10-Q 1 d10q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------- FORM 10-Q (Mark One) [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2002 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _____________________to______________________ Commission File Number: 000-23329 Charles & Colvard, Ltd. -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) North Carolina 56-1928817 ------------------------------------ -------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3800 Gateway Boulevard, Suite 310, Morrisville, N.C. 27560 -------------------------------------------------------------------------------- (Address of principal executive offices) 919-468-0399 -------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No___ --- As of April 30, 2002 there were 13,377,214 shares of the Registrant's Common Stock, no par value per share, outstanding. 1 Charles & Colvard, Ltd. Index Part I. Financial Information -------------------------------------------------------------------------------- Item 1. Financial Statements Condensed Consolidated Statements of Operations - Three Months Ended March 31, 2002 and 2001 Condensed Consolidated Balance Sheets - March 31, 2002 and December 31, 2001 Condensed Consolidated Statements Of Cash Flows - Three Months Ended March 31, 2002 and 2001 Notes to Condensed Consolidated Financial Statements Item 2. Management's Discussion And Analysis Of Financial Condition And Results Of Operations Item 3. Quantitative And Qualitative Disclosures About Market Risk Part II. Other Information -------------------------------------------------------------------------------- Item 6. Exhibits And Reports On Form 8-K Signatures 2 Part I. Financial Information Item 1. Financial Statements Charles & Colvard, Ltd. Condensed Consolidated Statements Of Operations (Unaudited)
Three Months Ended March 31, --------------------------------- 2002 2001 -------------- --------------- Net sales $ 4,150,146 $ 2,899,984 Cost of goods sold 2,038,954 1,262,699 -------------- --------------- Gross profit 2,111,192 1,637,285 Operating expenses: Marketing and sales 1,053,646 713,582 General and administrative 607,212 699,246 Other expense --- 47,104 -------------- --------------- Total operating expenses 1,660,858 1,459,932 -------------- --------------- Operating income 450,334 177,353 Interest income, net 49,876 69,821 -------------- --------------- Net income $ 500,210 $ 247,174 ============== =============== Basic and diluted net income per share $ 0.04 $ 0.03 ============== =============== Weighted-average common shares: Basic 13,373,747 9,838,489 ============== =============== Diluted 13,561,828 9,860,216 ============== ===============
See Notes to Condensed Consolidated Financial Statements. 3 Charles & Colvard, Ltd. Condensed Consolidated Balance Sheets
March 31, 2002 December 31, 2001 --------------------- ---------------------- Assets (Unaudited) Current Assets: Cash and equivalents $ 12,300,838 $ 10,236,319 Accounts receivable 2,339,972 2,803,117 Interest receivable 14,709 13,824 Inventory, net 20,607,681 21,341,071 Prepaid expenses and other assets 201,610 214,749 --------------------- ---------------------- Total current assets 35,464,810 34,609,080 Equipment, net 325,304 342,281 Patent and license rights, net 289,423 290,569 --------------------- ---------------------- Total assets $ 36,079,537 $ 35,241,930 ===================== ====================== Liabilities and Shareholders' Equity Current Liabilities: Accounts payable: Cree, Inc. $ 765,199 $ 405,020 Other 185,155 154,831 Accrued payroll 216,063 202,012 Accrued expenses and other liabilities 232,247 272,490 Deferred revenue 64,953 129,801 --------------------- ---------------------- Total current liabilities 1,463,617 1,164,154 Commitments Shareholders' Equity: Common stock 55,190,057 55,182,692 Additional paid-in capital - stock options 1,994,575 1,964,006 Accumulated deficit (22,568,712) (23,068,922) --------------------- ---------------------- Total shareholders' equity 34,615,920 34,077,776 --------------------- ---------------------- Total liabilities and shareholders' equity $ 36,079,537 $ 35,241,930 ===================== ======================
See Notes to Condensed Consolidated Financial Statements 4 Charles & Colvard, Ltd. Condensed Consolidated Statements Of Cash Flows (Unaudited)
Three Months Ended March 31, ----------------------------------------- 2002 2001 ------------------ ------------------- Operating Activities: Net income $ 500,210 $ 247,174 Adjustments: Depreciation and amortization 32,222 48,879 Stock option compensation 32,419 4,217 Loss on disposal of long-term assets --- 46,071 Change in provision for uncollectible accounts (40,000) 100,000 Change in operating assets and liabilities: Net change in assets 1,248,789 513,918 Net change in liabilities 299,463 (1,737,001) ------------------ ------------------- Net cash provided (used) in operating activities 2,073,103 (776,742) ------------------ ------------------- Investing Activities: Purchase of equipment (10,115) (10,221) Patent and license rights costs (3,984) (1,146) ------------------ ------------------- Net cash used in investing activities (14,099) (11,367) ------------------ ------------------- Financing Activities: Stock options exercised 5,515 --- Proceeds from stock rights offering, net --- 6,031,995 ------------------ ------------------- Net cash provided by financing activities 5,515 6,031,995 ------------------ ------------------- Net change in cash and equivalents 2,064,519 5,243,886 Cash and equivalents, beginning of period 10,236,319 3,826,402 ------------------ ------------------- Cash and equivalents, end of period $ 12,300,838 $ 9,070,288 ================== ===================
See Notes to Condensed Consolidated Financial Statements. 5 Charles & Colvard, Ltd. Notes To Condensed Consolidated Financial Statements (Unaudited) 1. Basis Of Presentation The accompanying unaudited financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information. However, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the financial statements include all normal recurring adjustments which are necessary for the fair presentation of the results of the interim periods presented. Interim results are not necessarily indicative of results for the year. Certain reclassifications have been made to prior year's financial statements to conform to the classifications used in fiscal 2002. These financial statements should be read in conjunction with the Company's audited financial statements for the year ended December 31, 2001, as set forth in the Company's Form 10-K, filed with the Securities and Exchange Commission on March 25, 2002. In preparing financial statements that conform with accounting principles generally accepted in the United States of America, management must make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses reflected during the reporting period. Actual results could differ from those estimates. In October 2000, the Company established a wholly-owned subsidiary in Hong Kong, Charles & Colvard HK Ltd. All inter-company accounts have been eliminated. All the Company's activities are within a single business segment. Export sales aggregated approximately $800,000 and $700,000 for the three months ended March 31, 2002 and 2001, respectively. 2. Inventories Inventories are stated at the lower of cost or market determined on a first in, first out basis. Based on current estimates and assumptions, the Company believes that a substantial amount of inventories will be sold or consumed during its operating cycle. However, to be prepared to react to possible customer demand for large purchases and for a variety of jewel styles, a significant amount of inventory must be maintained at all times. Finished goods are shown net of a reserve for excess jewelry inventory of $270,000 and $170,000 at March 31, 2002 and December 31, 2001, respectively. Test instruments are shown net of a reserve for excess inventory of $450,000 and $465,000 respectively. March 31, December 31, ------------- ------------- 2002 2001 ------------- ------------- Moissanite: Raw materials $ 305,908 $ 131,525 Work-in-process 1,541,736 1,604,699 Finished goods 18,742,903 19,588,295 ------------ ------------ 20,590,547 21,324,519 Test instruments 17,134 16,552 ------------ ------------ Total Inventory $ 20,607,681 $ 21,341,071 ============ ============ 6 3. Common Stock In September 2001, the Board of Directors authorized the repurchase of up to 1,300,000 shares of the Company's common stock. At the discretion of management, the repurchase program can be implemented through open market or privately negotiated transactions at prevailing prices. The Company will determine the time and extent of repurchases based on its evaluation of market conditions and other factors. There were no shares repurchased during the three months ended March 31, 2002. During 2001, the Company repurchased 76,000 shares at a cost of $1 per share. 4. Stock Based Compensation In accordance with Accounting Principles Board Opinion No. 25 and Statement of Financial Accounting Standards (FAS) No. 123, the Company recorded compensation expense of $32,419 during the three months ended March 31, 2002 due to stock options. Compensation expense related to stock options for the three months ended March 31, 2001 was $4,217. This compensation expense is recorded in general and administrative expense in the Statements Of Operations. 5. Newly Adopted Accounting Pronouncements In July 2001, FAS No. 142, Goodwill and Other Intangible Assets, was issued. This statement requires that goodwill and other intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. This statement was effective for the Company on January 1, 2002. The Company does not have goodwill or other intangible assets with indefinite useful lives and the adoption of this statement did not have an effect on its consolidated financial statements. 6. Newly Issued Accounting Pronouncements In August 2001, FAS No. 143, Accounting For Asset Retirement Obligations, was issued. This statement requires recording the fair value of a liability for an asset retirement obligation in the period in which it is incurred, and a corresponding increase in the carrying value of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, it is either settled for its recorded amount or a gain or loss upon settlement is recorded. FAS 143 is effective for the Company's year ended December 31, 2003. The Company does not have any asset retirement obligations and does not expect the adoption of FAS 143 to have an effect on its consolidated financial statements. In August 2001, FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets was issued. This statement addresses financial accounting and reporting for the impairment of disposal of long-lived assets. FAS 144 is effective for the Company's year ended December 31, 2003. The Company is currently assessing, but has not yet determined the impact of FAS 144 on its consolidated financial statements. 7 Item 2: Management's Discussion And Analysis Of Financial Condition And Results of Operations This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our judgment on future events. Our business is subject to business and economic risks and uncertainties that could cause our actual performance and results to differ materially from those expressed or implied by any of the forward-looking statements included herein. These risks and uncertainties are described under the heading "Business Risks" in our Form 10-K for the year ended December 31, 2001, which was filed with the Securities and Exchange Commission on March 25, 2002. Overview We manufacture, market and distribute Charles & Colvard created moissanite jewels (also called moissanite or moissanite jewels) for sale in the worldwide jewelry market. Moissanite, also known by its chemical name, silicon carbide (SiC), is a rare, naturally occurring mineral found primarily in meteorites. As the sole manufacturer of scientifically-made moissanite jewels, our strategy is to create a unique brand image which positions moissanite as a jewel in its own right, distinct from all other jewels based on its fire, brilliance, luster, durability and rarity. From our inception in June 1995 through June 30, 1998, we were a development stage enterprise, devoting our resources to fund research and development of colorless, scientifically made moissanite jewels. We began shipping moissanite to domestic retail jewelers and international distributors during the second quarter of 1998. At that time, we launched limited consumer-focused advertising and promotion activities. During the second quarter of 2000, we changed our domestic distribution model to sell through jewel distributors and jewelry manufacturers rather than direct to retail stores. In March 2000, we entered into distribution agreements with Stuller Settings, Inc. (Stuller) and Rio Grande, two of the largest suppliers of jewelry-related products to the jewelry industry, for the North American distribution of moissanite. We have also entered into several agreements with domestic jewelry manufacturers. Through these agreements with Stuller, Rio Grande and jewelry manufacturers and the brand awareness created by our marketing program, we sought to rapidly increase the introduction of moissanite into the domestic jewelry market while maintaining average selling prices. Although these new distribution and marketing strategies enabled us to achieve profitability and positive cash flow in 2001 and through the first quarter of 2002, these strategic efforts are still in an early stage, and we have no assurance that they will be successful in the long-term. In October 2000, we established a wholly-owned subsidiary in Hong Kong, Charles & Colvard HK Ltd., for the purpose of gaining better access to the important Far Eastern markets. The importance of having a presence in this market is twofold; Hong Kong is the headquarters city for a very large number of jewelry manufacturing companies with sales and distribution worldwide, and Hong Kong is the gateway to the markets of Mainland China. We do not anticipate establishing additional subsidiaries in the near future. In 2001, we dramatically cut marketing and sales expenses, primarily by discontinuing significant advertising and promotion expenses in favor of lower cost public relations and media editorial initiatives. Additionally, general and administrative costs were lowered through personnel reductions, and significant savings were realized by suspending all research and development efforts with Cree. Domestic sales accounted for 82% of total sales in 2001 as we concentrated on growing our domestic business. Domestic distribution of moissanite expanded in 2001 into additional retail stores, including our first retail jewelry chain. Catalog sales of moissanite jewelry expanded significantly. We demonstrated that with appropriate product mix and product positioning, home shopping channels were a viable distribution channel for jewelry featuring moissanite. Primarily as a result of these efforts, we became profitable and generated positive cash flow from operations in 2001. During the first quarter of 2002, we continued our focus on the domestic market, while investing limited resources in certain international markets that show the most potential. We recorded the largest quarterly sales in our history during the first quarter of 2002 and we are hopeful that our sales will continue to increase as the distribution of moissanite jewels expands both domestically and internationally. Although our 2002 goals are to continue achieving increases in sales, rapid growth and profitability, we cannot be sure that we will achieve or sustain sales increases or sustain profitability. 8 Results Of Operations Three Months ended March 31, 2002 compared with Three Months ended March 31, 2001. Net sales were $4,150,146 for the three months ended March 31, 2002 compared to $2,899,984 for the three months ended March 31, 2001, an increase of $1,250,162 or 43.1%. Shipments of moissanite jewels increased during the three months ended March 31, 2002 to approximately 25,700 carats from 15,400 carats in the same period of 2001. Domestic carat shipments increased by 79% and international carat shipments increased by 28%. It should be noted that a portion of the carats shipped to international customers are set in jewelry and distributed to retail markets in several countries, including the US. Average selling price per carat decreased by 15% primarily due to increased sales of smaller jewels which have a lower price per carat. We believe that increased domestic sales are primarily attributable to the additional exposure at the television shopping channel, ShopNBC, as well as expanded distribution at Landau's, a 60 store retail chain with outlets in upscale malls and hotels throughout the country. International sales increased due to increased distribution of moissanite jewels into Hong Kong, China, UK, & Italy. As part of our marketing and distribution strategy, we intend to continue seeking increased product exposure and distribution through television shopping channels. In fact, a second television network, ShopAtHome, introduced moissanite programming late in the first quarter. Our gross profit margin was 50.9% for the three months ended March 31, 2002 compared to 56.5% for the three months ended March 31, 2001. The decreased gross margin percentage is primarily due to a 15% decrease in average selling prices, partially offset by improved yields of moissanite jewels from SiC crystals. Marketing and sales expenses were $1,053,646 for the three months ended March 31, 2002 compared to $713,582 for the three months ended March 31, 2001, an increase of $340,064 or 47.7%. The increase resulted primarily from $210,000 of print media advertising, as well as $150,000 of increased costs associated with our co-op advertising program. During the first quarter of 2002, we advertised in national magazines, jewelry trade publications, and newspapers in certain markets to support sales events. General and administrative expenses were $607,212 for the three months ended March 31, 2002 compared to $699,246 for the three months ended March 31, 2001, a decrease of $92,034 or 13.2%. The decrease resulted primarily from a $100,000 decrease in bad debt expense and decreased professional fees of $80,000, offset by $110,000 of increased compensation costs, including additional costs associated with our Executive Compensation Plan. Other expenses for the three months ended March 31, 2001 amounted to $47,104 which resulted from the write-down to market of certain fixed assets scheduled for disposal. Net interest income was $49,876 for the three months ended March 31, 2002 compared to $69,821 for the three months ended March 31, 2001, a decrease of $19,945 or 28.6%. This decrease resulted from a lower interest rate earned on our cash balances. Liquidity And Capital Resources At March 31, 2002, we had $12.3 million of cash and cash equivalents and $34.0 million of working capital. Cash and inventory account for over 90% of our current assets. Our principal sources of liquidity are cash on hand and cash generated by operations. During the three months ended March 31, 2002, $2,073,103 was generated by operations. The major components of the generated cash were net income of $500,210, a reduction in inventory of $733,390, a reduction in receivables of $502,260 and a $390,503 increase in payables. We believe our existing capital resources are adequate to satisfy our capital requirements for at least the next 12 months. In January 2002, we agreed with Cree on a framework for purchases of SiC crystals during 2002. We will be obligated to purchase a minimum quantity of usable material on a quarterly basis if Cree meets certain minimum quality levels. Dependent upon the quality of material received, purchases from Cree during 2002 are expected to be between $900,000 and $3.7 million. During the three months ended March 31, 2002, we purchased $765,000 of material from Cree. 9 The 4-year Development Agreement with Cree, as amended, requires us to fund a development program at Cree for $1.44 million annually through December 31, 2002. Either party may terminate the agreement if Cree does not meet the annual performance milestone or if the parties do not mutually agree on the performance milestones for the ensuing year. Our funding obligations under the Development Agreement were suspended from January 2001 through December 31, 2002, and will be terminated upon our meeting certain purchasing levels in 2002. On September 18, 2001, we announced that our Board of Directors authorized the repurchase of up to 1,300,000 shares of our common stock. At the discretion of management, the repurchase program can be implemented through open market or privately negotiated transaction at prevailing prices. We will determine the time and extent of repurchases based on our evaluation of market conditions and other factors. No shares were repurchased during the three months ended March 31, 2002. During 2001, we repurchased 76,000 shares at a cost of $1 per share. Newly Adopted Accounting Pronouncements In July 2001, Statement of Financial Accounting Standards No. 142 ("FAS 142"), Goodwill and Other Intangible Assets, was issued. This statement requires that goodwill and other intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. This statement was effective on January 1, 2002. We do not have goodwill or other intangible assets with indefinite useful lives, and the adoption of this statement did not have an effect on our consolidated financial statements. Newly Issued Accounting Pronouncements In August 2001, FAS No. 143, Accounting For Asset Retirement Obligations, was issued. This statement requires recording the fair value of a liability for an asset retirement obligation in the period in which it is incurred, and a corresponding increase in the carrying value of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, it is either settled for its recorded amount or a gain or loss upon settlement is recorded. FAS 143 is effective for our year ended December 31, 2003. We do not have any asset retirement obligations and do not expect the adoption of this statement to have an effect on our consolidated financial statements. In August 2001, FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was issued. This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. FAS 144 is effective for our year ended December 31, 2003. We are currently assessing, and have not yet determined the impact of FAS 144 on our consolidated financial statements. Item 3: Quantitative and Qualitative Disclosures About Market Risk We believe that our exposure to market risk for changes in interest rates is not significant because our investments are limited to highly liquid instruments with maturities of three months or less. At March 31, 2002, we had approximately $11.8 million of short-term investments classified as cash and equivalents. All of our transactions with international customers and suppliers are denominated in U.S. dollars. This limits our currency fluctuation risk, however, the recent strong value of the dollar against our customer's local currency could limit the amount of their purchases. 10 Part II - Other Information Item 6: Exhibits And Reports On Form 8-K (a) Exhibits Exhibit No. Description ----------- ----------- 10.51 Manufacturing Agreement, dated April 2, 2002, between JewelNet Corporation (dba K&G Creations) and Charles & Colvard, Ltd.* 10.52 Sixth Amendment to Agreement, dated April 9, 2002, between John M. Bachman, Inc. and Charles & Colvard, Ltd.* * The Company has requested that certain portions of this exhibit be given confidential treatment. 11 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Charles & Colvard, Ltd. Date: May 8, 2002 /s/ Robert S. Thomas -------------------- Robert S. Thomas President & Chief Executive Officer (Principal Executive Officer) Date: May 8, 2002 /s/ James R. Braun ------------------ James R. Braun Vice President of Finance & Chief Financial Officer (Principal Accounting Officer) 12