Charles & Colvard Ltd (CTHR) 2011 Q3 法說會逐字稿

Good afternoon and welcome to the Charles & Colvard third quarter 2011 conference call. All participants will be in listen-only mode. (Operator Instructions).

As you are aware, we may make forward-looking statements, both during the call and in the following question-and-answer session. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from those we discuss here. These risks and uncertainties are available for you in the press release itself as well as with the Company's filings with the Securities and Exchange Commission. You may obtain these documents from the Company's website at www.charlesandcolvard.com. They are also available on the SEC website, www.sec.gov. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.

I would now like to turn the conference over to Randy McCullough. Mr. McCullough, please go ahead.

Thank you. Good morning. Thank you for -- sorry, good afternoon. And thank you for taking the time to join us in recapping the third quarter, ending September 30, 2011 and allowing me to update you on the progress to date in expanding our business.

As I said in our press release this morning, our goal was that the year end to date execution of our strategies would have resulted in stronger revenue in the third quarter, we are very encouraged by the surge in our sales we are seeing in the fourth quarter.

This year's October net sales through October 26 are up approximately 290% over the full month of October 2010. Tim will cover this in more detail shortly. We expect fourth quarter revenues to further benefit from our investments in new sales and marketing initiatives.

Our televised home shopping network customers have remained strong and the two of the largest social networks that focus on jewelry products, ShopNBC and JTV have significantly increased the number of moissanite shows scheduled for the fourth quarter.

Charles Winston, a known TV home shopping talent hosted shows during the third quarter for JTV, featuring moissanite set in silver with results exceeding all of our expectations. As a result, several additional shows featuring Charles are scheduled for the fourth quarter. Catch the dates and times to be posted on our Facebook page.

In addition, we've added Ideal World, one of the larger television-owned shopping channels in the UK to our list of direct merchandising customers and we are targeting to launch with two networks in China, servicing two of the top cities in Asia, Shanghai and Chongqing.

Our sales team has also made inroads into several international markets including opening new distributors in China and Kazakhstan, that represent new opportunities for moissanite and have the potential to provide incremental revenue for our Company.

In addition, we remain committed to the success of our highly-valued existing moissanite distributors and retailers in both the US and abroad with co-op marketing initiatives in place for this Christmas season.

We believe the third quarter launch of our direct consumer e-commerce website moissanite.com has considerably increased consumer awareness as a result of multiple social media campaigns, increased bloggers activity and satisfied customers spreading the word. We receive e-mails and phone calls on a daily basis from customers who are thrilled with the service and merchandise they receive. The increase in traffic to our website is very encouraging as we head into the holiday season with plans to market the web vigorously. The site built on the robust and scalable Magento e-commerce platform, which powers websites for many of the world's leading brands is scheduled to transition during the fourth quarter to a much broader selection of finished jewelry, most of which will be unique to moissanite.com.

We are targeting to finalize an exclusive agreement with one of America's top jewelry manufacturers to provide fulfillment of quality moissanite jewelry for our site only, thus eliminating some of the duplication with assortments throughout the e-commerce community.

MoissaniteCo.com, that's MoissaniteCo.com remains the low-cost provider on the web and frankly we believe is one of the best out there in merchandising, competitive pricing and customer service. We have purposely positioned moissanite.com prices at, or in most cases, above theirs in order to maintain stability in the marketplace.

We know that resellers are expressing concerns as we launch moissanite.com, and we want to be clear that we will continue to recognize those who have properly positioned moissanite and work with them in a professional manner to further extend the awareness among customers.

When we ask, what do we have that customers want that competition [can] deliver? We get extremely enthusiastic of the potential of Lulu Avenue, a new jewelry home party and direct sales business. I can't imagine a better way to spread the word and being among a captive audience of women where we can demonstrate the unique features and value proposition of our moissanite jewel.

As the sole provider of moissanite to the marketplace, we know exactly where our competitive advantage lies with the consumer, taking moissanite to them directly. This firm knowledge backed by the market testing in real life home party situations has created enthusiasm throughout the direct selling business for Lulu Avenue.

Kevin Raulston, a seasoned and highly respected direct-selling executive, who as COO led ventures that have grown to over $150 million in revenue annually is on Board and heading this new venture as General Manager of the Lulu division. He is putting together a winning team that is eager to take moissanite to the marketplace as part of an overall jewelry offering that both raises consumer awareness of moissanite and has the potential to significantly add to our topline revenues nationally.

Sales and consumer response throughout the test phase for Lulu Avenue confirm that the home parties were a great value and a good venue to introduce moissanite to the new population. Wherein the majority of the participants had never been exposed to moissanite, it also greatly exceeded our projections and goals beating the mature industry home party jewelry show averages by over 30%. Kevin has already assembled a team with extensive passion in jewelry sales and marketing experience in the direct sales marketplace.

Web, print and social media marketing materials are in development and we're already signing up independent sales representatives throughout the US. This team is focused on increasing market demand and meeting the demand by creating a relationship directly with the consumer.

Network marketing and businesses like Lulu Avenue are all about relationships. A critical component of the sales process involves building open, honest relationships with potential customers and bringing value to these relationships at every opportunity.

It is our belief that providing moissanite jewelry that exceeds expectations is critical to building the type of trust that we make -- that makes a network marketing business powerful. We believe the key of growing the Lulu Avenue business is a sound understanding of marketing techniques that bring the benefits of moissanite product to the attention of as many people as possible. These efforts will be supported by a state-of-the-art automated, online marketing and back office system that provides customizable websites for each of our independent sales representatives.

In turn, the anticipated improvement in consumer awareness of moissanite resulting from the new sales channel could also benefit sell-through in existing moissanite e-commerce and our wholesale moissanite distribution sales channels.

Lastly, to further enhance our branding of moissanite, we have engaged the Levine Design Group of New York to identify a proprietary position that creates a new space and paradigm in the luxury/jewelry market. Our goal is clearly and definitively separate the brand, and the moissanite jewels themselves from the diamond universe, thereby creating a uniform -- a unique platform for future growth.

After meeting with Pam in her New York office and here in Raleigh, it was clear that her creative talents and experience are exactly what we need to build our brands.

The Charles & Colvard brand will provide an umbrella under which Forever Brilliant moissanite jewels, Judy Evans designer finished jewelry, moissanite.com e-commerce, and Lulu Avenue direct selling sub-brands and brand iconography can be developed and optimized.

We remain confident that our multi-channel sales and marketing strategies will play a key role in the accomplishments of our goal and growth objectives. Additionally, we continue to remain well-positioned financially with a long-term debt-free balance sheet, healthy operating cash flows, and over $12 million in available working capital.

As a demonstration of our belief in the Company's future prospects, Charles & Colvard has repurchased 183,287 shares of its common stock to date under a Board-approved share repurchase program that extends through August 12, 2012.

I'd also like to address some of the questions I received from investors over the past few months, since our shareholders right plan of poison pill was terminated in August. I've heard pros and cons of such a plan and that is confusing to the ordinary investor, I believe the move to expire the plan was indeed in the best interest of all the shareholders.

Shareholder advisory firms like ISS are generally against poison pills, because they hinder the shareholder's ability to take advantage of an active market for corporate control. For that reason, many companies now take the approach of not having the poison pill in place, but being ready to quickly put one in place if there is a potential threat of a hostile takeover that the Board believes is adverse to the shareholder's interest, that is where our Board decided to go.

Before I turn the call over to Tim, I'd like to take a minute and share something I firmly believe in, which when it comes to successfully running the business much of which I picked up from Roy Spence, who runs GSD&M in Austin, Texas, a national advertising agency with a short list of successful clients like Southwest Airlines, BMW, Sam's and Wal-Mart, Procter & Gamble, Whole Foods, John Deere, American Red Cross and many others.

It's not enough to have a desire to dominate a marketplace. You must create a business model that is in alignment with your consumer. Successful organization finds new ways about -- to think about their business and provide something different or innovative in their space. I love questioning the status quo and testing things that people say can't be done.

In the process, they develop products, services, our experiences that are innovative in the marketplace. There's no right or wrong way to go about building a successful organization. Every company has to look at how they do business, both past and present, and identify which aspects of the business are working and which aren't. From there, you can begin to prune away the products, practices or people that undermine the Company's success and build upon those that facilitate your economic model.

You may need to walk for a while in your customer's shoes to identify the real opportunities. Each situation is unique and the strategies employed to land the operational model for success will vary accordingly. The point is to remember that you must execute in ways that deliver what your customers want and demand. Success is not the result of marketing gimmicks, it takes hard work, operational alignment, complete focus and 100% commitment.

Now I'd like to turn the call over to our Chief Financial Officer, Tim Krist, who will review in greater detail the financial results of our third quarter.

Thank you, Randy. Good afternoon everyone and thank you for joining us today. I'll discuss the financial results for the three and nine months ended September 30, 2011. As announced in today's press release, net sales for the third quarter of 2011 decreased 4% to approximately $2.9 million, compared with approximately $3 million in net sales during the same period of 2010.

Domestic sales for the quarter decreased 5% from the same period in 2010 to approximately $1.8 million and represented 63% of total net sales. International sales for the quarter decreased 1% from the same period in 2010 to approximately $1.1 million and represented 37% of total net sales. Our loose gemstone sales during the third quarter were down 22% from the same period in 2010 to approximately $2.2 million and represented 76% of total net sales. Our finished jewelry sales during the third quarter were up 303% from the same period in 2010 to approximately $682,000 and represented 24% of total net sales.

These fluctuations in quarter-over-quarter sales by product mix are primarily the result of the timing of restocking orders received from our customer base and our continued focus on expansion into the finished jewelry business through the creation of new sales channels.

As we continue to execute our strategy of developing new sales channels and expanding our finished jewelry business, we expect these fluctuations in product mix to continue. As an example, our fourth quarter 2011 sales to date through October 26 currently exceed $1.7 million, comprising approximately $1 million in loose gemstones sales and approximately $713,000 in finished jewelry sales. This compares with total fourth quarter revenue last year that included loose gemstone sales of approximately $1.9 million and finished jewelry sales of approximately $1.6 million.

Net sales for the nine months ended September 30, 2011 decreased 4% to approximately $8.9 million, compared with approximately $9.2 million in net sales during the same period of 2010.

Domestic sales for the nine-month period decreased 3% from the same period in 2010 to approximately $5.2 million and represented 58% of total net sales. International sales for the nine-month period decreased 4% from the same period in 2010 to approximately $3.7 million and represented 42% of total net sales.

Our loose gemstone sales during the nine-month period were down 12% from the same period in 2010 to approximately $7.2 million and represented 82% of total net sales. This decrease was primarily due to a one-time $889,000 [our sale] to an international customer in the second quarter of 2010 that did not recur in the first nine months of 2011. Our finished jewelry sales during the nine-month period were up 69% from the same period in 2010 to approximately $1.6 million and represented 18% of total net sales. This increase was primarily due to our continued focus on expansion into the finished jewelry business.

Our third quarter comparable sales decreased 6% and our first nine months compared to sales were flat when compared with the same periods of the previous year, primarily as a result of the timing of restocking orders received from our existing customer base and the addition of customers that did not have sales in the prior periods as we execute our strategy of developing new sales channels.

We define comparable sales as active customers with which we generated revenue during both periods on which we're reporting and we use it as a metric to measure sales growth within our existing customer base.

We recorded net income of $110,000, or $0.01 per diluted share during the most recent quarter compared with net income of $512,000, or $0.03 per diluted share during the third quarter of 2010. Net income in the most recent quarter included the recognition of an income tax benefit of $243,000.

Our net loss for the nine months ended September 30, 2011 was $230,000, or $0.01 per share, compared with net income of $1.1 million, or $0.06 per diluted share for the corresponding period of 2010. This net loss was a result of lower sales, higher manufacturing overhead, and increased operating expenses involving new business initiatives to support future revenue streams.

Also included in the year-to-date net loss was the disposal of assets of $94,000, representing manufacturing software modifications to our current ERP system that were abandoned in favor of improved jewelry specific manufacturing software that we are currently implementing.

Operating expenses totaled approximately $2.2 million in the quarter, compared with approximately $1.6 million for the same period of 2010, an increase of $579,000 or 35%. Operating expenses totaled approximately $5.8 million in the first nine months of 2011, compared with approximately $4.9 million for the same period of 2010, an increase of $916,000 or 19%. Of these increases, sales and marketing expenses increased $501,000, or 99% and $573,000, or 34%, during the third quarter and nine months ended September 30, 2011, respectively, primarily due to our investments in marketing and branding initiatives and our direct-to-consumer e-commerce and home party businesses.

We ended the quarter with a higher level of cash and liquid long-term investments on our balance sheet relative to the end of 2010. Cash and liquid long-term investments totaled $9.4 million at September 30, 2011, up from $8.8 million at December 31, 2010.

During the first nine months of 2011, $2.3 million in bonds were called by the issuers, which we have reinvested in certificates of deposit and non-callable similar liquid long-term investments.

We generated approximately $453,000 and $1.8 million in cash from operations during the three and nine months ended September 30, 2011 respectively.

Total inventory, which includes long-term and consignment inventory, approximated $36.6 million at the end of the third quarter, down from $37.4 million at the end of 2010. This decrease was primarily the result of sales offset in part by purchases of jewelry castings, findings and other jewelry components along with limited production of moissanite gemstones.

I'd now like to now turn the call back to Randy.

Thank you, Tim. This concludes our formal remarks this afternoon and now we would like to open the call to any questions that participants in the call may have. Operator, you can please open the floor for the question-and-answer session.

(Operator Instructions). [Mark Wright], private investor.

Hi, guys. Can you break out your sales by the moissanite website that you have now?

There I would say they are immaterial at this point, because it just launched the end of August. So we don't currently report our e-commerce sales as a separate line item at this time. In the future that's something that we're looking at.

Okay. That'd be good in the future then. How about sales via the TV shop channels?

We currently don't disclose individual customer sales, but it is a growing percent of our domestic sales at this time.

Okay. That will be good too, if you could just group those, it wouldn't be independent -- just group them all together, so we can see how things are going with the TV shop channel side. I expect it's significant for you, certainly helps.

And my last question on this around here, can you tell me the moissanite.com website. Are you going to setup for international sales by year-end, you're expecting to, I think?

Yes. We do plan to and we are contracting with the service to handle the interface with the transaction internationally. But currently we don't sell them nationally.

Okay. You still expect to have it by year end though?

We do.

Okay. That'd be great. All right, I'll release here, I'll get back in the queue.

Thanks.

Thank you.

[Quinn Moo], Joy Jewelers.

Hey, Tim. How are you?

Good, Quinn. How are you?

I'm great. You know what, I want to thank you for the statements you allowed us to post on our websites.

No problem.

[During the] enhanced moissanite. Just wanted to see if there is any movement in that area, if we're all going to stick to the factory stuff that we've been selling for you? And my follow-up question is on the pricing that we see for the loose on moissanite.com, is that just a preliminary price or even raise that price [headed it] here in the fourth quarter?

Yes. We look at it on a daily basis and our price is exact same as MoissaniteCo.com.

Right. Well, I guess my question is, is that the feeling that we need all to work with because MoissaniteCo is just one of other, I know that [Mike] does a lot of business with you, but that's just one website. Are you going off with what Mike says or are you going to go with a much higher value for yourself?

Yes. We don't sell Mike directly. I think he gets his stones, I don't know, if he gets them from Steller or Unique, I really don't know. But Mike's volume is significant, very significant. And we think that moissanite.com should be wherever the marketplace is.

Okay. Okay, so that means that really if Mike decides to go with a lower price, that's where you're going to have to go?

No. I'm telling you, I'm not going lower.

You are not going to go lower, okay.

I will tell you that.

Okay. Well, I appreciate to tell me that. That's one that concerns me.

Yes. He did go lower, as you -- I'm sure as you saw.

Well, I'll try to keep up on things, but sometimes I miss a couple of things here and there.

Yes.

I had a question about the enhanced moissanite as well, why don't you comment on it?

On the enhanced stone, we are -- we just can't warranty enhanced stones. With the enhancement process, when you do have high temperature or high pressure, it does effect the integrity of the stone and it creates an environment that sounds, [looks here] very easily.

Well, I think that's important only because a lot of people we talk to, they ask us if we sell a moissanite, [white or] anybody else's and then I get these questions about enhanced moissanite. I have to tell them that I only sell the items that you guys release to the public. So it's something we have to contain with.

And that's -- I think we've disclosed in the past that we continue to do research and development towards a [whiter] product. And don't be surprised, I mean, it won't be in the next six months, but don't be surprised if you don't see something that grows naturally in an environment that would be significantly better [to improve seller].

All right. That sounds great, guys. I appreciate the things that you guys are doing out there. Thank you so much. (inaudible).

Thank you.

Thank you.

All right, guys.

Chet Paulson, Paulson Investments.

Hi, Randy.

Hi, Chet.

I have a question for you, also for other shareholders. I understand that you need to spend your time on the business and promoting the business. Some of us would like to see you try a little harder on promoting the stock. Every public company runs into this, have an interest in developing an interest in the security as well as the business itself and I'd like to know what your plans are for the next period of time here on marketing your security?

Yes. We are working currently on a trip that would take us out and put us in front of some 60, 70 firms. And we just haven't finished the details on it. But the plan is to get out there sometime in late November or early December, which is the matter of a few weeks.

Okay. So you are on. That's good, I appreciate that fact. On your Lulu business, everyone is -- there's a lot of interest around that and by having the question is, are the price points right for that in-home buyer for the products you have?

I think they're right on target. That whole market structure requires a different mark up. And it would be very difficult for us to sell the stones to another manufacturer and them do the home party and be competitive of what's out there between the

e-commerce and the other environments.

But as the prime manufacturer, we can manufacture the jewelry and get the appropriate mark up and be at the appropriate retail, so that the consumer is getting a great value, a great product and it works. I don't know how much you know about this space, but the operating expense is mostly on the percentages that you pay the sellers and the people out in the field.

How many test meetings have you had?

Yes, around 20. I should have that number with me, but around 20. And I don't mind telling you, we've exceeded 1,300 average and we felt we'd come in around 750. The industry average is between 750 and 1,000.

Could you repeat what the background is for the gentleman who's going to be running it?

Kevin?

Yes.

You know what, I'm going to let Kevin do it, he's sitting here.

Okay.

Hi, Chet. I could talk about a lot of different background issues, but I can tell you specifically, I've been in the industry since 1989, I've headed up sales and marketing for companies in excess of $200 million as Vice President of Sales and Marketing, done international work and have also done similar -- I was also a Chief Operating Officer for a company in this space that was significant in size as well, about the same size as I just mentioned. I'm doing consistently since '89. So not new to it, I've done this before and I'm really excited about what we're finding out in the test and what we've been learning.

When it goes to implementing and increasing the number of people that you have, how does that happen?

It happens two different ways. One is organically through people and word of mouth. It's not usually done effectively through standard advertising. The other is by getting in touch with people who are fans of that type of product. Fortunately this gives Charles & Colvard a very good lever point for it, because there's a lot of fans of moissanite out there. The beauty is only 8% to 10% of the population have ever heard of moissanite and we can leverage that positively in the marketplace in a very short order.

All right. Thank you.

Thanks, Chet.

Neal Goldman, Goldman Capital Management.

Hi, guys.

Hi, Neal.

First of all, what's the average price point of the product you're selling in the home shopping -- the direct selling channel?

It's probably around $100, Neal, but it ranges from -- and as you know, you got to have product at $29, $39 and we go up to, say around $500, but then what we plan to do is have an offerings on the websites, the seller's websites that would hit price points in the $1,500 and possibly even higher.

Okay. And is it a completely different product line on what you're selling to the retailers or through home shopping?

We are designing unique product, yes. And what we're showing at the parties is in silver. They can order it in 14 carat gold or 18, but what we're showing at the parties is in silver.

Okay. When do you expect to start having a meaningful chunk in reduction of the long-term inventory, what's your sense?

It's going to be 2012. We -- I think the -- I really believe that the initiatives we've been working on for the past over 18 months and the first six months was just getting (inaudible), what we had to work with. We are really -- we're starting to see the momentum kick and I was really hopeful that I would kick more than it did in the third quarter. But boy, the week after it, it really kicked in and we've not seen it letup. It looks like we're headed [in that route]. It's like planting seeds and the crop grows and all of a sudden we're starting to yield the fruit. And I think from here, it just starts, the momentum keeps building.

I mean, what was your comment about the fourth quarter you gave through October 26. What would that imply for the quarter itself overall versus last year?

Quarter against quarter?

Yes. I think that the point we were re trying to make there is that current two things. One is, we do experience fluctuations in our product mix between loose and finished jewelry as we're developing these new sales channels. And the other point we want to make is that there are timing issues with when orders anticipated when they ship. And we happen to have some orders close in the early part of October. That will help to move October quite nicely.

Okay. I mean, but you're expecting a meaningful uptick in the fourth quarter versus a year ago at this point?

As I (technical difficulty).

What?

That is our current projection.

Okay. All right. Thank you very much. Good start.

Thank you.

Thank you, Neal.

Mark Wright, a private investor.

Just a couple more questions. Of the 183,000 shares repurchased, was all that in the third quarter?

Yes.

Okay.

All but 41,000, which was December of '09.

Okay. All right. And what specific advertising for moissanite should I expect to see in fourth quarter?

What we're doing is working with our distributors and the distributors are putting together catalogs in various mailings to their retailers. And then they'll work independently with the retailers. We're not doing national advertising. We've discussed that many times prior and as we all know from doing the analysis that the results were not good. But what does work and has worked very well for our distributors is the co-op advertising and we're working with them in a host of different ways to provide marketing support for the Christmas season.

All right. Thank you.

Thank you.

(Operator Instructions). All right. As there are no more questions, this concludes our question-and-answer session. I'd like to turn the conference back over to management for any closing remarks.

Thank you, operator. And I want to thank everybody for your questions and your comments and your support for the Company. Once again, I'd like to thank everyone for taking the time to participate in the call this afternoon. I hope that you share the enthusiasm for the balance of 2011 and the future years. We look forward to talking to you again in the New Year. Thanks, everyone.

Thank you. To access the digital replay of this conference, you may dial 1-877-344-7529, or 1-412-317-0088, beginning at 6.00 PM Eastern today. You will be prompted to enter a conference number, which will be 10005427. Please record your name and company when joining. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Have a pleasant day.

Thank you.