Charles & Colvard Ltd (CTHR) 2015 Q2 法說會逐字稿

Good afternoon and welcome to the Charles & Colvard second-quarter earnings conference call. (Operator Instructions). Please also note that you limit yourself to one question and one follow-up. Today's event is being recorded. This webcast may contain forward-looking statements as defined in Section 27A of the Securities Act of 1933 as amended, including statements regarding, among other things, the Company's business strategy and growth strategy.

Expressions which identify forward-looking statements speak only as of the date this statement is made. These forward-looking statements are based largely on our Company's expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond our control. Future developments and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements.

In light of these risks and uncertainties there can be no assurance that the forward-looking statements -- the forward-looking information will prove to be accurate. This webcast does not constitute an offer to purchase any securities nor a solicitation of a proxy, consent, authorization or agent designation with respect to a meeting of the Company's stockholders.

I would now like to turn the conference over to Mr. Marvin Beasley, President and CEO. Please go ahead, sir.

Thank you, Rocco. Good afternoon and thank you for taking the time to join us in recapping our second-quarter 2015 results. Joining me on the call today is Kyle Macemore, our CFO; Steve Larkin, our COO; and Michelle Jones, our President for LuLu Avenue.

I would like Kyle to review the second-quarter financial results and then I will share some thoughts about our initiatives and our performance. All four of us will be available to answer questions at the end of the call. Kyle?

Thank you, Marvin. Good afternoon, everyone, and thank you for joining us today. As announced in today's press release, net sales for the second quarter of 2015 decreased 5% to $7.5 million compared with $7.8 million in net sales during the same period of 2014.

Net sales for the first six months of 2015 were $15.9 million, an increase of 14% compared to the first six months of 2014. Wholesale net sales decreased 28% this quarter compared to the second quarter of 2014 to $4.9 million and comprised 66% of net sales.

The Company's direct-to-consumer home party business, LuLu Avenue, had net sales of $1.3 million in the second quarter of 2015, an increase of 355% compared to approximately $284,000 in the second quarter of 2014.

The Company's direct-to-consumer e-commerce business, Moissanite.com, had net sales of $1.3 million in the second quarter of 2015, an increase of 78% compared to $708,000 in the second quarter of 2014.

The Company's net sales of loose jewels decreased approximately 6% to $3.8 million in the second quarter and comprised 50% of sales this quarter compared with $4 million or 51% of sales in last year's second quarter. Finished jewelry net sales during the second quarter of 2015 were $3.7 million, a decrease of 3% as compared to the same quarter in 2014.

Gross margins for the second quarter of 2015 were 14% compared to gross margins for the second quarter of 2014 of 32%. The lower gross margins for the second quarter of 2015 were primarily the result of the following actions.

The Company took advantage of an opportunity to execute a net sale of $2.2 million of some of our lower grades of loose jewels to one customer at approximately 5% below cost. The Company also took a lower cost of market reserve on the remaining goods in these grades of $103,000.

The Company increased inventory reserves on finished jewelry and the re-cutting of loose jewels by approximately $288,000 during the second quarter. The Company processed a [melt] on some finished jewelry which also negatively impacted gross margins.

Operating expenses increased to $5.1 million in the second quarter of 2015 compared to $4.6 million in the second quarter of 2014. The increase was primarily driven by an increase in sales and marketing expense of $426,000 for sales to specific customers under which commission plans of sales representatives are based and the direct-to-consumer home party line of business.

The Company also incurred a $288,000 increase in severance expense in sales and marketing in the second quarter of 2015 due to personnel changes in the wholesale organization.

The Company recorded a net loss for the second quarter of 2015 of $4 million or $0.20 per share compared with a net loss of $6.2 million or $0.31 per share in the second quarter of 2014.

The Company ended the second quarter of 2015 with $5.3 million of cash and cash equivalents on the balance sheet compared to $4 million of cash and cash equivalents at the end of the fourth quarter of 2014.

Inventory at the end of the second quarter of 2015 was $34.5 million which was a decrease of $4.4 million from $38.9 million at December 31, 2014 and a decrease of $9.2 million from the peak inventory level of $43.7 million at March 31, 2014.

Loose jewel inventory at the end of the second quarter was $29.8 million and finished jewelry inventory was $4.7 million. The Company has no long-term debt and has not utilized the $10 million credit facility it entered into with Wells Fargo at the end of June, 2014. Now I would like to turn the call back over to Marvin.

Thank you, Kyle. Having spent considerable time analyzing our operations since our last quarterly call I am happy to report on some of the initiatives we have implemented to steer the Company forward and to enhance our brand strategy. Our team has worked toward strengthening our sales, reducing our inventory and strengthening our cash position.

While sales this quarter were $7.5 million, and that is about $300,000 less than last year's second quarter, we were up against very strong comps, as last year second quarter was the highest quarter of sales for the entire year.

Sales increases in our smaller yet rapidly growing direct-to-consumer businesses were very strong with LuLu Avenue increasing 355% for the quarter and 442% for the six months, and Moissanite.com increasing 78% in the second quarter and 67% for the first six months compared to 2014.

Together these two businesses make up about one-third of our sales compared with just 13% of sales during last year's second quarter. We expect these two segments to continue to post year-over-year sales gains compared to 2014.

I had the privilege to attend the LuLu Avenue 2015 Business & Bling conference in July. There was tremendous excitement and optimism about our -- from our style advisors. Moissanite was a huge focal point of the conference and I believe our style advisors see the unique opportunity moissanite offers.

In addition to our direct-to-consumer strategy, we have also made, and intend to continue to make, changes to our wholesale organization. As I mentioned during the last call, Steve Larkin, our COO, is now in charge of both our Wholesale Division and Moissanite.com. While we continue to expect quarterly volatility in our Wholesale business, I am optimistic based on the level of discussions happening with existing and potential customers in our Wholesale Division.

We spend a lot of time an emphasis on developing our brand strategies with our ultimate goal of building multiple, strong brands around the moissanite gemstone. Among the initiatives this quarter was the launch of Moissy.com, a platform that increases awareness of and knowledge about this unique gemstone and allows existing moissanite fans and new customers to share their personal moissanite stories, images and articles on social media and to be further inspired by the brilliance of moissanite. Now if you haven't already visited Moissy.com, I invite you to do so at the end of the call.

We are also quite excited about the upcoming launch of our newest and most innovative moissanite gemstone, Forever One. We introduced samples of Forever One at the JCK jewelry show in Las Vegas in May and received very positive feedback. I am very optimistic about the possibilities for this new colorless gemstone. We expect limited shipments to begin in September; Forever One will be launched in limited shapes and sizes with very targeted partners.

Investing in these strategies we believe will result in increasing consumer awareness of moissanite, continued sales growth and clear communication about the value proposition that moissanite offers. During the last conference call I told you that inventory was a key focus for me. I can assure you that after the last four months I understand our inventory a lot better.

Understanding and slicing and dicing our inventory has been a huge focus for our team. As Kyle mentioned, we are able to sell a significant amount of our lower grades of loose jewels during the second quarter. This was a good strategic opportunity for us and required very close cooperation between our team and our customer.

We do not like taking reserves or selling inventory at or below cost. But we intend to continue to take appropriate actions to reduce inventory without disrupting the market. We are executing on our strategy to grow our Company with the ultimate goals of increasing consumer awareness of moissanite and communicating our value proposition.

As we pursue these initiatives we also remain committed to our priorities of generating positive cash flow and strengthening our financial position while selling existing inventory and manufacturing our Forever Brilliant and Forever One loose jewels and finished jewelry to meet sales demand. We believe the results of these efforts will help increase our revenue growth and profitability and further enhance shareholder value in the coming years. We look forward to the excitement and the challenges ahead.

As I mentioned in my remarks last quarter, we must continue to look for ways to stay ahead of our competition while continuing to innovate. We believe this innovation must come in terms of our product offerings, our partnerships, our distribution and our relationships with our customers. This will require a great deal of hard work and analysis of our current business practices. I continue to make this a priority for our Company and of course for me personally.

This concludes our formal remarks this afternoon and now we would like to open up the call to answer a few questions that participants on the call may have. Operator, would you please open the floor for the Q&A session.

(Operator Instructions). Alex Christensen, Craig-Hallum.

A couple of questions. So you mentioned you didn't -- the new Forever One (inaudible) and I am interested in that (technical difficulty) specifically about how it is going to affect your inventory and the process on making it?

I know there is a big upside from Forever Brilliant, but the downside is that it produced a lot of lower grade stones that you had to take on and inventory as a byproduct. Is that going to be different for Forever One?

Well, Alex, this is Marvin. I will take a shot at that and then I will ask Mr. Larkin if he would like to add something to it as well.

I remember very well the launch of Forever Brilliant and we, quite frankly, had some issues and some problems in that launch. We tried to learn from that and not make the same mistakes again. And that is why you heard me say this is very calculated. We polished fewer shapes, sizes. We selected a group of 8 to 10 launch partners. We really wanted to control this from day one very, very carefully.

The wonderful situation with Cree is that over the years the material has improved and improved and improved. And early results of polishing this new gemstone means that a great deal of it will fall into this colorless category and the rest of it will fall into Forever Brilliant. We literally have seen hardly anything, an outlier or two, that may fall below that.

So with the help of Cree in producing this new 4H material it appears that a lot of the problems that we incurred in -- I guess 2013, Kyle, is that right? -- will not reoccur. We are really into it and I caution you to hear my comments. We have now polished two productions; I believe there is a third being polished today. But it is looking very, very good. We are really, really excited about it. Did that answer your question properly?

Yes, I think so, so just to clarify, if something that doesn't meet Forever One standards would still meet Forever Brilliant standards?

Yes, it would drop a notch. I would add this as well, and our launch partners know this. This gemstone will so at a premium, of course. If it didn't sell at a premium everyone would move to this overnight, believe me and we would be scratching our heads.

It will be a high profit opportunity for us and that needs to happen. And it will allow is probably to use that leverage to do some other things with our moissanite classic. We expect some pressure there and one will allow us to attack problems with the other.

Moissanite Classic, just by what I just said, means that over time it is going to go away. And it will be a while because we own a great deal of inventory. So we have to decide just how we are going to merchandise this as we go through these changes. But we absolutely believe there is a way to get through this and absolutely we will satisfy a bunch of different customers and different classes of trade with these three distinct categories of goods.

Okay, great. And then second -- last question. Based on your big inventory sell this quarter, is that a path you are going to be pursuing in the future? Is that kind of the model that you are looking at? And what kind of expectations do you have about how you are going to be able to draw down from the, what, $34 million, $35 million that you have now?

Right, I will be happy to do that and I will specifically ask Kyle to piggyback because I am sure that I won't touch on every aspect of this. Last quarter I opened by saying, my goodness, I think out of the first 10 questions I had eight of them had to do with inventory. And probably they should have.

This Company has carried for some time now a lot more inventory than it ought to. And I promised the folks -- there was one gentleman on the previous call 90 days ago who was really, really upset by inventory. And I promised him that next call I was going to darn well be able to give him a lot more information and answers about this.

Since probably there will be more questions about inventory in this call, let me just give you some data points for your reference.

Out of the $37 million plus in inventory at the end of quarter one we really, really began to look at it very closely. And as I use the old retailer term slicing and dicing, that is exactly what we have done. And Kyle and I have spent many hours, along with folks that report to us and other people in this organization, understanding this inventory. And as I said in my opening remarks I know a lot more about it today than ever before.

There is about 80% of this inventory, believe me, that is just fine. It is just fine. It is just that we had a lot of it. We have about, correct me if I am wrong, Kyle, help me, about $10 million either in free forms or other material of polished goods in Forever Brilliant. That merchandise we began to receive early in 2013, so it is pretty darn fresh and new.

We have got about $14 million, plus or minus a little, in moissanite classic, that is the lowest price of base inventory. I can't tell you the aging and all that. I can tell you I believe a lot of it probably came in 2012, 2013 -- not 2013, 2011 and 2012. But there's obviously some inventory there that is old. But as my friend (inaudible) always says, it is not milk in the fridge and it is not eggs, it doesn't go bad.

I haven't gone through, nor has anyone else in the last 90 days, to look at all that merchandise. But I have every confidence that it is a sorted properly, that it is in the right buckets and it is in good shape.

That takes us up to darn close to $25 million of today's $35 million. That leaves $10 million and that breaks down in $1.5 million, $2 million in this brand-new material roughly. And when we started the quarter about $6 million in finished jewelry. And there was a couple of million dollars in stuff that fell below the moissanite classic.

So as you can see, we really began to understand the problems. We decided we needed to eliminate the moissanite material that did not fit the qualities going forward and we really needed to look at the finished jewelry, some of which had been here for some time.

The first thing we did was to sell $2.2 million out of about $2.8 million to a very heavy user of lower quality material, that was the $2.2 million that Kyle referred to. And that was a good strategic move for us and for this customer. We also melted about $600,000 at our cost in finished jewelry during the quarter. We are really getting there.

So to answer your question, by the end of this quarter we really believe this inventory is going to be absolutely just fit as a fiddle. Now the next step is we need, and we haven't done a good job of this in the past -- we need to merchandise high quality jewelry that will eat this moissanite inventory of classic, that will go after those gemstones. And we can merchandise that jewelry to volume users and we can work on that segment of our inventory to move it down.

As I said, I don't like selling things at cost, God knows below cost. I don't like taking reserves. We have absolutely shot with a rifle and not a shotgun on this thing. We have -- in the operating room we have taken out a scalpel and we are removing the stuff that needs to be removed and we're trying not to get into anything that is of high quality. And I am really proud of this team for the results of these efforts. So I feel much better about where it is we are going.

We need to move the remainder -- small remainder of these gemstones that fell below the quality. And I am still suspect of some portion of the finished jewelry inventory, which we are going to be looking at monthly as we go to the end of the year. The worst is behind us I believe. Now that was a lot of data -- a lot of information. Kyle, what did I miss?

No, I think it was a good representation. The key is we definitely focused with a very targeted approach on certain aspects of our inventory. And we continue to do that and we will continue, as we said in the comments, to make decisions that we think make sense for our Company and our customers, as well as we are very aware of the market and making sure we don't disrupt it.

And by the way, on this finished jewelry inventory, and everyone in the jewelry business, whether they are selling diamonds or color or whatever, it doesn't matter, the last thing you want to do is melt a piece of jewelry. What happens here for every dollar we melt -- $0.50 of that dollar vanishes, it just goes away.

We lose -- we sell the metal, we lose the labor, we lose the profit that we paid for somebody to put it together, it is not a good scenario. But we always have breakage in stones. So the last thing we would want to do is melt it. But quite frankly if it is not sellable it is the best thing in the world you could ever do.

We will have some cash back for it, we will recycle the gemstones and we will move on with life. So I feel much better about inventory than the day I arrived here almost five months ago.

[Chuck Lane], private investor.

A couple of things. One, I think that I -- one of the things that plagues the jewelry industry, people fall in love with their inventory and you guys are doing exactly the right thing. And when you get into the finished jewelry game you are going to have to suck it up and get away from it. I think that is on target.

In an effort to understand, LuLu and dot.com business percentagewise have increased substantially. They now represent one-third of Charles & Colvard sales. What percentage of the expenses are dedicated to supporting those two businesses?

Hey, Chuck, it is Kyle. When we file our 10-Q in the morning you will see obviously a lot of detailed breakdowns. We have -- I kind of look at our expenses in an overall perspective. So our G&A, which basically makes up -- in this quarter our G&A was $1.5 million. That expense covers the whole business. It is IT, it is [finding], it's HR, administrative, so we are supporting everybody.

We have about $3.5 million this quarter of sales and marketing expense. A pretty decent size of that is to support the three various businesses being LuLu. And the thing to remember about LuLu is as its revenue grows there is a high level of commission so it is a variable cost, which is a big portion of their expenses.

Their infrastructure is a pretty decent size of that. The Moissanite.com team is a little bit smaller team. And our wholesale organization is slightly bigger than that. So, and in that organization we pay advertising costs with some various other things to outside sales reps, commissions, things like that.

So, I think right now our expenses -- I don't have the exact split but it is pretty evenly spread. I think we are probably -- we are investing the most in LuLu because of the commissions and the infrastructure. So we will continue to do that and need to do that as the business grows.

We also are spending more money in our marketing area since we brought Sarah and her team on board. And that marketing expense is supporting all three business units, trying to drive the branding, the positioning of Forever One and you are going to see a rollout of all new branding for most of the Company. And we hope that raises all boats. So we've kind of reallocated some of the expenses to that area because we think it is necessary to increase awareness.

Well, you are absolutely right. I know there are things that we could not disclose previously, which I think we probably need to today and we are. I was just trying to wrap my arms around the relative profitability of the major business segments? And that is difficult to come up with because some of it is -- it cuts across all areas.

But I would hope that somewhere along the way -- and maybe this is coming out tomorrow -- that we could say X percentage of our revenue or X percentage of our operating expenses are dedicated to each of these three business units. And I understand. And when we --.

Chuck I would -- sorry, I would ask you to read footnote 3 of our 10-Q that gets filed tomorrow. I think a lot of the information you are looking for will be in that (multiple speakers).

That is great. Thank you, so much. Hope you guys are staying cool up there. It is hotter than hell in south Louisiana right now.

Thank you, Chuck.

[Paul Johnson], private investor.

Yes, I have questions related to the last caller's comments and just trying to understand the sales and marketing expense. The wholesale sales are dropping so I would imagine of the three business units most of the sales and marketing increase is going towards the direct to consumer, LuLu and dot.com, is that correct?

That is true, we are investing in Moissanite.com and LuLu Avenue.

Right. So I guess what is discouraging is that if you look at the total sales increase in direct-to-consumer over the last year, it is an increase of about $1.6 million. But we just spent $1.5 million more in sales and marketing. So to get that increase it is a crazy amount of sales and marketing increase in order to get that amount of sales.

Well, I guess one thing I will point out is we have not reduced the expenses in our wholesale business. We get high volatility and revenue there and it is down year to date, but we continue to have a staff to support that business because we believe long-term there are some opportunities there that will eventually improve our results. So it is not like we have taken our expenses down in the wholesale business, because we believe long-term we need that level of support to drive that business.

Right, I understand that. And maybe the wholesale business will be better than expected. But it just -- to get a $1.6 million increase on these fast-growing businesses, but to spend substantially all of that on increased sales and marketing expense, it is like we are always going to be chasing our tail.

Well, I think -- I understand your point, we have been really clear that we continue to invest for the future. We are adding some of the resources we have added, continue to build the foundation especially for LuLu Avenue and for Moissanite.com as more of the dollars from our revenue base go to those businesses.

So we are investing with the long-term in mind, there will be a point where those businesses will start to generate profitability, but we are not at that point yet. And we have been pretty clear that we have been committed to those two businesses for the long-term.

Okay, so going to the wholesale for a second -- I appreciate what you are saying. It is just a little discouraging to see exponential growth in those divisions basically get swallowed up by sales and marketing expense. But, leaving that aside for a second, can you talk a little bit about what the wholesale strategy is because we're spending a lot of time up on the direct-to-consumer. But what is the strategy for wholesale?

This is Steve Larkin. The strategy is to -- and again, I have been overseeing the Wholesale Division for approximately four months. But the strategy is to have healthy distribution across a multitude of channels, leveraging the different qualities of our gemstones, leveraging finished jewelry where appropriate, domestically as well as internationally.

And that is everything from e-commerce wholesale, distributor wholesale, brick-and-mortar retail wholesale, television shopping, domestically and potentially internationally. So those are the things that we are working on and the channels that we are pursuing.

Okay, thank you.

(Operator Instructions). Jay Steinhilber of [Retail].

Could you comment on the amount of LuLu reps quarter over quarter, what type of growth we are seeing there? And also the LuLu revenue went down from $1.4 million to $1.3 million. If you could comment on the reasons behind that, that would be great.

Hi, Jay, this is Michelle. So, yes, we did see a slight decline quarter over quarter. And really the reason for that -- and by the way, we do not disclose the number of [style advisors] -- was because if you recall in Q1 actually, December, January and February, we did on board a significant number of new style advisors. And that was actually a major transition adding so many style advisors and that did impact our second quarter just like any business.

For some LuLu Avenue wasn't for them, maybe it was the jewelry. This definitely impacted our growth. As well the style advisors that we did bring on board, because it was a whole new program they had to learn there was a significant learning curve that frankly we did not anticipate. And this team is very heavily focused on selling versus recruiting.

So our focus right now is pretty clear. It is teaching them how to sponsor while they keep up their sales because that is how they earn instant money. And at the same time it just helping them really understand the power of moissanite and how they can embrace that and earn more money through that.

We did just come off of an amazing conference where we had a significant number of our active selling style advisors attend and that was the message very loud and clear, as Marvin had said. We are a Company that is disrupting the direct sales industry with moissanite and at the same time we need them to go out and share the opportunity with others.

All right, thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to the management team for any closing remarks.

Well, I know this is unusual and, by the way, I really appreciate the questions. It gives us an opportunity to really satisfy that desire that you have to get more clarification.

I would tell you that something that came up on the last call and I was sure that it would on this one, and I think I ought to make the comment about it, is the patent expiration. And to this point we have been buying material where we can. We really -- and I will underline this statement, I am not cocky about this issue, because we all here take it seriously.

To this point we have not seen a great deal that concerns us at all. They are one offs and we see those popping up on eBay and places out of China and out of India and we do not hear from any of our business partners that they have seen much as well.

That is not to mean that on September 2 we don't see more. But quite frankly, due to the nature of this kind of thing I think we would have seen it long before now. But we feel a little better than we did about the situation as we have all known that this was coming out at us for some time.

And please remember, in India there has been no patent and people there don't pay much attention to it anyway if they did. And we had one of our Indian distributors in this week and his description is that there is a lot of cheating going on there.

There's people that are engraving Forever Brilliant on moissanite there and that will forever happen. They are mixing it in parcels of diamonds. There is a large business in black material there, which we do not participate in. And so it is quite a market there. But we just have not seen anything.

I would make a comment as well on the weakness in our wholesale business for the second quarter. We kind of expected that and there is a number of things going on, some of it we have to look in the mirror on, some of it not.

The new material with Forever One that is going to be shipping in September, there is a lot of folks who are waiting and want to see it. They are not sure how they are going to merchandise yet. They want to see this material before they commit to orders certainly for the early fall and late fall for sure. And I can understand that perfectly, I really can. Not everyone understands it will come at a premium as well.

So with the angst of the patent expiration and folks hanging on because they don't know if they will see a 20 mule team with sacks of moissanite coming over the hill there at half the price at twice the quality, they just don't know and they are playing it very conservatively. And they know that our Company is not going to price protect inventory and so they are being very careful.

I think those things are real things and I don't blame them. I think I told you on the call -- last call that the Company last year made a very strategic decision to move away from distributors, some distributors and to sell directly to higher users. That move has meant that for the first six months $3.6 million of previous distributor business was not there. So the distributor business dropped significantly and we got little back for it.

Now what is happening there? Our read is that that inventory that was out there is being eaten up. And if I were one of those distributors I would be selling it out probably at cost. I would be giving deals because I would want to get rid of it. And we think that is a real factor as well.

So I am of the opinion that things will improve. And as Kyle said, we still believe in that business, it is the backbone of what we do today and we still think it is going to be a lot of volume for us. So just a couple of comments there on things that I really thought would come up that did not.

Once again I would like to thank everyone for taking the time to participate in our call today, it means a great deal to us. Most of all I want to thank our associate team for all of the hard work and their continued dedication. Rocco?

Thank you, sir. Today's conference will be archived for review on the Internet at www.webcaster4.com\webcast\page\346\9363 and on the Company's website at www.CharlesandColvard.com/investorrelations/events. It will be archived until Friday, August 21, 2015. Today's conference has now concluded and we thank you all for attending today's presentation. You may now disconnect your lines.