moissanite category. And then to dominate that category by establishing the Charles & Colvard brand.

By positioning moissanite as a unique jewel with a unique value proposition for both retailers and consumers, we sincerely believe that consumer awareness will continue to grow and that we can become a much larger enterprise. We remain committed to building value for our shareholders and believe our planned initiatives have better positioned our Company for future growth.

Jim will now update you with our detailed financial results.

Good afternoon and thank you for joining us for today's conference call.

As a reminder, share and per-share data for all periods presented have been adjusted to reflect the effect of the 5% stock dividend distributed on July 15, 2005, and the one share for four shares owned stock split affected in the form of a 25% stock dividend distributed on January 30, 2006.

Total sales for the third quarter of 2006 increased 7% to $12.1 million compared to $11.3 million achieved during the third quarter of 2005. Our revenue growth was the result of increased sales to our manufacturing customers in anticipation of the holiday buying season.

Gross margin as a percentage of sales for the third quarter was 68.9%, an increase of 140 basis points when compared to the same quarter in 2005. This increase was primarily caused by lower production costs, offset by a slight decrease in the average selling price per carat. As Bob mentioned, the average selling price per carat for the third quarter was 4% below the third quarter of 2005. This decrease was due to a product mix in which a greater percentage of smaller sized jewels were sold.

Larger stones have a higher selling price per carat than smaller stones. As we have discussed in past calls, the average selling price per carat will fluctuate based on stone size requirements of our customers.

Total operating expenses as a percentage of net sales was 40.0% for the third quarter - the same percentage as in the prior year. Marketing sales expense was up $332,000 in the third quarter over the prior year primarily due to a $347,000 increase in advertising expense, $190,000 of Web page design and $100,000 of industry sponsorship costs partially offset by a $319,000 decrease in stock option compensation expense on options issued to consultants.

As a percentage of sales, marketing and sales expense increased 90 basis points to 31.1% of sales compared to 30.2% of sales for the prior period. Third quarter net income was $2.2 million or $0.12 per diluted share which approximated net income for the third quarter of 2005.

Domestic sales, which represent 89% of total sales, were up 3% for the third quarter, 12% in carats. International sales for the third quarter increased 59%, 57% in carats, primarily due to increased sales in Hong Kong, United Kingdom, Thailand and Indonesia offset by lower sales in Taiwan and Italy. (technical difficulty) same period of 2005.

Our effective tax rate for the three and nine months ended September 30, 2006, are higher than those in the same periods in the previous year, primarily due to a reduction in state tax expense in the three months ended September 30, 2005, caused by the allocation of pre-tax income at a taxable state jurisdictions. For the nine months ended September 30, 2006, total sales aggregated $28.6 million on shipments of 175,500 carats, compared to total sales of $31.9 million on shipments of 185,700 carats for the first nine months of fiscal 2005.

Net income for the first nine months of 2006 was $4.8 million or $0.26 per diluted compared to net income of $5 million or $0.26 per diluted share for the first nine months of 2005. As of September 30, 2006, our tax position decreased to $14.4 million from $15.6 million at June 30, 2006. This $1.2 million decrease was primarily due to the $4 million increase in Accounts Receivable and the $1.1 million increase in inventory, which includes consigned inventory, offset by $3.7 million of pre-tax income generated during the quarter.

Accounts Receivable increased to $14.3 million as of the end of our fiscal 2006 third quarter from $10.3 million at June 30, 2006 - primarily due to the $3.6 million increase in third-quarter sales as compared to the second quarter of 2006.

Inventory increased to $30 million at September 30, 2006 from $29.2 million at June 30, 2006 - primarily due to the level of raw material purchases. In March 2006, the Board of Directors authorized a repurchase program for up to one million shares of the Company's common stock. This program expires in March 2007. During the three months ended September 30, 2006, no shares were repurchased under the program.

This concludes our remarks for today's call. Bob and I would like to open up the call for any questions.

(OPERATOR INSTRUCTIONS). Chris [Terry]. First Dallas Securities.

I sort of understand the lack of transparency, but is there anything you could give comment on as to how much of the growth was fill-in to new doors here in the quarter versus sales to maybe counter who have been in your distribution for over a year now?

Let me try to take a broader -- give you a broader sense of where we are and talk about the first nine months versus the first nine months. Obviously in late 2004 and 2005, we benefited dramatically from sell-ins to two major groups - both Finlay and JCPenney - over the course of the first 12-month period starting the fourth quarter of '04 and ending the third quarter of '05.

So the inventory levels at both manufacturers and retailers really went up dramatically over that period. And not all of the goods that we shipped, sold through at retail - obviously because all those people had inventory at the end of the period. Then they did not have the beginning of the period. As we have very carefully gone through each one of those four streams that we talked about and it became very apparent that we were making estimates doing averages, making assumptions about different things and was all predicated on a false assumption - that the inventory levels at the beginning and the inventory levels at the end were constant or static.

So it became very apparent to us that without very specific information from both retail involved, retailer involved, and the manufacturer, that any members or estimates we arrived at would be at very best a guess. And we did not feel like we should share those guesses with you. (multiple speakers)

I mean, I am sure it's got to be a nightmare for internal budgeting purposes.

It is and our Board's not exactly thrilled about the situation as are we. We are developing contractual clauses with our manufacturers that will give us more visibility into their businesses, into their moissanite businesses. But as we develop relationships particularly with very large and well-established jewelry manufacturing customers, that is not something they are used to sharing with their suppliers. And so it is a hard sell.

As opposed to not doing business with them, we have chosen in some cases to put up with the lack of transparence and move forward with the business opportunities - but that's a business judgment. But we are trying to develop very specific information and we have retailers who are very open and very transparent and we reward them with more advertising support.

And we will continue to do that, so we are developing a message and a way to deliver that message so that we will get - hopefully we will get more transparency. We could use one or two examples today and make broad characterizations, based on that specific information but that really wouldn't be fair to the retailer nor do we think it'd be fair to you.

Let me finish my earlier thought, just briefly, and maybe this will be helpful.

We believe that the sell-through, broadly defined, is greater for the first nine months of 2006 than it was for the first nine months of 2005. That is something we believe based on all the work we've done, on all our discussions, anecdotally and based on the limited amount of specific information we have. We cannot prove that with a pencil but that is our belief - that our penetration to the consumer, it has gained traction and we are making progress. But that is not something we can demonstrate with a calculator or a spread sheet.

One more question and a follow-up. So Operator, please do not cut me off. But Bob, can you give us an update on the buyback?

Yes. As Jim said, there were no shares repurchased in the most recent quarter. I think we have purchased 280,000 of the million authorized to date, and that plan is in place and subject to being executed based on open windows or a plan that is broadly defined (multiple speakers) (audio skip).

If we choose to adopt one of those plans, we'll announce it, so we can bide through a black period or a blackout period where the Company has to honor those blackout periods, just like insiders do. We can't buy ourselves without executing one of those plans.

When there is no blackout open, then the Company is free to make transactions in the open market, and we have that authorization in place.

Last call you mentioned JCPenney was looking to expand and broaden the moissanite selection.

Yes. I think that continues to be the case. Don't think all that jewelry has made it to the retail stores yet; I think that you will see that activity in the near future that a wider array of merchandise choices, at least in their - what they would characterize as their top performing doors.

Jeff [Messer]. Manchester Management.

A couple of quick questions. As far as the marketing expense for the fourth quarter, could you give us just some broad stroke sense as to what that might look like?

I would refer you back to fourth quarter of '05. We will be more aggressive. The retailers expect and demand more aggressive posture in the fourth quarter. That is the selling season for them and we are going to provide that support.

So if you go back to the fourth quarter of '05, it would give you some sense. In May, depending on what the revenue number ends up being, it could be percentage points higher or smaller, but that will give you some sense.

So if I use that absolute dollar number, that will put me somewhere in the -- ?

No, I would not use the -- that percentage of revenue number is what I was referring to.

And I guess the other question I had for Jim is could you go into some more detail on what changed the tax rate so dramatically?

The tax rate for these three quarters in 2006 really hasn't changed. In 2005, in the third-quarter based on analysis we reduced what was our previously higher rates in earlier years based on apportioning a portion of our income out of the taxable states we are currently in, based on us having residency in some of the other states.

So that permanently reduced it. That effect occurred in the third quarter of last year and brought that down. Now we are continuing to reap the benefit of that at a lower rate than what we historically had prior to that third quarter.

To give you a more specific example, we now operate a full-time office in Texas. The tax rate in Texas, lower than it is in North Carolina. We have a tax -- we have an office for our employees in other places and as we apportion those taxes across the various states, if the tax rates are lower than North Carolina, we enjoy a one-time benefit third quarter of '05 but now that is being apportioned appropriately, depending on the revenue source and our domicile in various states.

(OPERATOR INSTRUCTIONS). Raj Shastri, Thomas Weisel.

On the sell-in and sell-through, do you also plan -- I know you have a contractual clauses now with your manufacturing customers. Do you also plan to move from a sell-in recognition to a sell through recognition? I just want to understand it --

Yes, we have done some of that work in those numbers but I am just not comfortable that they are accurate enough to start the process. What I'd like to do is build a history of numbers that I am very comfortable with in the sell-in, so when we compare a quarter over a like quarter, we can give you both numbers - both the previous quarter and the current quarter.

I am pretty comfortable with the number for the most recent quarter, but I am not at all comfortable with the numbers from '05. And to make a comparison would not be accurate or fair. It'd just be an estimate at this point in time. And I am not willing to share that internal work.

But is it a plan of your actually moving into a sell-through later on? (multiple speakers)

From a disclosure standpoint, that has nothing to do with revenue recognition but from disclosure of the make up of our quarterly sales.

Yes, we are trying very hard to develop a methodology so we have great confidence and we give you a number that that number could be supported on the ground with the facts. But we do not have that methodology totally developed.

Okay. In terms that you mentioned the second quarter that 170 stores, which now is up to 208 stores, some of the revenues were actually expected in this quarter. So was it the case? Or you said the launch is actually the last week of October?

Yes, but we have to ship goods well in advance of the retail launch. We shipped only the moissanite jewel. The manufacturing process takes weeks, particularly if you are loading inventory for as many as 100 or in this case 208 doors. So that inventory has been in production, in jewelry production over the past several weeks so yes, the revenue -- to build that initial inventory was shipped and recognized in the third quarter of '06.

Also, can you give us an idea of what is the revenue growth except K&G, excluding K&G?

K&G continued to be a negative comparison in the third quarter. I do not have those numbers in front of me. But if K&G had been flat, our revenue growth would have been higher.

So do you have a specific number like you gave (multiple speakers)?

We have a record share. I do not have them in front of me.

We will have in the 10-Q that percentage of sales of each of our customers over 10%. But yes.

I think that is the right answer. I do not have those numbers. I am very confident with what I am telling you. K&G had a negative comparison in our sales to K&G third quarter of '06 versus third quarter '05. Had they been flat, our growth would have been higher.

Okay. That helps. On the gross margins, we saw gross margin on a sequential basis drop quite a bit. So was it also due to the benefit which is tapering off what you had earlier due to the low-cost inventory?

Part of it was due to that mix that we had that we shipped this quarter versus the previous quarter. It was down -- from the same quarter last year it was down about 4% from the previous quarter. It was down about 2.5, 3%. That - coupled with the fact that now as I think we've mentioned in previous quarterly meetings, we are going to be getting -- it is going to be a little choppy, the margins. And that is why we continue to say between 65 and 75%, we expect margins to be in the foreseeable future. I think Bob said that in his comments.

But the quarter of June 30 had both a pretty good average selling price, plus was in one in our better periods of production. And so we slipped a little bit (indiscernible) in the mix, in that we just had a slightly smaller (indiscernible) . And we had a slightly lower higher cost or lower profit from the period we relieved inventory from and but we, as I said, we expect to be around these numbers if not more. Between 65 and 75% (multiple speakers).

And it's still up, as Jim said, 110 basis points over the same period of '05.

Ryan Thibodeaux, Maple Leaf Partners.

Did you guys say that all of the -- basically all of the sell-in in new into Kohls, that all occurred in the third quarter?

Yes. For this initial, this 208 doors that is correct.

So therefore none of that will be recognized in Q4, right?

No. Everything's been shipped and has been made into jewelry. Title was transferred. Title transferred back in July and August or August and September, I guess. And those goods are being made, they are owned by the manufacturer until they are delivered to Kohls and then they are owned by Kohls. So that revenue has been recognized.

What I can't give you is what the sell-in revenue was, can't give you with any degree of confidence what the sell-in revenue was in the third quarter of '05 and other retailers.

Which there was significant.

And was significant, that's correct.

Can you talk about, I guess just as a method for comparison, the length of time once you got around the 200 door level at JCPenney, how long thereafter did they decide to go with the full rollout? If you could just refresh everyone.

We went into the first 460 doors in October of '04 and we were in the full rollout sometime in the second quarter of '05.

Actually, it was February, the end of February. (Multiple speakers) end of February, beginning of March.

242 doors.

242 additional doors.

In March of '05.

So from October to March, six months.

Okay, and so would you have started, then, shipping to manufacturers prior to that?

Absolutely, yes. The same scenario. For the October period, some of those goods would have been shipped -- with Penney's, it is a little different situation. Some of those goods, a significant portion of those goods, was shipped on memo. Not all of that was an asset transfer. The terms of sale were different under that initial 460 door test. So we started -- you are identifying some of the issues we are dealing with here as we try to provide you this information you rightly want. We understand why you want it and we'd love to be able to give it to you in great detail.

But as we go back in the history and start looking at the components and how that played out, it becomes very, very difficult to be able to do a direct comparison. But for the October of '04 shipment those goods would have been shipped in the third quarter of that year and the February would have been shipped in the fourth quarter of '04.

And the Kohls test, that's not on memo. That is direct.

That is an asset. That is a total different terms of sale, that is correct.

And my last question is, can you actually give a dollar figure for the average selling price?

Yes, we disclosed that was approximately $161 and change in the most recent quarter. That's down from $165 in the second quarter.

$169 same quarter last year.

And what was Q1 of '06?

Q1 of '06 was $166.

(OPERATOR INSTRUCTIONS). Chris Terry. (indiscernible) Securities.

Bob or Jim, you gave us the name of Kohls. Who is the other major retailer you're beginning tests with?

We are not allowed to disclose that one yet. It became pretty common knowledge in the industry and so we have no [reluctance] to disclose the Kohls. But we do not have permission from the other retailer to disclose their name.

And that is 20 doors currently?

That will be approximately 20 doors that we will be executed in this quarter.

And then also you mentioned also last quarter a prominent Internet retailer jumping on with moissanite. Any update there?

I think if you go to my comments earlier, there are several there that operate very prominent -- that have a very prominent Web presence. Included in that would be Ross-Simons, JCPenney, HSN.com, for that matter ShopNBC.com does a significant amount of business through their Web presence. So I am sure that we were alluding to either one of those or someone very similar to that.

And lastly on the gross margin, Jim can you help me understand it? I understand the mix and the average selling prices, but if volumes continue to increase, you guys had a record sales quarter here. Volumes are up, why wouldn't you guys benefit from greater production efficiencies? If you are able to get more moissanite stones from your supplier?

That is a good question. Right now, we're on a FIFO basis. So what we relieve from inventory was production in the third quarter of '05. So that is the cost that went into expense, cost of goods sold for this quarter was that which was produced in '05. Because what we do is we look at our number of carats in inventory and we value that inventory based on the production of the last number of months that those carats got produced through. And then what goes into gross goods sold is that that is produced just prior to that period.

So it was production costs for the, as I said, for the three months ended in September of '05.

Does that imply that margins should improve if the mix -- ? (multiple speakers)

It depends. We have not increased purchases. We started to increase purchases right around then to the level that they are currently at. So it is not that we have increased purchases any more to allow for increased efficiency. We got to a level of efficiency which we saw both last quarter and the quarter before and we feel that when we look at the average cost per carat of every month that was -- is currently in inventory, it would cause margins to fluctuate somewhere around 70%.

Let me give you a little more insight into this whole margin issue as well. Smaller stones, as we sell smaller stones, they not only have a lower average price per carat selling point, but they also have a higher cost to manufacture. So as we sell a higher mix of smaller stones, we have a higher cost to manufacture on a per carat basis and a lower selling price on a per carat basis. That is a fact of life based on the fact that each one of our jewels is hand-faceted and polished.

So on a per piece basis, we pay our vendors to facet and polish each stone or each jewel. And as it takes more pieces to make a carat, that cost per carat goes up. And the average selling price is really arrived at through what the market will bear. We had a very substantial increase in price in some of the smaller stones earlier this year and have seen no dramatic fall off in demand for those goods.

That may mean that we have some elasticity up in future periods. But we tend not to adjust prices more than once a year and we will take looks at that when it is appropriate. But hopefully it will give you some idea of the other issue on these smaller stone sizes. Not only the lower selling price, it is also the higher cost of production.

Well, it does some. I am just trying to gauge where we are right now and then where we go forward.

The more you understand our business, the better analysis you can do, and we appreciate that.

[Alan Allbright], NCF Corp.

I know you can't specifically answer any questions relating to a full roll out with a retailer, but just so I can better understand the story going forward, how did it work with JCPenney, was there a nice trial period with a small base? And then a huge initial order to -- of several hundred stores, or was it spaced out evenly over a 12-month period?

No. It was relatively rapid, and I do not mind detailing that history. We were able to gain through the great efforts of one of the great advocates of moissanite a consultant to the Company. Through his good offices, we were able to gain a test, a trial test with JCPenney, at 15 retail locations, 10 in California, five in Florida -- trunk show events. I am sorry. They were trunk show weekends, one day only events. Scheduled 10 in California, five in Florida for the summer of 2004.

Based on the results of the first 10 of those events, that we supported and executed with a high degree of efficiency and success, the merchants at JCPenney recognized an opportunity, made the call to go to 460 -- approximately 460 doors in July of 2004. Our team and at Reeves Park, who was the jewelry manufacturer, responded incredibly well in preparing for and executing that rollout from mid July to October 1.

And then further did a marvelous job of executing the advertising, promotion, the full marketing campaign that led to great moissanite success for JCPenney in the fourth quarter of 2004, which led directly to the decision by the merchants at JCPenney to the 703 door. At that point in time, 703 doors. Since that time, it has grown to approximately 720 doors at JCPenney.

That was a very quick from beginning to end. That is atypical from what happens in the jewelry business. More commonly, it would take 15 to 18 months from the first test to a full rollout with a major retailer. And that may be aggressive. It may take two years to go from a small test in a particular retailer to a full rollout. But JCPenney's merchant rightly recognized an opportunity in our view; and she and our team did an outstanding job of executing the plan and delivering great results for JCPenney and for us.

[Peter Wright], Paulson Investments.

Can you tell us anything going on in the supply front to you from the acquisition -- (multiple speakers)

Sure. Be happy to address that.

-- and your other deal in Scandinavia?

First all, as you know, or as many of you should know or may know, Cree has acquired a company called Intrinsic from the Dulles area of the Washington suburbs. We had a recent agreement with Intrinsic earlier for a test program whereby we were committed to spend our purchase from them approximately $400,000 in raw material, subject to them meeting certain minimum quality standards.

Intrinsic remains a live entity even though they're now wholly owned by Cree, but they were not able to meet those quality standards. And verbally at this point Cree and Charles & Colvard reached an agreement that our agreement with Intrinsic will lapse and be voided. Cree continues to be a terrific supplier and we are not displeased with how that process is unfolding.

The other concern - opened their plant, their new plant about six weeks ago. We -- Steve [Abate], our Director of Manufacturing, was in attendance of that event. They are up and running with a limited number of growers. We expect to see some production from that facility late in this quarter or early next quarter.

Again, our commitment there is based on them meeting quality standards and assuming that they are able to meet those standards, we will fulfill the terms of our agreement and have discussions about getting them added volume. But at this point in time, and for the foreseeable future - and by that I mean years, not months, but years - Cree will continue to be the primary dominant source raw material for Charles & Colvard.

My other question is -- I see you had a little spike up in international sales. Can you give us some flavor as to what is going on over there and what we can expect going forward?

Well, we're seeing some great opportunities. What has happened in certain marketplaces is that they are seeing the success we're having in the United States; and we are seeing certain manufacturers and retailers say maybe we should get on board with this. Maybe we should get serious about moissanite. And so we're seeing a lot more interest and we are having better conversations with certain people. I would also caution to my prepared comments.

Some portion, and it could be a substantial portion, of the inventory that goes to Asia will come back to the United States, be reimported, either to directly by a major retailer or by a domestic manufacturer buying from said contractors in Asia. So even though we saw really nice increase there, some portion of those goods will come back to North America and be sold in JCPenney or Helzberg or whoever.

It is not uncommon for the major retailers in this country to source goods in Asia and/or to source goods from domestic manufacturers who subcontract work in Asia; and it is in their best interest to buy the goods there, and that is one of the reasons -- you'll remember that I've spoken about now for many years about the reason for our presence in Hong Kong and how important is for our long-term growth and well-being.

I will ask one more question and give it up here. And that is any idea about colored stones? And their future?

Colored stones. Colored moissanite.

In order to develop a repeatable, predictable shade of color, we would have to spend a significant amount of money most logically with Cree to develop a process. At this point in time, given the relatively still small awareness level for moissanite, we think our monies are much better spent building demand for near colorless moissanite.

With that said, there are experiments - no development dollars, no significant development dollars have been spent - but there are certain efforts underway to produce certain colors. And that is as far as I want to go with that today.

Ken [Marsalas] with [Overwright].

I apologize. I had to hop off the call for a few minutes, and I just had a couple quick questions. Can you just give us more clarity on Kohls? Is the implication that you will not recognize any Kohls revenue until this current quarter, or did you recognize -- ?

No, it has all been recognized.

It has already been recognized.

Yes. That was an asset transaction from its inception. And we sold those goods to Samuel Aaron, who in turn is manufacturing the gold jewelry, and will sell the totality of that inventory to Kohls.

So the sell in has already occurred there?

That is correct.

And did you disclose, or wait for the 10-Q here, the revenues to K&G and JCPenney?

We will give you the specific revenue numbers by or percentages of anybody over 10% in the Q. I do not have those in front of me here this afternoon.

Tom [Zulis]. Paulson Investments.

Could you give me an update on how the trial went with Gordon's?

Things are positive, and we have some good indications, but there is nothing specific we can share.

Helzberg, is their commitment permanent at this point?

Dennis?

Yes, Tom, we are in all stores as of September 1, and they are very excited about our category. You can go to their Web site and see more about it.

As a matter-of-fact, I would encourage you, each and every one of you, go to their Web site today and check at what you see about moissanite at the Helzberg Web site.

The number of doors at Helzberg?

There are 272 stores.

It is up a bit from what we previously announced.

Bob, can you talk at all about the next phase of getting consumer awareness up? I mean, it is nice to have all of these retail outlets now, but we have got to move product.

And we talked about that. Dennis and I and our members of our executive team and our Board talk about this constantly, and that is, we have to build awareness to -- defined as demand faster than we build distribution. Otherwise, we run the risk of taking of the pie and splitting it into smaller pieces and the retailers who come on board become less than enthused. Or lose interest. And that would not be a good outcome.

So we spent a significant amount of money last year in the fourth quarter. We will spend a significant amount of money this year in the fourth quarter. You are going to see a little heavier Internet presence. We have some trial things on Internet advertising that we can talk about on the next call. But you're going to see a much -- a sustained effort to build awareness and demand.

Additionally, we will have our new Web site up and running November 15. We think that will add some excitement. We know that many, many consumers learn about moissanite or attempt to learn more about moissanite online, and we are taking some steps and have spent a significant amount of money on that -- (multiple speakers).

$190,000 in this quarter.

$190,000 in the third quarter, right, on Web site development, and we're excited about what that is going to look like and what that will mean to help people understand what moissanite is.

We are spending aggressively. We are constantly evaluating where those dollars are going, and you may see some different initiatives in the coming periods.

There is a retailer buying Ultra -- I think it is Ultra Diamond, the seventh largest specialty retailer of fine jewelry in the United States. Is this a relatively new relationship? Is this an ongoing relationship?

Ultra is a customer of Reeves Park, and Reeves has not disclosed everything about Ultra to us. We do know that they -- Ultra has had moissanite in some stores on a limited basis for some period of time. We are told that moissanite enjoys a larger presence in a larger number of doors at Ultra today. But I do not have the specific number of doors, the number of SKUs, and that type information this afternoon.

But we are making progress all across the country, and to a lesser degree, offshore. But the progress is real. We had a very successful third quarter. There are things in my comments that if you go back and read those, you will see that we have even more reason for optimism. It is an exciting time, of the momentous year, we have to be very careful. We have to continue to execute. But we feel very, very positive about where we are here on October 17, 2006.

One point that Bob made in his comments was concerning consigned inventory, which went up over $400,000 from June to September. That increases the amount of potential revenue recognition that we will have when it gets sold by the various different retailers and, hopefully, a good part of it in the fourth quarter.

Your inventory. Are you comfortable with the levels of inventory at this point?

We have actually had a couple of shortages on different SKUs. But to be honest with you, I am -- although the number of days in inventory did come down in the third quarter from what it was at June 30, significantly down from days of inventory down significantly, it is still not at our target. And if our revenue does not increase on a percentage basis faster than it has over the last two or three quarters, then we may have to slow some production down temporarily.

But because we don't want that inventory -- don't want the days of inventory to grow much from here. We would like to bring it down.

New Zealand and Australia, I understand there is a distributor, [Moi Moi] -- are they considered to be exclusive, or is there are multiple distributions going through that region?

Moi Moi is a retailer originally started in the Gold Coast of Australia. It is a distributor that has exclusive rights to Australia. It also operates a successful moissanite retail store on the Gold Coast there in Australia. And they have made some gains in distribution to other retailers in the very recent past. The success of that store has spawned interest in a similar store in New Zealand.

I would not characterize as a huge market or a huge opportunity, but it is another indication that people are seeing moissanite as an opportunity and are making an investment. To be honest with you, I do not know a hell of a lot about New Zealand or Moi Moi in New Zealand other than what I just told you. I would not characterize it based on what I know about the size of the market as an enormous opportunity for Charles & Colvard. It is just another positive indicator that people are discovering and appreciating moissanite.

One last question -- could you just give us an idea about the discussions and respect -- whether you're getting respect of the industry, whether you are now considered to be a commodity that is going to stand the test of time and where you stand on that level?

If you have not seen the October 1 edition of National Jeweler, e-mail Jim or myself and we will mail you a copy of the 32 page moissanite insert that was in the National Jeweler. I think that to say that we have created a buzz among the retail as well as other manufacturers would be accurate, if not an understatement.

So that, alongside our sponsorship, very significant sponsorship over the last two years of [Sibjo], the World Jewelry Congress, and of most recently the symposium, [GA] symposium, in Carlsbad, California, where we have been received very warmly and very well and have been held up as a positive example of various discussions in those meetings. So to say that Barbara Moody and Dennis have accomplished a lot in regards to interrelations over the last four or five years would be a terrible understatement.

They have accomplished a tremendous amount and we appreciate their leadership in gaining that recognition and making that progress.

Walter Ramsley. [Walrus] Partners.

John asked about the number of doors. As I recall, going into the year, you had about 1500 really active doors. Was that right?

Well no, it was probably a little more than that. I think we said -- and I don't have that in front of me and I apologize -- I think the way we've characterized that in the past is doors that had really a complete moissanite category were approximately 2000, we believe going in -- 20, 2200 was the number we had used. Somewhere in that range. We said that our goal for this year was to add 1000 doors that had a complete moissanite category.

Not the jewels in the back room or the special order or people who had one or two pieces, but somebody who had a full display and was representing moissanite as a category. And we said earlier in the year that our goal for the year was to add 1000. I think we're well above 700 to date. I do not know that we will get to the 1000, but I do not know that we won't.

There are other things in play that could lead us there. As Dennis Reed said in our annual meeting, if all the places, all the chains that currently had moissanite in various stages of test distribution or in trial distribution, were to decide that they were going to accept moissanite in all their locations, we would had approximately 2900 doors overnight.

We have not done that, but we have made great progress adding plus 700 doors year-to-date, and we hpee to add a few more between now and year end.

I understand that. So the 700, those are full-scale customers now?

Full-scale customers with moissanite. What I would define, a minimum of 28 SKUs, 28 different items in a special location, a moissanite destination, and so if we had add that to the existing doors at the beginning of the year, we are approaching 3000.

Right, so just doing the math, I mean, say you took the average of that other range, 2000, 2200 call it 2100, and add the 700, that would be a 33% increase but the sales were up 12%. (Multiple speakers) rationalize all of that.

Go back to what I said earlier. The sell-in -- we did not do a very good job at the time or in documenting what the sell-in was in '04 and '05. We're starting to do a better job of documenting what we believe the sell-in is in 2006.

So if we go back, we know that the manufacturer -- what we do not know is specifically the inventory levels held at the manufacturers and/or the retailers at any given point in time. What we believe that over the course of the nine months - 2005 versus 2006 - there has actually been an increase in sellthrough, even though -- and a lot of that was accomplished with existing inventory, not with inventory that was purchased from us during that period.

So we have great confidence; we believe it; we cannot prove it. We cannot take it; we just don't have the information available to less to prove that, but that is what we believe is the case. So go back and we look at the sell-in in previous periods. We look at what those inventory levels might have been. Those are all guesses on our part, but our instincts tell us that we made progress with the consumer this year, even though our topline revenue growth does not demonstrate that.

So the sales, the inventory for the -- like the sell-in for the Christmas season this year, do you think that all went out by September 30, or was there more to go in October?

We have existing orders that are substantial that are here today, that will be shipped in the fourth quarter at some point. Some of those are, as I said, are substantial. So we will see some more activity for the fourth quarter. Not all the fourth-quarter retail sales have left the building yet.

And just one last thing, a year -- a year and a half ago, there was just rampant optimism about the sales taking off from 40 to 80 and off to 300 million. Have you kind of tamped down the projections or is that still --?

I think on this call last year is when I made some comment about expectations being unrealistic. The third-quarter call, if I'm not mistaken -- might have been later in the year.

(multiple speakers) call for the fourth quarter.

It might have been later in the year. But the -- my optimism about becoming a much, much larger business is no different now than it was then. I think that realistically, this industry is a much harder nut to crack than any of us thought it was going to be. But with just a continuation of what we are doing -- we've got the right formula, we've got the right template, we continue to prove it, day in, day out, we execute very, very well at the retail level, the marketing speaks to the consumer and the consumer reacts. We know that from all our research and surveys we do constantly. And so we just have to reach a larger audience, and that is advertising and promotion. And we are concentrating on massaging our efforts there to try to get more bang for the buck and to grow that awareness level at a faster rate, and we believe that awareness level will equate to more demand going forward and we'll be a much larger company.

So my optimism is no less than it was this time a year ago or for that matter two years ago. I think we've got the right message, we've got the right template. It is a matter of having and utilizing the resources appropriately to build that awareness and demand.

Well, I do have to handed to you -- you have been able to keep less profit margin up despite the lower than expected sales. So you got a really good chance.

We've got a great business, and we're very optimistic about the future. Operator, thank you very much. Ladies and gentlemen, do we have any other in queue or no? Operator?

That is all the time we have left for questions today, sir. Thank you.

Thank you very much, ladies and gentlemen. Appreciate you being with us, and if your interest in Charles & Colvard. We look forward to reporting the fourth-quarter in mid to January. Have a good day.

And that does conclude today's call. We thank you for your participation and you may disconnect at this time.