10-Q

UNITED STATES

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 June 30, 2014

OR

o   Transition report pursuant to Section 13 of 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.)

170 Southport Drive Morrisville, North Carolina	27560
(Address of principal executive offices)	(Zip Code)

(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   o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   x No   o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	o	Accelerated filer	o
Non-accelerated filer	o (Do not check if a smaller reporting company)	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   o No   x

As of August 4, 2014, there were 20,357,333 shares of the registrant’s common stock, no par value per share, outstanding.

CHARLES & COLVARD, LTD.

FORM 10-Q

For the Quarterly Period Ended June 30, 2014

TABLE OF CONTENTS

		Page Number
PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of June 30, 2014 (unaudited) and December 31, 2013	3
	Condensed Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2014 and 2013	4
	Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2014 and 2013	5
	Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 6.	Exhibits	31
	Signatures	32

2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

CHARLES & COLVARD, LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

	June 30, 2014 (unaudited)			December 31,  2013
ASSETS
Current assets:
Cash and cash equivalents	$	3,362,813		$	2,573,405
Accounts receivable, net		7,816,710			10,244,732
Inventory, net		12,419,064			13,074,428
Prepaid expenses and other assets		1,055,610			951,635
Deferred income taxes		-			1,197,832
Total current assets		24,654,197			28,042,032
Long-term assets:
Inventory, net		29,055,044			29,337,674
Property and equipment, net		2,163,187			1,717,692
Intangible assets, net		305,955			325,867
Deferred income taxes		-			2,841,891
Other assets		349,466			58,696
Total long-term assets		31,873,652			34,281,820
TOTAL ASSETS	$	56,527,849		$	62,323,852
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3,659,900		$	3,670,551
Accrued cooperative advertising		196,000			188,000
Accrued expenses and other liabilities		713,860			642,186
Total current liabilities		4,569,760			4,500,737
Long-term liabilities:
Accrued rent		575,907			-
Accrued income taxes		401,496			395,442
Total long-term liabilities		977,403			395,442
Total liabilities		5,547,163			4,896,179
Commitments and contingencies
Shareholders’ equity:
Common stock, no par value		53,949,001			53,949,001
Additional paid-in capital – stock-based compensation		10,751,470			9,940,980
Accumulated deficit		(13,719,785	)		(6,462,308	)
Total shareholders’ equity		50,980,686			57,427,673
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	56,527,849		$	62,323,852

See Notes to Condensed Consolidated Financial Statements.

3

CHARLES & COLVARD, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Net sales	$	7,841,647		$	6,512,500		$	13,909,200		$	13,017,574
Costs and expenses:
Cost of goods sold		5,324,981			3,389,315			8,988,023			6,271,293
Sales and marketing		2,171,614			2,532,995			4,366,225			4,779,204
General and administrative		2,376,466			1,344,408			3,752,681			2,193,785
Research and development		9,514			9,041			11,501			15,024
Loss on abandonment of assets		-			95,052			2,201			95,052
Total costs and expenses		9,882,575			7,370,811			17,120,631			13,354,358
Loss from operations		(2,040,928	)		(858,311	)		(3,211,431	)		(336,784	)
Other income (expense):
Interest income		20			6,972			49			14,474
Interest expense		(188	)		(234	)		(318	)		(974	)
Total other (expense) income, net		(168	)		6,738			(269	)		13,500
Loss before income taxes		(2,041,096	)		(851,573	)		(3,211,700	)		(323,284	)
Income tax net (expense) benefit		(4,152,987	)		359,988			(4,045,777	)		137,972
Net loss	$	(6,194,083	)	$	(491,585	)	$	(7,257,477	)	$	(185,312	)
Net loss per common share:
Basic	$	(0.31	)	$	(0.02	)	$	(0.36	)	$	(0.01	)
Diluted	$	(0.31	)	$	(0.02	)	$	(0.36	)	$	(0.01	)
Weighted average number of shares used in computing net loss per common share:
Basic		20,262,299			19,812,397			20,229,979			19,736,068
Diluted		20,262,299			19,812,397			20,229,979			19,736,068

See Notes to Condensed Consolidated Financial Statements.

4

CHARLES & COLVARD, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Six Months Ended June 30,
	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(7,257,477	)	$	(185,312	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		588,745			384,749
Amortization of bond premium		-			2,706
Stock-based compensation		810,490			743,633
Provision for uncollectible accounts		682,725			(60,805	)
Provision for sales returns		(845,000	)		(135,000	)
Provision for inventory reserves		69,000			75,000
Provision (benefit) for deferred income taxes		4,039,723			(150,832	)
Loss on abandonment of assets		2,201			95,052
Changes in assets and liabilities:
Accounts receivable		2,590,297			476,974
Interest receivable		-			(891	)
Inventory		868,994			(3,664,506	)
Prepaid expenses and other assets, net		(394,745	)		(392,819	)
Accounts payable		(10,651	)		430,126
Accrued cooperative advertising		8,000			108,000
Accrued income taxes		6,054			5,810
Other accrued liabilities		647,581			(40,620	)
Net cash provided by (used in) operating activities		1,805,937			(2,308,735	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(956,666	)		(202,610	)
Patent, license rights, and trademark costs		(59,863	)		(91,678	)
Net cash used in investing activities		(1,016,529	)		(294,288	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Stock option exercises		-			13,400
Net cash provided by financing activities		-			13,400
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		789,408			(2,589,623	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		2,573,405			11,860,842
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	3,362,813		$	9,271,219
Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	318		$	974
Cash paid during the period for income taxes	$	-		$	7,050

See Notes to Condensed Consolidated Financial Statements.

5

CHARLES & COLVARD, LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. DESCRIPTION OF BUSINESS

Charles & Colvard, Ltd. (the “Company”), a North Carolina corporation founded in 1995, manufactures, markets, and distributes Charles & Colvard Created Moissanite^® jewels (hereinafter referred to as moissanite or moissanite jewels), finished jewelry featuring moissanite, and fashion finished jewelry for sale in the worldwide jewelry market. Moissanite, also known by its chemical name of silicon carbide (“SiC”), is a rare mineral first discovered in a meteor crater. Because naturally occurring SiC crystals are too small for commercial use, larger crystals must be grown in a laboratory. Leveraging its advantage of being the sole source worldwide of created moissanite jewels, the Company’s strategy is to establish itself with reputable, high-quality, and sophisticated brands and to position moissanite as an affordable, luxurious alternative to other gems, such as diamond. The Company believes this is possible due to moissanite’s exceptional brilliance, fire, luster, durability, and rarity like no other jewel available on the market. The Company sells loose moissanite jewels and finished jewelry at wholesale to distributors, manufacturers, and retailers and at retail to end consumers through its wholly owned operating subsidiaries Moissanite.com, LLC and Charles & Colvard Direct, LLC.

2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation - The accompanying unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. However, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with U.S. GAAP have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of the Company’s management, the unaudited statements in this Quarterly Report on Form 10-Q include all normal and recurring adjustments necessary for the fair statement of the results for the interim periods presented. The results for the three and six months ended June 30, 2014 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2014.

The condensed consolidated financial statements as of and for the three and six months ended June 30, 2014 and 2013 included in this Quarterly Report on Form 10-Q are unaudited. The balance sheet as of December 31, 2013 is derived from the audited financial statements as of that date. The accompanying statements should be read in conjunction with the audited financial statements and related notes, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on March 27, 2014 (the “2013 Annual Report”).

The accompanying condensed consolidated financial statements as of and for the three and six months ended June 30, 2014 and 2013 include the accounts of the Company and its wholly owned subsidiaries Moissanite.com, LLC, formed in 2011; Charles & Colvard Direct, LLC, formed in 2011; and Charles & Colvard (HK) Ltd., the Company’s Hong Kong subsidiary that became a dormant entity in the second quarter of 2009 and the operations of which ceased in 2008. All intercompany accounts have been eliminated.

Significant Accounting Policies - In the opinion of the Company’s management, the significant accounting policies used for the three and six months ended June 30, 2014 are consistent with those used for the year ended December 31, 2013. Accordingly, please refer to the 2013 Annual Report for the Company’s significant accounting policies.

Use of Estimates - The preparation of financial statements in conformity with U.S. GAAP requires management to 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 the reported amounts of revenues and expenses during the reporting period. The most significant estimates impacting the Company’s condensed consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions, stock compensation expense, and cooperative advertising. Actual results could differ materially from those estimates.

Reclassifications - Certain amounts in the prior year’s condensed consolidated financial statements have been reclassified to conform to the current year presentation.

6

Recently Adopted/Issued Accounting Pronouncements - In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers(ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.

The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures).  The Company is currently evaluating the impact of the pending adoption of ASU 2014-09 on its consolidated financial statements and has not yet determined the method by which the Company will adopt the standard in 2017.

3. SEGMENT INFORMATION AND GEOGRAPHIC DATA

The Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of the Company’s operating and reportable segments.

The Company manages its business primarily by its two distribution channels that it uses to sell its product lines, loose jewels and finished jewelry. Accordingly, the Company determined its two operating and reporting segments to be wholesale distribution transacted through the parent entity and direct-to-consumer distribution transacted through the Company’s wholly owned operating subsidiaries, Moissanite.com, LLC and Charles & Colvard Direct, LLC. The accounting policies for these segments are the same as those described in Note 2, “Basis of Presentation and Significant Accounting Policies,” of this Quarterly Report on Form 10-Q and in the Notes to Consolidated Financial Statements in the 2013 Annual Report.

The Company evaluates the financial performance of its segments based on net sales; product line gross profit, or the excess of product line sales over product line cost of goods sold; and operating income (loss). The Company’s inventories are maintained in the parent entity’s wholesale distribution segment and are transferred without intercompany markup to the operating subsidiaries as product line cost of goods sold when sold to the end consumer. Product line cost of goods sold is defined as product cost of goods sold in each of the Company’s wholesale distribution and direct-to-consumer distribution operating segments excluding non-capitalized expenses from the Company’s manufacturing and production control departments, comprising personnel costs, depreciation, rent, utilities, and corporate overhead allocations; freight out; inventory valuation allowance adjustments; and other inventory adjustments, comprising costs of quality issues, damaged goods, and inventory write-offs.

The Company allocates certain general and administrative and information technology-related expenses from its parent entity to its two direct-to-consumer operating subsidiaries primarily based on net sales and headcount, respectively. Unallocated expenses, which also include interest and taxes, remain in the parent entity’s wholesale distribution segment.

Summary financial information by reporting segment is as follows:

	Three Months Ended June 30,
	2014									2013
	Wholesale			Direct-to- Consumer			Total			Wholesale		Direct-to- Consumer			Total
Net sales
Loose jewels	$	3,837,012		$	173,327		$	4,010,339		$	3,984,058	$	91,238		$	4,075,296
Finished jewelry		3,012,372			818,936			3,831,308			1,905,430		531,774			2,437,204
Total	$	6,849,384		$	992,263		$	7,841,647		$	5,889,488	$	623,012		$	6,512,500
Product line cost of goods sold
Loose jewels	$	2,040,944		$	25,346		$	2,066,290		$	1,334,472	$	11,795		$	1,346,267
Finished jewelry		2,377,715			369,649			2,747,364			1,330,109		290,816			1,620,925
Total	$	4,418,659		$	394,995		$	4,813,654		$	2,664,581	$	302,611		$	2,967,192
Product line gross profit
Loose jewels	$	1,796,068		$	147,981		$	1,944,049		$	2,649,586	$	79,443		$	2,729,029
Finished jewelry		634,657			449,287			1,083,944			575,321		240,958			816,279
Total	$	2,430,725		$	597,268		$	3,027,993		$	3,224,907	$	320,401		$	3,545,308
Operating (loss) income	$	(1,008,146	)	$	(1,032,782	)	$	(2,040,928	)	$	624,419	$	(1,482,730	)	$	(858,311	)
Depreciation and amortization	$	214,021		$	96,926		$	310,947		$	101,876	$	90,486		$	192,362
Capital expenditures	$	928,341		$	-		$	928,341		$	108,645	$	5,968		$	114,613

7

	Six Months Ended June 30,
	2014									2013
	Wholesale			Direct-to- Consumer			Total			Wholesale		Direct-to- Consumer			Total
Net sales
Loose jewels	$	7,370,756		$	320,269		$	7,691,025		$	8,278,212	$	144,998		$	8,423,210
Finished jewelry		4,632,243			1,585,932			6,218,175			3,634,153		960,211			4,594,364
Total	$	12,002,999		$	1,906,201		$	13,909,200		$	11,912,365	$	1,105,209		$	13,017,574
Product line cost of goods sold
Loose jewels	$	3,816,079		$	47,619		$	3,863,698		$	3,050,412	$	18,542		$	3,068,954
Finished jewelry		3,657,816			727,796			4,385,612			1,931,079		473,467			2,404,546
Total	$	7,473,895		$	775,415		$	8,249,310		$	4,981,491	$	492,009		$	5,473,500
Product line gross profit
Loose jewels	$	3,554,677		$	272,650		$	3,827,327		$	5,227,800	$	126,456		$	5,354,256
Finished jewelry		974,427			858,136			1,832,563			1,703,074		486,744			2,189,818
Total	$	4,529,104		$	1,130,786		$	5,659,890		$	6,930,874	$	613,200		$	7,544,074
Operating (loss) income	$	(1,133,003	)	$	(2,078,428	)	$	(3,211,431	)	$	2,264,325	$	(2,601,109	)	$	(336,784	)
Depreciation and amortization	$	393,693		$	195,052		$	588,745		$	192,855	$	191,894		$	384,749
Capital expenditures	$	956,666		$	-		$	956,666		$	189,316	$	13,294		$	202,610

	June 30, 2014									December 31, 2013
	Wholesale			Direct-to- Consumer			Total			Wholesale			Direct-to- Consumer			Total
Total assets		$	55,724,771		$	803,078		$	56,527,849		$	61,702,449		$	621,403		$	62,323,852

A reconciliation of the Company’s product line cost of goods sold to cost of goods sold as reported in the condensed consolidated financial statements is as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Product line cost of goods sold	$	4,813,654	$	2,967,192	$	8,249,310	$	5,473,500
Non-capitalized manufacturing and production control expenses		256,144		208,389		411,167		608,640
Freight out		76,077		51,453		135,976		87,962
Inventory valuation allowances		45,000		94,000		69,000		75,000
Other inventory adjustments		134,106		68,281		122,570		26,191
Cost of goods sold	$	5,324,981	$	3,389,315	$	8,988,023	$	6,271,293

8

The Company’s net inventories by product line maintained in the parent entity’s wholesale distribution segment are as follows:

	June 30, 2014		December 31, 2013
Loose jewels
Raw materials	$	5,110,412	$	3,311,375
Work-in-process		6,486,882		9,526,769
Finished goods		21,671,343		20,002,881
Finished goods on consignment		149,142		32,948
Total	$	33,417,779	$	32,873,973
Finished jewelry
Raw materials	$	283,378	$	270,043
Work-in-process		562,916		764,355
Finished goods		6,781,866		8,117,035
Finished goods on consignment		355,735		299,514
Total	$	7,983,895	$	9,450,947

Supplies inventories of approximately $72,000 and $87,000 at June 30, 2014 and December 31, 2013, respectively, included in finished goods inventories in the condensed consolidated financial statements are omitted from inventories by product line because they are used in both product lines and are not maintained separately.

The Company recognizes sales by geographic area based on the country in which the customer is based. A portion of the Company’s international wholesale distribution segment sales represents products sold internationally that may be re-imported to United States (“U.S.”) retailers. Sales to international end consumers made by the Company’s direct-to-consumer distribution segment are included in U.S. sales because products are shipped and invoiced to a U.S.-based intermediary party that assumes all international shipping and credit risks. The following presents certain data by geographic area:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Net sales
United States	$	7,267,441	$	5,373,178	$	12,976,474	$	10,485,467
International		574,206		1,139,322		932,726		2,532,107
Total	$	7,841,647	$	6,512,500	$	13,909,200	$	13,017,574

	June 30, 2014		December 31, 2013
Property and equipment, net
United States	$	2,163,187	$	1,717,692
International		-		-
Total	$	2,163,187	$	1,717,692

	June 30, 2014		December 31, 2013
Intangible assets, net
United States	$	54,090	$	70,830
International		251,865		255,037
Total	$	305,955	$	325,867

9

4. FAIR VALUE MEASUREMENTS

Under U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy consists of three levels based on the reliability of inputs, as follows:

● Level 1 - quoted prices in active markets for identical assets and liabilities

● Level 2 - inputs other than Level 1 quoted prices that are directly or indirectly observable

● Level 3 - unobservable inputs that are not corroborated by market data

The Company evaluates assets and liabilities subject to fair value measurements on a recurring and non-recurring basis to determine the appropriate level to classify them for each reporting period. This determination requires significant judgments to be made by management of the Company. The instruments identified as subject to fair value measurements on a recurring basis are cash and cash equivalents, trade accounts receivable, trade accounts payable, and accrued expenses. All instruments are reflected in the consolidated balance sheets at carrying value, which approximates fair value due to the short-term nature of these instruments.

Assets that are measured at fair value on a non-recurring basis include property and equipment, leasehold improvements, and intangible assets, comprising patents, license rights, and trademarks. These items are recognized at fair value when they are considered to be impaired. Level 3 inputs are primarily based on the estimated future cash flows of the asset determined by market inquiries to establish fair market value of used machinery or future revenue expected to be generated with the assistance of patents, license rights, and trademarks.

5. INVENTORIES

The Company’s total inventories, net of reserves, consisted of the following as of June 30, 2014 and December 31, 2013:

	June 30, 2013			December 31,  2013
Raw materials	$	5,393,790		$	3,581,418
Work-in-process		7,049,798			10,291,124
Finished goods		29,185,643			28,771,098
Finished goods on consignment		552,877			407,462
Less inventory reserves		(708,000	)		(639,000	)
Total	$	41,474,108		$	42,412,102
Current portion	$	12,419,064		$	13,074,428
Long-term portion		29,055,044			29,337,674
Total	$	41,474,108		$	42,412,102

Inventories are stated at the lower of cost or market on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs. Any inventory on hand at the measurement date in excess of the Company’s current requirements based on historical and anticipated levels of sales is classified as long-term on the Company’s consolidated balance sheets. The Company’s classification of long-term inventory requires it to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized over the next 12 months.

10

The Company’s work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. The Company’s moissanite jewel manufacturing process involves the production of intermediary shapes, called “preforms,” that vary depending upon the size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of June 30, 2014 and December 31, 2013, work-in-process inventories issued to active production jobs approximated $2.11 million and $4.09 million, respectively.

The Company’s jewels do not degrade in quality over time and inventory generally consists of the shapes and sizes most commonly used in the jewelry industry. In addition, the majority of jewel inventory is not mounted in finished jewelry settings and is therefore not subject to fashion trends nor is obsolescence a significant factor. The Company has very small market penetration in the worldwide jewelry market, and the Company has the exclusive right in the U.S. through mid-2015 and in many other countries through mid-2016 to produce and sell created SiC for use in jewelry applications. In view of the foregoing factors, management has concluded that no excess or obsolete loose jewel inventory reserve requirements existed as of June 30, 2014.

In 2010, the Company began manufacturing finished jewelry featuring moissanite. Relative to loose moissanite jewels, finished jewelry is more fashion oriented and subject to styling trends that could render certain designs obsolete. The majority of the Company’s finished jewelry featuring moissanite is held in inventory for resale and consists of such basic designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets that tend not to be subject to significant obsolescence risk due to their classic styling. In addition, the Company manufactures small individual quantities of designer-inspired moissanite fashion jewelry as part of its sample line that are used in the selling process to its wholesale customers.

In 2011, the Company began purchasing fashion finished jewelry comprised of base metals and non-precious gemstones for sale through Lulu Avenue^®, the direct-to-consumer home party division of the Company’s wholly owned operating subsidiary, Charles & Colvard Direct, LLC. This finished jewelry is fashion oriented and subject to styling trends that may change with each catalog season, of which there are several each year. Typically in the jewelry industry, slow-moving or discontinued lines are sold as closeouts or liquidated in alternative sales channels.  The Company reviews the finished jewelry inventory on an ongoing basis for any lower of cost or market and obsolescence issues.  The Company identified certain fashion finished jewelry inventory that could not be sold due to damage or branding issues and established an obsolescence reserve of $128,000 as of June 30, 2014 and December 31, 2013, for the carrying costs in excess of any estimated scrap values.  As of June 30, 2014, the Company identified certain finished jewelry featuring moissanite that was obsolete and established an obsolescence reserve of $30,000 for the carrying costs in excess of any estimated scrap values.

Periodically, the Company ships finished goods inventory to wholesale customers on consignment terms. Under these terms, the customer assumes the risk of loss and has an absolute right of return for a specified period. Finished goods on consignment at June 30, 2014 and December 31, 2013 are net of shrinkage reserves of $48,000 and $75,000, respectively, to allow for certain loose jewels and finished jewelry on consignment with wholesale customers that may not be returned or may be returned in a condition that does not meet the Company’s current grading or quality standards.

Total net loose jewel inventories at June 30, 2014 and December 31, 2013, including inventory on consignment net of reserves, were $33.42 million and $32.87 million, respectively. The loose jewel inventories at June 30, 2014 and December 31, 2013 include shrinkage reserves of $1,000 and $2,000, respectively, with no shrinkage reserves on inventory on consignment. Loose jewel inventories at June 30, 2014 and December 31, 2013 also include recuts reserves of $197,000 and $172,000, respectively.

Total net jewelry inventories at June 30, 2014 and December 31, 2013, including inventory on consignment net of reserves, finished jewelry featuring moissanite manufactured by the Company since entering the finished jewelry business in 2010, and fashion finished jewelry purchased by the Company for sale through Lulu Avenue^®, were $7.98 million and $9.45 million, respectively. Jewelry inventories consist primarily of finished goods, a portion of which the Company acquired as part of a January 2009 settlement agreement with a former manufacturer customer to reduce the outstanding receivable to the Company. Due to the lack of a plan to market this inventory at that time, a jewelry inventory reserve was established to reduce the majority of the acquired jewelry inventory value to scrap value, or the amount the Company would expect to obtain by melting the gold in the jewelry and returning to loose-jewel finished goods inventory those jewels that meet grading standards. The scrap reserve established for this acquired inventory at the time of the agreement is adjusted at each reporting period for the market price of gold and has generally declined as the associated jewelry is sold down. At June 30, 2014, the balance increased to $114,000 from $106,000 at December 31, 2013 as a result of a sales return, offset in part by sell down of the inventory during the quarter. Because the finished jewelry the Company began manufacturing in 2010 after it entered that business was made pursuant to an operational plan to market and sell the inventory, it is not subject to this reserve. The finished jewelry inventories at June 30, 2014 and December 31, 2013 also include shrinkage reserves of $160,000 and $180,000, respectively, including shrinkage reserves of $48,000 and $75,000 on inventory on consignment, respectively; and finished jewelry inventories at June 30, 2014 and December 31, 2013 include a repairs reserve of $78,000 and $51,000, respectively.

11

The need for adjustments to inventory reserves is evaluated on a period-by-period basis.

6. INCOME TAXES

The Company recognized an income tax net expense of approximately $4.15 million for the three months ended June 30, 2014 compared to an income tax net benefit of approximately $360,000 for the three months ended June 30, 2013.  The Company recognized an income tax net expense of $4.05 million for the six months ended June 30, 2014 compared to an income tax net benefit of $138,000 for the six months ended June 30, 2013.

As of each reporting date, the Company’s management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. The Company’s management determined that sufficient positive evidence existed as of March 31, 2014 and December 31, 2013 to conclude that it is more likely than not that deferred tax assets of $4.15 million and $4.04 million, respectively, were realizable.  A valuation allowance remained at March 31, 2014 and December 31, 2013 against certain deferred tax assets relating to state net operating loss carryforwards from the Company’s e-commerce and home party operating subsidiaries due to the timing uncertainty of when the subsidiaries will generate cumulative positive taxable income to utilize the associated deferred tax assets. A valuation allowance also remained at March 31, 2014 and December 31, 2013 against certain deferred tax assets relating to investment loss carryforwards because the Company does not anticipate it will generate sufficient investment income to utilize the carryforwards.  The Company also previously considered various strategic alternatives, resulting in management determining that a valuation allowance was not necessary at that time.  During the three months ended June 30, 2014, the Company’s management determined that such alternatives were no longer in the best interest of the Company.  Accordingly, the Company’s management concluded that the positive evidence was no longer sufficient to offset available negative evidence, primarily as a result of the pre-tax operating loss for the three and six months ended June 30, 2014.   As a result, management concluded that it was uncertain that the Company would have sufficient future taxable income to utilize its deferred tax assets, and therefore, the Company established a valuation allowance against its deferred tax assets, resulting in a tax expense of $4.15 million and $4.05 million for the three and six months ended June 30, 2014, respectively.  During the three and six months ended June 30, 2014, the Company also recognized approximately $6,000 of income tax expense for estimated tax, penalties, and interest associated with uncertain tax positions.

For the three months ended June 30, 2013, the Company recognized $358,000 of current period income tax benefit, offsetting an income tax expense recorded in the first quarter of 2013 of approximately $211,000. The resulting income tax net benefit of $147,000 for the six months ended June 30, 2013 represents an effective tax rate of 45.4% on the year-to-date pre-tax book loss. The effective tax rate for the six months ended June 30, 2013 differs from the federal statutory rate of 34.0% primarily due to the impact of state income taxes, stock-based compensation expense that is not deductible for tax purposes, and other book-to-tax reconciling items. This effective tax rate increased from December 31, 2012 due to anticipation of higher taxable income in 2013, and an additional $7,000 of income tax expense was accrued and paid in the first quarter of 2013 related to the prior tax year, primarily for adjustment of the federal alternative minimum tax. Additionally, the Company recorded approximately $4,000 of income tax benefit for a discrete permanent tax deduction difference during the three and six months ended June 30, 2013 and approximately $2,000 and $6,000 of income tax expense for estimated tax, penalties, and interest associated with uncertain tax positions during the three and six months ended June 30, 2013, respectively.

12

7. COMMITMENTS AND CONTINGENCIES

Lease Commitments

In March 2004, the Company entered into a seven-year lease, beginning in August 2004, for approximately 16,500 square feet of mixed-use space from an unaffiliated third party at a base cost with escalations throughout the lease term plus additional common-area expenses based on the Company’s proportionate share of the lessor’s operating costs. The lease provided for two rent holidays, during which no rent was payable, and a moving allowance. In January 2011, the Company amended the lease effective January 1, 2011 to extend the term through January 2017 in exchange for a reduced rental rate and 50% rent abatement in the first 12 months of the extended term.  The amended lease includes 3% annual rent escalations and a one-time option to terminate the lease effective as of July 31, 2014. The Company exercised this right to terminate the lease by giving notice to the lessor prior to October 31, 2013.  The cost to terminate the lease effective July 31, 2014 was approximately $112,000, which the Company paid at the time notice was given to terminate the lease.  This amount reflects all unamortized lease transaction costs, including, without limitation, all rent abated since January 1, 2011, plus two months’ rent at the current rental rate.  On December 9, 2013, the Company entered into a Lease Agreement, as amended on December 23, 2013 and April 15, 2014 (the “Lease Agreement”), for a new corporate headquarters, which occupies approximately 36,350 square feet of office, storage, and light manufacturing space. The Company took possession of the leased property on May 23, 2014 once certain improvements to the leased space were completed.  These improvements and other lease signing and moving incentives offered by the landlord totaled approximately $550,000 and $73,000, respectively, which will be amortized over the life of the lease.  Included in the Lease Agreement is a seven-month rent abatement period expected to begin June 2014 through December 2014.

The Company recognizes rent expense on a straight-line basis, giving consideration to the rent holidays and escalations, the lease signing and moving allowance to be paid to the Company, and the rent abatement.

As of June 30, 2014, the Company’s future minimum payments under the operating leases were as follows:

2014	$	-
2015		553,905
2016		569,138
2017		584,789
2018		600,871
Thereafter		1,793,725
Total	$	4,102,428

Rent expense for the three months ended June 30, 2014 and 2013 was approximately $84,000 and $77,000, respectively.  Rent expense for the six months ended June 30, 2014 and 2013 was approximately $115,000 and $133,000, respectively.

Purchase Commitments

On June 6, 1997, the Company entered into an amended and restated exclusive supply agreement with Cree, Inc. (“Cree”). The exclusive supply agreement had an initial term of ten years that was extended in January 2005 to July 2015. In connection with the amended and restated exclusive supply agreement, the Company has committed to purchase from Cree a minimum of 50%, by dollar volume, of its raw material SiC crystal requirements. If the Company’s orders require Cree to expand beyond specified production levels, the Company must commit to purchase certain minimum quantities. Effective February 8, 2013, the Company entered into an amendment to a prior letter agreement with Cree, which provides a framework for the Company’s purchases of SiC crystals under the amended and restated exclusive supply agreement. Pursuant to this amendment, the Company agreed to purchase at least $4.00 million of SiC crystals in an initial new order. After the initial new order, the Company has agreed to issue non-cancellable, quarterly orders that must equal or exceed a set minimum order quantity. The total purchase commitment under the amendment until July 2015, including the initial new order, is dependent upon the grade of the material and ranges between approximately $7.64 million and approximately $18.56 million.  During the six months ended June 30, 2014 and 2013, the Company purchased approximately $3.58 million and $4.99 million, respectively, of SiC crystals under the exclusive supply agreement.

8. LINE OF CREDIT

On September 20, 2013, the Company obtained a $10,000,000 revolving line of credit (the “Line of Credit”) from PNC Bank, National Association (“PNC Bank”) for general corporate and working capital purposes. The Line of Credit was evidenced by a Committed Line of Credit Note, dated September 20, 2013 (the “Note”), which was set to mature on June 15, 2015.  The interest rate under the Note was the one-month LIBOR rate (adjusted daily) plus 1.50%, calculated on an actual/360 basis.

13

The Line of Credit was also governed by a loan agreement, dated September 20, 2013 (the “Loan Agreement”) and was guaranteed by Charles & Colvard Direct, LLC, and Moissanite.com, LLC. The Line of Credit was secured by a lien on substantially all assets of the Company and its subsidiaries.

Effective June 25, 2014, the Line of Credit was terminated concurrent with the Company entering into a new banking relationship with Wells Fargo Bank, National Association (“Wells Fargo”).   The Company had not utilized the Line of Credit.  The Company recognized the remaining $19,000 of deferred legal expenses associated with this Line of Credit upon termination.

On June 25, 2014, the Company and its wholly owned subsidiaries, Charles & Colvard Direct, LLC, and Moissanite.com, LLC (collectively, the “Borrowers”), obtained a $10,000,000 asset-based revolving credit facility (the “Credit Facility”) from Wells Fargo. The Credit Facility will be used for general corporate and working capital purposes, including transaction fees and expenses incurred in connection therewith and the issuance of letters of credit up to a $1,000,000 sublimit. The Credit Facility will mature on June 25, 2017.

The Credit Facility includes a $5,000,000 sublimit for advances that are supported by a 90% guaranty provided by the U.S. Export-Import Bank. Advances under the Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers’ eligible accounts and inventory, less reserves. Advances against inventory are further subject to an initial $3,000,000 maximum. The Borrowers must maintain a minimum of $1,000,000 in excess availability at all times. There are no other financial covenants.

Each advance accrues interest at a rate equal to Wells Fargo’s 3-month LIBOR rate plus 2.50%, calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default accrues interest at a rate of 3% in excess of the above rate. Any advance may be prepaid in whole or in part at any time. In addition, the maximum line amount may be reduced by the Company in whole or part at any time, subject to a fee equal to 2% of any reduction in the first year after closing, 1% of any reduction in the second year after closing, and 0% thereafter. There are no mandatory prepayments or line reductions.

The Credit Facility is secured by a lien on substantially all assets of the Borrowers, each of which is jointly and severally liable for all obligations thereunder.

The Credit Facility is evidenced by a credit and security agreement, dated as of June 25, 2014 (the “Credit Agreement”), and customary ancillary documents. The Credit Agreement contains customary covenants, representations and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, contingent obligations, liens, loans, investments, mergers, acquisitions, divestitures, subsidiaries, affiliate transactions, and changes in control.

Events of default under the Credit Facility include, without limitation, (1) any impairment of the Export-Import Bank guaranty, unless the guaranteed advances are repaid within two business days, (2) an event of default under any other indebtedness of the Borrowers in excess of $200,000, and (3) a material adverse change in the ability of the Borrowers to perform their obligations under the Credit Agreement or in the Borrowers’ assets, liabilities, businesses or prospects, or other circumstances that Wells Fargo believes may impair the prospect of repayment. If an event of default occurs, Wells Fargo is entitled to take enforcement action, including acceleration of amounts due under the Credit Agreement and foreclosure upon collateral.

The Credit Agreement contains other customary terms, including indemnity, expense reimbursement, yield protection, and confidentiality provisions.  Wells Fargo is permitted to assign the Credit Facility.

As of June 30, 2014, the Company had not borrowed against the Credit Facility.

9. STOCK-BASED COMPENSATION

The following table summarizes the components of the Company’s stock-based compensation included in net loss:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Employee stock options	$	209,698		$	161,227		$	392,422		$	300,497
Restricted stock awards		224,281			335,740			418,068			443,136
Income tax benefit		(78,349	)		(162,247	)		(146,046	)		(201,184	)
Totals	$	355,630		$	334,720		$	664,444		$	542,449

14

No stock-based compensation was capitalized as a cost of inventory during the three and six months ended June 30, 2014 and 2013.

Stock Options - The following is a summary of the stock option activity for the six months ended June 30, 2014:

	Shares			Weighted  Average Exercise Price
Outstanding, December 31, 2013		1,204,297		$	3.14
Granted		215,000		$	2.89
Exercised		-		$	-
Forfeited		(15,775	)	$	2.85
Expired		(37,576	)	$	3.84
Outstanding, June 30, 2014		1,365,946		$	3.09

The weighted average grant-date fair value of stock options granted during the six months ended June 30, 2014 was $2.06. The total fair value of stock options that vested during the six months ended June 30, 2014 was approximately $445,000. The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option pricing model with the following weighted average assumptions for stock options granted during the six months ended June 30, 2014:

Dividend yield	0.0	%
Expected volatility	92.9	%
Risk-free interest rate	1.61	%
Expected lives (years)	5.0

Although the Company issued dividends in prior years, a dividend yield of zero was used due to the uncertainty of future dividend payments. Volatility is a measure of the amount by which a financial variable such as share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company estimates expected volatility giving primary consideration to the historical volatility of its common stock. The risk-free interest rate is based on the published yield available on U.S. Treasury issues with an equivalent term remaining equal to the expected life of the stock option. The expected lives of the stock options represent the estimated period of time until exercise or forfeiture and are based on historical experience of similar awards.

The following table summarizes information about stock options outstanding at June 30, 2014:

Options Outstanding						Options Exercisable						Options Vested or Expected to Vest
Balance as of 6/30/2014		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Balance as of 6/30/2014		Weighted Average  Remaining Contractual Life (Years)		Weighted Average Exercise Price		Balance as of 6/30/2014		Weighted Average Remaining Contractual  Life (Years)		Weighted Average Exercise Price
	1,365,946		7.72	$	3.09		892,453		6.99	$	2.63		1,302,584		6.99	$	3.05

As of June 30, 2014, the unrecognized stock-based compensation expense related to unvested stock options was approximately $953,000, which is expected to be recognized over a weighted average period of approximately 25 months.

The aggregate intrinsic value of stock options outstanding, exercisable, and vested or expected to vest at June 30, 2014 was approximately $385,000, $383,000, and $385,000, respectively. This amount is before applicable income taxes and represents the closing market price of the Company’s common stock at June 30, 2014 less the grant price, multiplied by the number of stock options that had a grant price that is less than the closing market price. This amount represents the amount that would have been received by the optionees had these stock options been exercised on that date. During the three and six months ended June 30, 2014, no stock options were exercised.

15

Restricted Stock - The following is a summary of the restricted stock activity for the six months ended June 30, 2014:

	Shares			Weighted Average Grant Date Fair Value
Unvested, December 31, 2013		350,903		$	4.26
Granted		160,032		$	2.22
Vested		(175,903	)	$	4.00
Canceled		-		$	-
Unvested, June 30, 2014		335,032		$	3.42

As of June 30, 2014, the unrecognized stock-based compensation expense related to unvested restricted stock was approximately $967,000, which is expected to be recognized over a weighted average period of approximately 18 months.

Dividends - The Company has not paid any cash dividends in the current year through June 30, 2014.

10. NET LOSS PER COMMON SHARE

Basic net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the periods. Diluted net loss per common share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the periods. Common equivalent shares consist of stock options that are computed using the treasury stock method. Antidilutive stock awards are comprised of stock options and unvested restricted shares which would have been antidilutive in the application of the treasury stock method in accordance with “Earnings Per Share” topic of the Financial Accounting Standard Board Accounting Standards Codification.

The following table reconciles the differences between the basic and diluted earnings per share presentations:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Numerator:
Net loss	$	(6,194,083	)	$	(491,585	)	$	(7,257,477	)	$	(185,312	)
Denominator:
Weighted average common shares outstanding:
Basic		20,262,299			19,812,397			20,229,979			19,736,068
Stock options		-			-			-			-
Fully diluted		20,262,299			19,812,397			20,229,979			19,736,068
Net loss per common share:
Basic	$	(0.31	)	$	(0.02	)	$	(0.36	)	$	(0.01	)
Diluted	$	(0.31	)	$	(0.02	)	$	(0.36	)	$	(0.01	)

For the three months ended June 30, 2014 and 2013, stock options to purchase approximately 1.37 million and 289,000 shares, respectively, were excluded from the computation of diluted net loss per common share because the exercise price of the stock options was greater than the average market price of the common shares or the effect of inclusion of such amounts would be anti-dilutive to net loss per common share. For the six months ended June 30, 2014 and 2013, stock options to purchase approximately 1.37 million and 463,000 shares, respectively, were excluded from the computation of diluted net loss per common share because the exercise price of the stock options was greater than the average market price of the common shares or the effect of inclusion of such amounts would be anti-dilutive to net loss per common share.

16

11. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments, and trade accounts receivable. The Company maintains cash and cash equivalents, and investments with high-quality financial institutions and invests in low-risk securities, primarily money market funds or long-term U.S. government agency obligations. At times, cash balances may exceed the Federal Deposit Insurance Corporation (“FDIC”) insurable limits of $250,000 per depositor at each financial institution. Amounts on deposit in excess of FDIC insurable limits at June 30, 2014 and 2013 approximated $3.0 million and $6.78 million, respectively.

Trade receivables potentially subject the Company to credit risk. The Company’s standard wholesale customer payment terms on trade receivables are generally between 30 and 90 days, though it may offer extended terms with specific customers and on significant orders from time to time. The Company believes its competitors and other vendors in the wholesale jewelry industry have also expanded their use of extended payment terms and, in aggregate, the Company believes that by expanding its use of extended payment terms, it has provided a competitive response in its market and that its net sales have been favorably impacted. The Company is unable to estimate the impact of this program on its net sales, but if it ceased providing extended payment terms in select instances, the Company believes it would not be competitive for some wholesale customers in the marketplace and that its net sales and profits would likely decrease. The Company extends credit to its customers based upon a number of factors, including an evaluation of the customer’s financial condition and credit history, the customer’s payment history with the Company, the customer’s reputation in the trade, and/or an evaluation of the Company’s opportunity to introduce its moissanite jewels or finished jewelry featuring moissanite to new or expanded markets. Collateral is not generally required from customers. The need for an allowance for doubtful accounts is determined based upon factors surrounding the credit risk of specific customers, historical trends, and other information. The Company has not experienced any significant accounts receivable write-offs related to revenue arrangements with extended payment terms, but has increased its allowance for doubtful accounts by approximately $700,000 due to one customer that has become past due on its payment arrangement.

As of June 30, 2014 and December 31, 2013, one customer accounted for 29% and 21%, respectively, of trade accounts receivable.  No other customers accounted for more than 10% of trade accounts receivable at December 31, 2013.  As of June 30, 2014, one other customer accounted for 12% of trade accounts receivable.

A significant portion of sales is derived from certain customer relationships. The following is a summary of customers that represent greater than or equal to 10% of total gross sales:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Customer A		36	%		1	%		30	%		16	%
Customer B		15	%		6	%		17	%		7	%
Customer C		4	%		6	%		13	%		9	%
Customer D		9	%		19	%		0	%		10	%
Customer E		0	%		19	%		0	%		12	%

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

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Statements expressing expectations regarding our future and projections relating to products, sales, revenues, and earnings are typical of such statements and are made under the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, representations, and contentions and are not historical facts and typically are identified by use of terms such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “continue,” and similar words, although some forward-looking statements are expressed differently.

All forward-looking statements are subject to the risks and uncertainties inherent in predicting the future. You should be aware that although the forward-looking statements included herein represent management’s current judgment and expectations, our actual results may differ materially from those projected, stated, or implied in these forward-looking statements as a result of many factors including, but not limited to, the following:

17

● Our future financial performance depends upon increased consumer acceptance, growth of sales of our products, and operational execution of our strategic initiatives.

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

● The execution of our business plans could significantly impact our liquidity.

● Our business and our results of operations could be materially adversely affected as a result of our inability to fulfill orders on a timely basis.

● The financial difficulties or insolvency of one or more of our major customers or their lack of willingness and ability to market our products could adversely affect results.

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

● Our current wholesale customers may potentially perceive us as a competitor in the finished jewelry business.

● We face intense competition in the worldwide jewelry industry.

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

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

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

● Seasonality of our business may adversely affect our net sales and operating income.

● We may not be able to adequately protect our intellectual property, which could harm the value of our products and brands and adversely affect our business.

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

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

● Governmental regulation and oversight might adversely impact our operations.

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

Forward-looking statements speak only as of the date they are made. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur except as required by the federal securities laws, and you are urged to review and consider disclosures that we make in the reports that we file with the Securities and Exchange Commission, or SEC, that discuss other factors relevant to our business.

The following discussion is designed to provide a better understanding of our unaudited condensed consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. This information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the condensed consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2013. Historical results and percentage relationships among any amounts in the condensed consolidated financial statements are not necessarily indicative of trends in operating results for future periods.

Overview

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

18

We manage our business primarily by our two distribution channels that we use to sell our product lines, loose jewels and finished jewelry. Accordingly, we determined our two operating and reporting segments to be wholesale distribution transacted through our parent entity and direct-to-consumer distribution transacted through our wholly owned operating subsidiaries, Moissanite.com, LLC and Charles & Colvard Direct, LLC. We sell our loose moissanite jewels at wholesale to some of the largest distributors and manufacturers in the world, which mount them into fine jewelry to be sold at retail outlets and via the Internet. We also sell loose moissanite jewels and finished jewelry featuring moissanite at wholesale to retailers to be sold to end consumers and, in the third quarter of 2011, we established a direct-to-consumer e-commerce sales channel through our wholly owned operating subsidiary Moissanite.com, LLC that sells both loose moissanite jewels and finished jewelry featuring moissanite. Additionally, in April 2012 we launched a pilot test of a direct-to-consumer home party sales channel through our wholly owned operating subsidiary Charles & Colvard Direct, LLC, or Charles & Colvard Direct, that sells fashion and moissanite finished jewelry. We believe the expansion of our sales channels to the jewelry trade and the end consumer with branded finished moissanite jewelry creates a more compelling consumer value proposition to drive increased demand.

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

The wholesale finished jewelry business that we launched in 2010 is currently expanding through select retailers and television shopping networks. We believe there is significant opportunity to further expand our wholesale finished jewelry business through e-commerce, television shopping, and other retailers. We also believe our finished jewelry business, including finished jewelry sold through our direct-to-consumer e-commerce and home party sales channels, allows us to have more control over the end product and enhance our relationships with consumers, as well as provide incremental sales and gross profit dollars due to the higher price points of finished jewelry containing moissanite relative to loose jewels. To that end, we are focusing on the following critical aspects of our strategic plan during 2014:

● Developing brand strategies - Our goal is to build multiple strong brands around the moissanite jewel and finished jewelry collections in attractive and desirable jewelry designs, especially those featuring larger center stones that leverage moissanite’s point of differentiation and value proposition. We believe branding will allow us to increase consumer awareness, which we expect to help drive sales and develop consumer brand recognition and loyalty.

In June 2012, we launched a moissanite jewel with optical properties that are significantly whiter than our standard VG “classic moissanite” grade jewels. We are marketing these whiter jewels under the Forever Brilliant^® trademark as a premier brand to differentiate from other grades of our moissanite as well as moissanite sold by potential competitors in the future.

We expect demand for our Forever Brilliant^® loose jewel and finished jewelry featuring the Forever Brilliant^® jewel to grow, both in our wholesale channel and on our Moissanite.com e-commerce website, and that Forever Brilliant^® will become an increasingly important brand for Charles & Colvard, Ltd. as we execute future branding initiatives. We are also exploring additional product lines and branding strategies that will differentiate our products in the market.

In June 2013, we engaged Cindy Riccio Communications, Inc., or CRC, a New York-based public relations, marketing, and events agency, as our agency of record to generate optimal exposure with consumer media for both our Lulu Avenue^® and Forever Brilliant^® brands, with the goal to increase consumer awareness of our brands specifically and moissanite generally. Several media events occurred during 2013 where magazine editors, fashion columnists, and bloggers were invited to experience first-hand our Lulu Avenue^® fashion and moissanite finished jewelry and our Forever Brilliant^® loose jewels. We are also utilizing CRC to increase exposure for our brands in 2014 through improved product placement in leading fashion periodicals and blogging sites, and through broadcast and print editorial outreach.

19

We believe our efforts to position Forever Brilliant^® as the whitest and brightest moissanite jewel available anywhere in the world, the introduction of designer finished jewelry brands, and the engagement of a branding public relations agency will help us to build brand recognition and increase consumer awareness of our products. We also expect that this strategy of building brand recognition will help to support revenue streams as our intellectual property rights expire beginning in 2015.  To better position us for greater market share growth, we identified the need for a VP of Marketing, and filled the role in April 2014.  This position will focus our branding efforts on our target consumers.

● Expanding our direct-to-consumer e-commerce business - Our direct-to-consumer e-commerce website, Moissanite.com, features an intuitive site design with robust functionality to enhance the customer experience and convert traffic into sales. We continue to expand the website’s jewelry collections and its loose moissanite jewel assortment by featuring a variety of colors and shapes, and we are investing resources in targeted advertising and marketing campaigns. In 2013 and the first six months of 2014, we continued fine-tuning such marketing efforts to maximize return on investment, increasing product assortment, and building new site functionality designed to increase sales conversion rates. We believe our direct-to-consumer e-commerce sales channel will not only add to our top-line revenues in a significant manner, but will also play a key role in our campaign to increase overall consumer awareness of moissanite. We also envision e-commerce as a part of a broader effort to establish online connections with consumers that build our brands and our business with retail partners.

● Developing our direct-to-consumer home party business - In October 2012, our direct-to-consumer home party business, Lulu Avenue^®, began to integrate the custom designs of a well-known jewelry designer into the current jewelry line. The first phase of the integration was completed in March 2013. In April 2013, we hired a President of Lulu Avenue^® whose focus is on the scale-up of the sales force, and in March 2013, we hired a Director of Finance and Administration, who leads the back office technology and supply chain efforts of Lulu Avenue^®. With these key personnel, we completed the final phase of the integration process in 2013. We believe our direct-to-consumer home party sales channel will provide future sales growth in 2014 and play a role in our campaign to increase overall consumer awareness of moissanite.

As we execute our strategy to build and reinvest in our businesses, significant expenses and investment of cash will be required ahead of the revenue streams we expect in the future, and this may result in some unprofitable reporting periods in 2014. Despite this, we have maintained as one of our primary goals to generate positive cash flow to protect our cash position. We were not successful in achieving this goal during 2013 primarily as a result of our significant inventory build of Forever Brilliant^® loose jewels to meet anticipated demand, establish an in-stock position for future orders and collect on our trade receivables generated from these sales.  However, during the first six months of 2014 we were able to reduce our inventories and aggressively collect on our trade accounts receivable balance from year end and on sales in the first six months of 2014. We will continue to diligently focus on cost-management, and monitor our cash burn rate and collection efforts as we grow the business.

Our total consolidated net sales for the six months ended June 30, 2014 of $13.91 million were 7% greater than total consolidated net sales during the same period of 2013. Wholesale distribution segment net sales for the six months ended June 30, 2014 of $12.0 million were 1% greater than wholesale distribution segment net sales during the same period of 2013. Direct-to-consumer distribution segment net sales for the six months ended June 30, 2014 of $1.91 million were 72% greater than direct-to-consumer distribution segment net sales during the same period of 2013.

Loose jewel sales comprised 55% of our total consolidated net sales and decreased 9% to $7.69 million, compared with $8.42 million in the same period of 2013. Finished jewelry sales comprised 45% of our total consolidated net sales and increased 35% to $6.22 million, compared with $4.59 million in the same period of 2013. We expect these shifts in sales by product mix to continue as we execute our strategy of developing new wholesale and direct-to-consumer sales channels and expanding our finished jewelry business.

Operating expenses increased by $1.05 million, or 15%, to $8.13 million for the six months ended June 30, 2014, compared with $7.08 million in the same period of 2013. Of this increase, general and administrative expenses increased $1.56 million, or 71%, to $3.75 million primarily as a result of bad debt expenses, as well as personnel and consulting additions. Sales and marketing expenses decreased $413,000, or 9%, to $4.37 million, primarily as a result of lower consulting expenses incurred to launch the e-commerce and home party direct sales businesses and cooperative advertising expense, offset in part by increased expenses for personnel additions.  As we grow our business, we intend to continue to closely manage our operating expenses by seeking the most cost effective and efficient solutions to our operating requirements. We recorded a net loss of $7.26 million, or $0.36 per diluted share, for the six months ended June 30, 2014, primarily due to higher general and administrative expenses, a lower gross profit margin, and a $4.05 million tax expense resulting from a valuation allowance on certain deferred tax assets based on our cumulative negative taxable income over the last three years and the uncertainty of sufficient future taxable income to utilize its deferred tax assets.  Our lower gross profit resulted from a greater sales mix of finished jewelry that typically yields a lower gross margin than loose jewels due to the lower markup on precious metals and labor used in the manufacture of jewelry, and an effort to move existing finished gemstones that will not be a focus of our future initiatives.

20

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

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which we prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosures of contingent assets and liabilities. “Critical accounting policies and estimates” are defined as those most important to the financial statement presentation and that require the most difficult, subjective, or complex judgments. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Under different assumptions and/or conditions, actual results of operations may materially differ. We have disclosed our critical accounting policies and estimates in our Annual Report on Form 10-K for the year ended December 31, 2013, and that disclosure should be read in conjunction with this Quarterly Report on Form 10-Q.

Results of Operations

The following table sets forth certain consolidated statements of operations data for the three and six months ended June 30, 2014 and 2013:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Net sales	$	7,841,647		$	6,512,500		$	13,909,200		$	13,017,574
Costs and expenses:
Cost of goods sold		5,324,981			3,389,315			8,988,023			6,271,293
Sales and marketing		2,171,614			2,532,995			4,366,225			4,779,204
General and administrative		2,376,466			1,344,408			3,752,681			2,193,785
Research and development		9,514			9,041			11,501			15,024
Loss on abandonment of assets		-			95,052			2,201			95,052
Total costs and expenses		9,882,575			7,370,811			17,120,631			13,354,358
Loss from operations		(2,040,928	)		(858,311	)		(3,211,431	)		(336,784	)
Other income (expense):
Interest income		20			6,972			49			14,474
Interest expense		(188	)		(234	)		(318	)		(974	)
Total other (expense) income, net		(168	)		6,738			(269	)		13,500
Loss before income taxes		(2,041,096	)		(851,573	)		(3,211,700	)		(323,284	)
Income tax net (expense) benefit		(4,152,987	)		359,988			(4,045,777	)		137,972
Net loss	$	(6,194,083	)	$	(491,585	)	$	(7,257,477	)	$	(185,312	)

21

Consolidated Net Sales

Consolidated net sales for the three and six months ended June 30, 2014 and 2013 comprise the following:

	Three Months Ended June 30,						Change							Six Months Ended June 30,						Change
	2014			2013			Dollars				Percent			2014			2013			Dollars				Percent
Loose jewels		$	4,010,339		$	4,075,296		$	(64,957	)		-2	%		$	7,691,025		$	8,423,210		$	(732,185	)		-9	%
Finished jewelry			3,831,308			2,437,204			1,394,104			57	%			6,218,175			4,594,364			1,623,811			35	%
Total consolidated net sales		$	7,841,647		$	6,512,500		$	1,329,147			20	%		$	13,909,200		$	13,017,574		$	891,626			7	%

Consolidated net sales were $7.84 million for the three months ended June 30, 2014 compared to $6.51 million for the three months ended June 30, 2013, an increase of $1.33 million, or 20%. Consolidated net sales were $13.91 million for the six months ended June 30, 2014 compared to $13.02 million for the six months ended June 30, 2013, an increase of $892,000, or 7%.  The improvement in consolidated net sales for the three and six months ended June 30, 2013 was due primarily to an increase in loose jewel sales to our existing domestic wholesale customer base resulting from an effort to reduce inventories of older standard grade finished gemstones, sales of our new whiter Forever Brilliant^® moissanite jewel and the growth of our wholesale customers’ moissanite finished jewelry lines with styles that include both Forever Brilliant^® and our loose jewel standard grades, and the growth in sales of our direct-to-consumer businesses, Moissanite.com and Lulu Avenue^®, which collectively increased 59% to $992,000 and 72% to $1.91 million during the three and six months ended June 30, 2014, respectively. We anticipate orders and related sales of loose moissanite jewels and finished jewelry featuring moissanite in both our wholesale distribution segment and direct-to-consumer distribution segment will improve as we execute our growth strategies.

Sales of loose jewels represented 51% and 55% of total consolidated net sales for the three and six months ended June 30, 2014, respectively, compared to 63% and 65% of total consolidated net sales for the corresponding periods of the prior year. For the three months ended June 30, 2014, loose jewel sales were $4.01 million compared to $4.08 million for the corresponding period of the prior year, a decrease of $65,000, or 2%. For the six months ended June 30, 2014, loose jewel sales were $7.69 million compared to $8.42 million for the corresponding period of the prior year, a decrease of $732,000, or 9%. The slight decrease for the three months ended June 30, 2014 was primarily due to a focus to reduce inventory of slower moving standard grade loose jewels through existing distribution channels. The decrease for the six months ended June 30, 2014 was primarily attributable to a decrease in loose jewel sales to two of our larger international wholesale customers, offset in part by increased sales to two of our larger domestic wholesale customers.  Overall sales orders from some of our larger international customers were lower in the first six months of 2014 compared to the same period in 2013, due to economic and market conditions facing these larger international customers.   We believe the economic and market conditions will improve in our international markets.

Sales of finished jewelry represented 49% and 45% of total consolidated net sales for the three and six months ended June 30, 2014, respectively, compared to 37% and 35% of total consolidated net sales for the corresponding periods of the prior year. For the three months ended June 30, 2014, finished jewelry sales were $3.83 million compared to $2.44 million for the corresponding period of the prior year, an increase of $1.39 million, or 57%. For the six months ended June 30, 2014, finished jewelry sales were $6.22 million compared to $4.59 million for the corresponding period of the prior year, an increase of $1.62 million, or 35%. These increases were primarily attributable to our ongoing expansion into the finished jewelry business, primarily through the growth of our e-commerce and home party businesses in our direct-to-consumer distribution segment.

United States, or U.S., net sales accounted for approximately 93% of total consolidated net sales for the three and six months ended June 30, 2014, compared to 83% and 81% of total consolidated net sales for the corresponding periods of the prior year, respectively. U.S. net sales increased 35% and 24% during the three and six months ended June 30, 2014, respectively, from the corresponding periods of the prior year primarily as a result of an increase in loose jewel sales to our domestic wholesale customer base resulting from the launch of our new whiter Forever Brilliant^® moissanite jewel and the growth of our wholesale customers’ moissanite finished jewelry lines. The increase in U.S. sales was also attributable to an increase in finished jewelry sales through our direct-to-consumer businesses, Moissanite.com and Lulu Avenue^®.

22

Our two largest U.S. customers during the three months ended June 30, 2014 accounted for 36% and 15% of total consolidated sales compared to 1% and 6%, respectively, during the same period of 2013.  Two U.S. customers accounted for 19% each of total consolidated sales during the three months ended June 30, 2013, but did not account for a significant percentage of total consolidated sales during the same period of 2014.  Our three largest U.S. customers during the six months ended June 30, 2014 accounted for 30%, 17%, and 13%, respectively, of total consolidated sales compared to 16%, 7%, and 9%, respectively, during the same period of 2013. Two U.S. customers accounted for 12% and 10% of total consolidated sales during the six months ended June 30, 2013 but did not account for a significant percentage of total consolidated sales during the same period of 2014. We expect that we will remain dependent on our ability, and that of our largest customers, to maintain and enhance retail programs. A change in or loss of any of these customer or retailer relationships could have a material adverse effect on our results of operations.

International net sales accounted for approximately 7% of total consolidated net sales for the three and six months ended June 30, 2014, compared to 17% and 19% of total consolidated net sales for the corresponding periods of the prior year. International sales decreased 50% and 63% during the three and six months ended June 30, 2014, respectively, from the corresponding periods of the prior year primarily as a result of a decrease in loose jewel sales to our international wholesale customer base.   Overall sales orders from some of our larger international customers were lower in the first three and six months of 2014 compared to the same periods in 2013, due to economic and market conditions facing these larger international customers.   We believe the economic and market conditions will improve in our international markets.

No international customers accounted for more than 10% of total consolidated sales during the three and six months ended June 30, 2014 or 2013. A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers. Our top three international distributors by sales volume during the three months ended June 30, 2014 were located in Belgium, United Kingdom, and Australia. Our top three international distributors by sales volume during the six months ended June 30, 2014 were located in Belgium, United Kingdom, and Hong Kong.

Costs and Expenses

Cost of Goods Sold

Cost of goods sold for the three and six months ended June 30, 2014 and 2013 are as follows:

	Three Months Ended June 30,				Change					Six Months Ended June 30,				Change
	2014		2013		Dollars		Percent			2014		2013		Dollars			Percent
Product line cost of goods sold
Loose jewels	$	2,066,290	$	1,346,267	$	720,023		53	%	$	3,863,698	$	3,068,954	$	794,744			26	%
Finished jewelry		2,747,364		1,620,925		1,126,439		69	%		4,385,612		2,404,546		1,981,066			82	%
Total product line cost of goods sold		4,813,654		2,967,192		1,846,462		62	%		8,249,310		5,473,500		2,775,810			51	%
Non-product line cost of goods sold		511,327		422,123		89,204		21	%		738,713		797,793		(59,080	)		-7	%
Total cost of goods sold	$	5,324,981	$	3,389,315	$	1,935,666		57	%	$	8,988,023	$	6,271,293	$	2,716,730			43	%

Total cost of goods sold was $5.32 million for the three months ended June 30, 2014 compared to $3.39 million for the three months ended June 30, 2013, an increase of $1.94 million, or 57%. Total cost of goods sold was $8.99 million for the six months ended June 30, 2014 compared to $6.27 million for the six months ended June 30, 2013, an increase of $2.72 million, or 43%. Product line cost of goods sold is defined as product cost of goods sold in each of our wholesale distribution and direct-to-consumer distribution operating segments excluding non-capitalized expenses from our manufacturing and production control departments, comprising personnel costs, depreciation, rent, utilities, and corporate overhead allocations; freight out; inventory valuation allowance adjustments; and other inventory adjustments, comprising costs of quality issues, damaged goods, and inventory write-offs.

23

The increase in cost of goods sold for the three months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $1.13 million increase in finished jewelry product line cost of goods sold resulting from the 57% increase in finished jewelry sales and the sale of slow moving jewelry at lower product margins to one customer, a $720,000 increase in loose jewel product line cost of goods sold resulting from a greater percentage of higher-cost Forever Brilliant^® loose jewel sales during the quarter; lower product margins driven primarily from the sale of slow moving standard grade loose jewel inventory during the second quarter of 2014; and a net increase in non-product line cost of goods sold of $89,000. The net increase in non-product line cost of goods sold comprises a $65,000 increase in other inventory adjustments; a $48,000 increase in non-capitalized manufacturing and production control expenses; and a $25,000 increase in freight expenses; offset in part by a $49,000 decrease in inventory valuation allowances, including inventory shrinkage, recuts, repairs, and scrap reserves. See Note 3, “Segment Information and Geographic Data,” in the Notes to Condensed Consolidated Financial Statements for further discussion of non-product line cost of goods sold.

The increase in cost of goods sold for the six months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $1.98 million increase in finished jewelry product line cost of goods sold resulting from the 35% increase in finished jewelry sales and the sale of slow moving jewelry at lower product margins to one customer during the second quarter, $795,000 increase in loose jewel product line cost of goods sold resulting from a greater percentage of higher-cost Forever Brilliant^® loose jewel sales during the first six months of 2014; lower product margins driven primarily from the sale of slow moving standard grade loose jewel inventory during the second quarter of 2014; offset in part by a net decrease in non-product line cost of goods sold of $59,000. The net decrease in non-product line cost of goods sold comprises a $197,000 decrease in non-capitalized manufacturing and production control expenses; and a $6,000 decrease in inventory valuation allowances including inventory shrinkage, recuts, repairs, and scrap reserves, offset in part by a $96,000 increase in other inventory adjustments; and a $48,000 increase in freight expenses. See Note 3, “Segment Information and Geographic Data,” in the Notes to Condensed Consolidated Financial Statements for further discussion of non-product line cost of goods sold.

Sales and Marketing

Sales and marketing expenses for the three and six months ended June 30, 2014 and 2013 are as follows:

	Three Months Ended June 30,						Change							Six Months Ended June 30,						Change
	2014			2013			Dollars				Percent			2014			2013			Dollars				Percent
Sales and marketing		$	2,171,614		$	2,532,995		$	(361,381	)		-14	%		$	4,366,225		$	4,779,204		$	(412,979	)		-9	%

Sales and marketing expenses were $2.17 million for the three months ended June 30, 2014 compared to $2.53 million for the three months ended June 30, 2013, a decrease of $361,000, or 14%. Sales and marketing expenses were $4.37 million for the six months ended June 30, 2014 compared to $4.78 million for the six months ended June 30, 2013, a decrease of $413,000, or 9%.

The decrease in sales and marketing expenses for the three months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $405,000 net decrease in advertising expenses;  a $74,000 net decrease in professional services related to the reduction of temporary personnel, consulting services, and the maintenance of software platforms for our direct-to-consumer e-commerce and home party lines of business; a $29,000 decrease in office-related expenses; a $17,000 decrease in travel due to fewer international sales trips; and an $11,000 decrease in recruiting fees.  These decreases were partially offset by increases of $164,000 in net compensation expenses and an $11,000 increase in depreciation expense related to the Moissanite.com and Lulu Avenue^® e-commerce websites direct sales platforms.  The decrease in advertising expenses comprises a $288,000 decrease in cooperative advertising; a $123,000 decrease in agency and other media spending; and a decrease in Internet marketing of $10,000 primarily due to greater efficiencies gained in paid search advertising in support of our Moissanite.com e-commerce website.  These decreases in advertising expenses were partially offset by an increase of $16,000 in print media expenses to develop and promote brand awareness campaigns.  The decrease in cooperative advertising expenses resulted primarily from the decrease in sales of loose jewels to our international customers, compared to the same period in the prior year and management’s decision to offer sales discounts in lieu of cooperative advertising assistance.

Compensation costs for the three months ended June 30, 2014 compared to the same period in 2013 increased primarily as a result of an increase in severance over the prior year period in which a severance agreement was terminated resulting in a $158,000 benefit for the three months ended June 30, 2013; and an increase in commissions of $141,000 for sales to specific customers under which commission plans of sales representatives are based.  These increases were partially offset by a $74,000 decrease in salaries and related employee benefits; a decrease in bonus expense of $37,000; a decrease in stock-based compensation expense of $23,000; and a decrease in employee relocation costs of $1,000.

24

The decrease in sales and marketing expenses for the six months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $428,000 net decrease in advertising expenses;  a $167,000 net decrease in professional services related to the reduction of temporary personnel, consulting services, and the maintenance of software platforms for our direct-to-consumer e-commerce and home party lines of business; a $77,000 decrease in recruiting fees; and an $8,000 decrease in travel due to fewer international sales trips.  These decreases were partially offset by increases of $247,000 in net compensation expenses; a $10,000 increase in office-related expenses; and a $10,000 increase in depreciation expense related to the Moissanite.com and Lulu Avenue^® e-commerce websites direct sales platforms.  The decrease in advertising expenses comprises a $305,000 decrease in cooperative advertising; a $99,000 decrease in agency and other media spending; and a decrease in Internet marketing of $44,000 primarily due to greater efficiencies gained in paid search advertising in support of our Moissanite.com e-commerce website.  These decreases in advertising expenses were partially offset by an increase of $20,000 in print media expenses to develop and promote brand awareness campaigns.  The decrease in cooperative advertising expenses resulted primarily from the decrease in sales of loose jewels to our international customers, compared to the same period in the prior year and management’s decision to offer sales discounts in lieu of cooperative advertising assistance.

Compensation costs for the six months ended June 30, 2014 compared to the same period in 2013 increased primarily from an increase in commissions of $180,000 for sales to specific customers under which commission plans of sales representatives are based; a $170,000 increase in salaries and related employee benefits; and a $35,000 increase in severance.  These increases were partially offset by a decrease in bonus expense of $137,000; and a $1,000 decrease in stock-based compensation costs.

We expect our total sales and marketing expenses will increase as sales increase, but the rate of growth should slow and become a lower percentage of sales as expenses more variable in nature, such as advertising and commissions, increase as part of our strategy to build sales; but fixed expenses remain relatively constant.  While employee compensation costs may fluctuate from period to period as we continue to build a more efficient and productive sales organization, we expect that these costs will become more fixed in nature over time.

General and Administrative

General and administrative expenses for the three and six months ended June 30, 2014 and 2013 are as follows:

	Three Months Ended June 30,						Change						Six Months Ended June 30,						Change
	2014			2013			Dollars			Percent			2014			2013			Dollars			Percent
General and administrative		$	2,376,466		$	1,344,408		$	1,032,058		77	%		$	3,752,681		$	2,193,785		$	1,558,896		71	%

General and administrative expenses were $2.38 million for the three months ended June 30, 2014 compared to $1.34 million for the three months ended June 30, 2013, an increase of $1.03 million, or 77%. General and administrative expenses were $3.75 million for the six months ended June 30, 2014 compared to $2.19 million for the six months ended June 30, 2013, an increase of $1.56 million, or 71%.

The increase in general and administrative expenses for the three months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $648,000 increase in bad debt expense associated with our allowance for doubtful accounts reserve policy, and for which we placed a full reserve against one customer account that is in dispute and has become past due; a $247,000 increase in professional services; a $71,000 increase in office-related expenses; a $52,000 increase in depreciation and amortization expense; an increase of $30,000 for moving the corporate headquarters to its new leased space; a $12,000 increase in business and franchise taxes; and a $2,000 increase in board compensation.  Professional services increased primarily due to an increase in legal fees of $165,000; investor and public relations expenses increase of $43,000; a $30,000 increase in audit and tax services; and an increase of $9,000 in consulting and other professional services.  These increases were offset in part by a $15,000 decrease in travel-related expenses associated with investor, customer, and supplier meetings; and a $15,000 decrease in net compensation expenses.  Compensation expenses decreased primarily as a result of a decrease in bonus expense of $64,000; and a decrease in stock-based compensation expense of $52,000, offset in part by an increase in salaries and related employee benefits in the aggregate of $101,000.

25

The increase in general and administrative expenses for the six months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $744,000 increase in bad debt expense associated with our allowance for doubtful accounts reserve policy, and for which we placed a full reserve against one customer account that is in dispute and has become past due; a $406,000 increase in professional services; a $268,000 net increase in compensation expense; an $89,000 increase in depreciation and amortization expense; a $32,000 increase in office-related expenses; an increase of $30,000 for moving the corporate headquarters to its new leased space; and a $24,000 increase in business and franchise taxes.  Professional services increased primarily due to an increase in legal fees of $254,000; investor and public relations expenses increase of $96,000; a $32,000 increase in audit and tax services; and an increase of $24,000 in consulting and other professional services.  Compensation expenses increased primarily as a result of an increase in salaries and related employee benefits in the aggregate of $280,000; and an increase in stock-based compensation expense of $52,000; offset partially by a decrease in bonus expense of $64,000.  These increases were offset in part by a $32,000 decrease in travel-related expenses associated with investor, customer, and supplier meetings; and a $2,000 decrease in board compensation.

Research and Development

Research and development expenses for the three and six months ended June 30, 2014 and 2013 are as follows:

	Three Months Ended June 30,						Change						Six Months Ended June 30,						Change
	2014			2013			Dollars			Percent			2014			2013			Dollars				Percent
Research and development		$	9,514		$	9,041		$	473		5	%		$	11,501		$	15,024		$	(3,523	)		-23	%

Research and development expenses were $10,000 for the three months ended June 30, 2014 compared to $9,000 for the three months ended June 30, 2013, an increase of $1,000, or 5%. Research and development expenses were $11,000 for the six months ended June 30, 2014 compared to $15,000 for the six months ended June 30, 2013, a decrease of $4,000, or 23%.

The increase in research and development expenses for the three months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $2,000 increase in consulting professional services, offset in part by a $1,000 decrease in compensation costs for time allocated by operations personnel to research and development activities.

The decrease in research and development expenses for the six months ended June 30, 2014 compared to the same period in 2013 was primarily due to a $4,000 decrease in compensation costs for time allocated by operations personnel to research and development activities.

Loss on Abandonment of Assets

Loss on abandonment of assets for the three and six months ended June 30, 2014 and 2013 are as follows:

	Three Months Ended June 30,						Change							Six Months Ended June 30,						Change
	2014			2013			Dollars				Percent			2014			2013			Dollars				Percent
Loss on abandonment of assets		$	-		$	95,052		$	(95,052	)		-100	%		$	2,201		$	95,052		$	(92,851	)		-98	%

Loss on abandonment of assets was $0 for the three months ended June 30, 2014 compared to $95,000 for the three months ended June 30, 2013, a decrease of $95,000, or 100%.  Loss on abandonment of assets was $2,000 for the six months ended June 30, 2014 compared to $95,000 for the six months ended June 30, 2013, a decrease of $93,000, or 98%.

During the second quarter of 2013, we transitioned our Lulu Avenue^® direct sales front-end and back-office system to a new platform and abandoned the prior capitalized software modifications of approximately $95,000 associated with the previous platform, resulting in a loss on abandonment of assets for the three and six months ended June 30, 2013.  For the six months ended June 30, 2014, we abandoned a trademark with remaining carrying costs of $2,000 after we determined the trademark would no longer be utilized.

26

Interest Income

Interest income for the three and six months ended June 30, 2014 and 2013 is as follows:

	Three Months Ended June 30,						Change							Six Months Ended June 30,						Change
	2014			2013			Dollars				Percent			2014			2013			Dollars				Percent
Interest income		$	20		$	6,972		$	(6,952	)		-100	%		$	49		$	14,474		$	(14,425	)		-100	%

Interest income was $0 for the three months ended June 30, 2014 compared to $7,000 for the three months ended June 30, 2013, a decrease of $7,000, or 100%. Interest income was $0 for the six months ended June 30, 2014 compared to $14,000 for the six months ended June 30, 2013, a decrease of $14,000, or 100%.

The decrease in interest income resulted primarily from not investing excess cash in U.S. government agency securities and lower average cash balances in lower yielding money market accounts during the three and six months ended June 30, 2014 as compared to the same periods in 2013.

Provision for Income Taxes

We recognized an income tax net expense of approximately $4.15 million for the three months ended June 30, 2014 compared to an income tax net benefit of approximately $360,000 for the three months ended June 30, 2013.  We recognized an income tax net expense of $4.05 million for the six months ended June 30, 2014 compared to an income tax net benefit of $138,000 for the six months ended June 30, 2013.

As of each reporting date, management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. Management determined that sufficient positive evidence existed as of March 31, 2014 and December 31, 2013 to conclude that it is more likely than not that deferred tax assets of $4.15 million and $4.04 million, respectively, were realizable.  A valuation allowance remained at March 31, 2014 and December 31, 2013 against certain deferred tax assets relating to state net operating loss carryforwards from our e-commerce and home party operating subsidiaries due to the timing uncertainty of when the subsidiaries will generate cumulative positive taxable income to utilize the associated deferred tax assets. A valuation allowance also remained at March 31, 2014 and December 31, 2013 against certain deferred tax assets relating to investment loss carryforwards because management does not anticipate we will generate sufficient investment income to utilize the carryforwards.  Management also previously considered various strategic alternatives, resulting in management determining that a valuation allowance was not necessary at that time.  During the three months ended June 30, 2014, management determined that such strategic alternatives were no longer in our best interest.  Accordingly, management concluded that the positive evidence was no longer sufficient to offset available negative evidence, primarily as a result of the pre-tax operating loss for the three and six months ended June 30, 2014.   As a result, management concluded that it was uncertain that we would have sufficient future taxable income to utilize our deferred tax assets, and therefore, we established a valuation allowance against our deferred tax assets, resulting in a tax expense of $4.15 million and $4.05 million for the three and six months ended June 30, 2014, respectively.  During the three and six months ended June 30, 2014, we also recognized approximately $6,000 of income tax expense for estimated tax, penalties, and interest associated with uncertain tax positions.

For the three months ended June 30, 2013, we recognized $358,000 of current period income tax benefit, offsetting an income tax expense recorded in the first quarter of 2013 of approximately $211,000. The resulting income tax net benefit of $147,000 for the six months ended June 30, 2013 represents an effective tax rate of 45.4% on the year-to-date pre-tax book loss. The effective tax rate for the six months ended June 30, 2013 differs from the federal statutory rate of 34.0% primarily due to the impact of state income taxes, stock-based compensation expense that is not deductible for tax purposes, and other book-to-tax reconciling items. This effective tax rate increased from December 31, 2012 due to anticipation of higher taxable income in 2013, and an additional $7,000 of income tax expense was accrued and paid in the first quarter of 2013 related to the prior tax year, primarily for adjustment of the federal alternative minimum tax. Additionally, we recorded approximately $4,000 of income tax benefit for a discrete permanent tax deduction difference during the three and six months ended June 30, 2013 and approximately $2,000 and $6,000 of income tax expense for estimated tax, penalties, and interest associated with uncertain tax positions during the three and six months ended June 30, 2013, respectively.

27

Liquidity and Capital Resources

We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of June 30, 2014, our principal sources of liquidity were cash and cash equivalents totaling $3.36 million, trade accounts receivable of $7.82 million, and current inventory of $12.42 million, as compared to cash and cash equivalents totaling $2.57 million, trade accounts receivable of $10.24 million, and current inventory of $13.07 million as of December 31, 2013.  As described more fully below, we also have access to a $10 million credit facility.

During the six months ended June 30, 2014, our working capital decreased by approximately $3.46 million to $20.08 million from $23.54 million at December 31, 2013. As described more fully below, the decrease in working capital at June 30, 2014 is primarily attributable to a decrease in our current deferred income taxes, decrease in trade accounts receivable, a greater allocation of inventory to long-term, and a net increase in accrued expenses and other liabilities, offset in part by a decrease in trade accounts payable, and an increase in prepaid expenses and other assets.

During the six months ended June 30, 2014, $1.81 million of cash was provided by operations. The primary drivers of positive cash flow were a decrease in trade accounts receivable of $2.59 million, a decrease in inventory of $869,000, and an increase in accrued liabilities of $662,000.  These factors were partially offset by our loss of $7.26 million that included $5.35 million of non-cash expenses, an increase in prepaid expenses of $395,000 and a decrease in accounts payable of $11,000.  Accounts receivable decreased primarily as a result of collection efforts during the first six months of 2014 on higher sales made in the fourth quarter of 2013, offset in part by extended wholesale customer payment terms that we offer from time to time that may not immediately increase liquidity as a result of current-period sales. We believe our competitors and other vendors in the wholesale jewelry industry have also expanded their use of extended payment terms and, in aggregate, we believe that by expanding our use of extended payment terms, we have provided a competitive response in our market and that our net sales have been favorably impacted.  We are unable to estimate the impact of this program on our net sales, but if we ceased providing extended payment terms in select instances, we believe we would not be competitive for some wholesale customers in the marketplace and that our net sales and profits would likely decrease. Generally, we have not experienced any significant accounts receivable write-offs related to revenue arrangements with extended payment terms; however, we have increased our reserves for uncollectible accounts primarily due to one customer with extended terms, but we do not believe the terms are a factor with this customer’s non-payment.  Inventories decreased primarily as a result of sales, including the sale of slower moving standard grade loose jewels, offset in part by the purchase of new raw material SiC crystals during the quarter pursuant to our Amended and Restated Exclusive Supply Agreement with Cree, or the Cree Exclusive Supply Agreement; purchases of jewelry castings, findings, and other jewelry components; and production of moissanite gemstones.  Accrued rent increased primarily as a result of the lease incentives received from our landlord associated with the new corporate headquarters.  Prepaid expenses and other assets increased primarily as a result of deposits made during the quarter in advance of goods or services received.  Accounts payable increased primarily as a result of the timing of costs incurred but not yet paid as of June 30, 2014 associated with inventory-related purchases and professional services incurred but not yet due under our vendors’ payment terms.

We manufactured approximately $5.75 million in loose jewels and $3.5 million in finished jewelry, which includes the cost of the loose jewels and the purchase of precious metals and labor in connection with jewelry production, during the six months ended June 30, 2014. We expect our purchases of precious metals and labor to increase as we increase our finished jewelry business. In addition, from the beginning of 2006 through the second quarter of 2014, the price of gold has increased significantly (approximately 148%), resulting in higher retail price points for gold jewelry. Because the market price of gold and other precious metals is beyond our control, the recent upward price trends could continue and have a negative impact on our operating cash flow as we manufacture finished jewelry.

Historically, our raw material inventories of SiC crystals had been purchased under exclusive supply agreements with a limited number of suppliers. Because the supply agreements restricted the sale of these crystals exclusively to us, the suppliers negotiated minimum purchase commitments with us that, when combined with our reduced sales during the periods when the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As of June 30, 2014, $29.06 million of our inventories were classified as long-term assets. Loose jewel sales and finished jewelry that we manufacture will utilize both the finished good loose jewels currently on hand and, as we deplete certain shapes and sizes, our on-hand raw material SiC crystals of $5.11 million and new raw material that we are purchasing from Cree.

In connection with the Cree Exclusive Supply Agreement, which expires in July 2015, we have committed to purchase from Cree a minimum of 50%, by dollar volume, of our raw material SiC crystal requirements. If our orders require Cree to expand beyond specified production levels, we must commit to purchase certain minimum quantities.

28

In February 2013, we entered into an amendment to a prior letter agreement with Cree, which provides a framework for our purchases of SiC crystals under the Cree Exclusive Supply Agreement. Pursuant to this amendment, we agreed to purchase at least $4.00 million of SiC crystals in an initial new order. After the initial new order, we have agreed to issue non-cancellable, quarterly orders that must equal or exceed a set minimum order quantity. Our total purchase commitment under the amendment (as subsequently amended) until July 2015, including the initial new order, is dependent upon the grade of the material and ranges between approximately $7.64 million and approximately $18.56 million. During the six months ended June 30, 2014, we purchased $3.58 million of raw material SiC crystals from Cree. We expect to use existing cash and cash equivalents and other working capital, together with future cash expected to be provided by operating activities and, if necessary, our credit facility, to finance this purchase commitment.

We made no income tax payments during the six months ended June 30, 2014. As of June 30, 2014, we had approximately $882,000 of remaining federal income tax credits, $533,000 of which expire between 2018 and 2021 and the balance without an expiration, which can be carried forward to offset future income taxes. As of June 30, 2014, we also had a federal tax net operating loss carryforward of approximately $5.66 million expiring between 2020 and 2033, which can be used to offset against future federal taxable income, a North Carolina tax net operating loss carryforward of approximately $11.28 million expiring between 2023 and 2028, and various other state tax net operating loss carryforwards expiring between 2016 and 2033, which can be used to offset against future state taxable income.

On August 9, 2013, the Board authorized the extension of our share repurchase program for an additional 12 months. The program, which was originally authorized on November 13, 2009, authorizes us to repurchase up to 1,000,000 shares of our common stock until August 12, 2014 in open market or in privately negotiated transactions. As of June 30, 2014, 809,213 shares of our common stock remain available for repurchase under the program.  We have not repurchased any shares under this program during the six months ended June 30, 2014, or through August 4, 2014.  We have determined not to extend the plan past the current expiration due to covenants within the credit facility described below.

On September 20, 2013, we obtained a $10,000,000 revolving line of credit, or the Line of Credit, from PNC Bank, National Association, or PNC Bank, for general corporate and working capital purposes. The Line of Credit was evidenced by a Committed Line of Credit Note, dated September 20, 2013, or the Note, which was set to mature on June 15, 2015. The interest rate under the Note was the one-month LIBOR rate (adjusted daily) plus 1.50%, calculated on an actual / 360 basis.

The Line of Credit was also governed by a loan agreement, dated September 20, 2013, or the Loan Agreement, and was guaranteed by Charles & Colvard Direct and Moissanite.com, as our wholly owned subsidiaries. The Line of Credit was secured by a lien on substantially all of our assets, including those of our subsidiaries.

Effective June 25, 2014, the Line of Credit was terminated concurrent with our entering into a new banking relationship with Wells Fargo Bank, National Association, or Wells Fargo.  We had not utilized the Line of Credit.

On June 25, 2014, we and our wholly owned subsidiaries, Charles & Colvard Direct and Moissanite.com, collectively referred to as the Borrowers, obtained a $10,000,000 asset-based revolving credit facility, or the Credit Facility, from Wells Fargo. The Credit Facility will be used for general corporate and working capital purposes, including transaction fees and expenses incurred in connection therewith and the issuance of letters of credit up to a $1,000,000 sublimit. The Credit Facility will mature on June 25, 2017.

The Credit Facility includes a $5,000,000 sublimit for advances that are supported by a 90% guaranty provided by the U.S. Export-Import Bank. Advances under the Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers’ eligible accounts and inventory, less reserves. Advances against inventory are further subject to an initial $3,000,000 maximum. We must maintain a minimum of $1,000,000 in excess availability at all times. There are no other financial covenants.

29

Each advance accrues interest at a rate equal to Wells Fargo’s 3-month LIBOR rate plus 2.50%, calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default accrues interest at a rate of 3% in excess of the above rate. Any advance may be prepaid in whole or in part at any time. In addition, the maximum line amount may be reduced by us in whole or part at any time, subject to a fee equal to 2% of any reduction in the first year after closing, 1% of any reduction in the second year after closing, and 0% thereafter. There are no mandatory prepayments or line reductions.

The Credit Facility is secured by a lien on substantially all assets of ours.

The Credit Facility is evidenced by a credit and security agreement, or Credit Agreement, dated as of June 25, 2014, and customary ancillary documents. The Credit Agreement contains customary covenants, representations and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, contingent obligations, liens, loans, investments, mergers, acquisitions, divestitures, subsidiaries, affiliate transactions, and changes in control.

Events of default under the Credit Facility include, without limitation, (1) any impairment of the Export-Import Bank guaranty, unless the guaranteed advances are repaid within two business days, (2) an event of default under any other indebtedness of the Borrowers in excess of $200,000, and (3) a material adverse change in the ability of the Borrowers to perform their obligations under the Credit Agreement or in the Borrowers’ assets, liabilities, businesses or prospects, or other circumstances that Wells Fargo believes may impair the prospect of repayment. If an event of default occurs, Wells Fargo is entitled to take enforcement action, including acceleration of amounts due under the Credit Agreement and foreclosure upon collateral.

As of June 30, 2014, we had not borrowed against the Credit Facility.

We believe that our existing cash and cash equivalents and other working capital, together with future cash expected to be provided by operating activities, will be sufficient to meet our working capital and capital expenditure needs over the next 12 months. Our future capital requirements and the adequacy of available funds will depend on many factors, including our rate of sales growth; the expansion of our sales and marketing activities, including the operating capital needs of our wholly owned subsidiaries; the timing and extent of raw materials and labor purchases in connection with loose jewel production to support our moissanite jewel business and precious metals and labor purchases in connection with jewelry production to support our finished jewelry business; the timing of capital expenditures; and risk factors described in more detail in “Risk Factors” in this report and in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013.  We obtained the Line of Credit, and subsequently, the Credit Facility, to mitigate these risks to our cash and liquidity position.  Also, we may make investments in, or acquisitions of, complementary businesses, which could also require us to seek additional equity or debt financing.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective at the reasonable assurance level.

30

Changes in Internal Control Over Financial Reporting

We routinely review our internal control over financial reporting and from time to time make changes intended to enhance the effectiveness of our internal control over financial reporting. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an ongoing basis and will take action as appropriate. During the three months ended June 30, 2014, we made no changes to our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, that we believe materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

There are no material pending legal proceedings to which we are a party or to which any of our property is subject.

Item 1A. Risk Factors

We discuss in our Annual Report on Form 10-K for the year ended December 31, 2013 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 various risks that may materially affect our business. There have been no material changes to such risks.

Item 6. Exhibits

The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:

Exhibit No.	Description
10.1	Second Amendment to Lease, dated April 15, 2014, between Charles & Colvard, Ltd. and Southport Business Park Limited Partnership
10.2	Charles & Colvard, Ltd. Short-Term Incentive Plan, effective January 1, 2014 (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on April 21, 2014)
10.3	Charles & Colvard, Ltd. Long-Term Incentive Program, effective January 1, 2014 (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on April 21, 2014)
10.4	Form of Restricted Stock Award Agreement pursuant to the Charles & Colvard, Ltd. Long-Term Incentive Program (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K, as filed with the SEC on April 21, 2014)
10.5	Form of Employee Nonqualified Stock Option Agreement pursuant to the Charles & Colvard, Ltd. Long-Term Incentive Program (incorporated by reference to Exhibit 10.4 to our Current Report on Form 8-K, as filed with the SEC on April 21, 2014)
10.6	Credit and Security Agreement, dated as of June 25, 2014, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on June 30, 2014)
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	The following materials from Charles & Colvard, Ltd.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Cash Flows; and (iv) Notes to Condensed Consolidated Financial Statements.

31

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.
	By:	/s/ Randy N. McCullough
August 6, 2014		Randy N. McCullough
		President and Chief Executive Officer
	By:	/s/ Kyle Macemore
August 6, 2014		Kyle Macemore
		Senior Vice President and Chief Financial Officer
		(Principal Financial Officer and Chief Accounting Officer)

32

EXHIBIT INDEX

Exhibit No.	Description
10.1	Second Amendment to Lease, dated April 15, 2014, between Charles & Colvard, Ltd. and Southport Business Park Limited Partnership
10.2	Charles & Colvard, Ltd. Short-Term Incentive Plan, effective January 1, 2014 (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on April 21, 2014)
10.3	Charles & Colvard, Ltd. Long-Term Incentive Program, effective January 1, 2014 (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K, as filed with the SEC on April 21, 2014)
10.4	Form of Restricted Stock Award Agreement pursuant to the Charles & Colvard, Ltd. Long-Term Incentive Program (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K, as filed with the SEC on April 21, 2014)
10.5	Form of Employee Nonqualified Stock Option Agreement pursuant to the Charles & Colvard, Ltd. Long-Term Incentive Program (incorporated by reference to Exhibit 10.4 to our Current Report on Form 8-K, as filed with the SEC on April 21, 2014)
10.6	Credit and Security Agreement, dated as of June 25, 2014, by and among Charles & Colvard, Ltd., Charles & Colvard Direct, LLC, Moissanite.com, LLC, and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, as filed with the SEC on June 30, 2014)
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	The following materials from Charles & Colvard, Ltd.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Cash Flows; and (iv) Notes to Condensed Consolidated Financial Statements.

33

EX-10.1

Exhibit 10.1

SECOND AMENDMENT TO LEASE

THIS SECOND AMENDMENT TO LEASE (“Second Amendment”) made as of the 15^th day of April, 2014, by and between Southport Business Park Limited Partnership, a North Carolina limited partnership (the “Landlord”) and Charles & Colvard, LTD., a North Carolina corporation (the “Tenant”).

WITNESSETH:

WHEREAS, Landlord and Tenant entered into a certain lease dated as of December 9, 2013, as amended by the First Amendment to Lease dated December 23, 2013 (collectively, the “Lease”), for certain premises located at 170 Southport Drive, Morrisville, Wake County, North Carolina (the “Demised Premises”), the Demised Premises being more particularly described in the Lease; and

WHEREAS, Landlord and Tenant desire to modify the terms of the Lease to change the dates of the Lease, among other things;

NOW THEREFORE, in consideration of the premises contained herein, the sum of Ten Dollars ($10.00) and other good and valuable consideration, the mutual receipt and sufficiency of which is hereby acknowledged, the parties agree to amend the Lease as follows:

1. Page 2 and 3: Section 1.02 — TERM OF THE LEASE

In the second paragraph delete “April 15, 2014” and insert “May 23, 2014” in its place subject to the following:

Should Tenant cause any delays that are not cured within Tenant's two (2) days' notice and opportunity to cure as defined in Page 10: SECTION 3.05 — TENANT DELAYS of the Lease, the Commencement Date will automatically revert to May 16, 2014.

2. Page 34 - EXHIBIT B-2 — CHANGES TO LANDLORD'S WORK. Landlord and Tenant acknowledge that the Town of Morrisville has required the following additions to Landlord's Work as depicted in Exhibit A of this Second Amendment:

· The removal of a semi-circle drive at front door of the Building that will be replaced with a grassy landscaped area;

· Sidewalk extension.

Such work shall be paid for as part of the Allowance, Additional Allowance, or by Tenant.

3. Page 23 -SECTION 12.03 — SURRENDER OF DEMISED PREMISES. At the end of the first paragraph, add the following: Landlord and Tenant agree that Landlord, at the end of the Term, may require that Tenant remove the expanded concrete pads and sidewalk extension and that the cost of such removal will be split evenly between Landlord and Tenant.

4. Tenant warrants that it has had no dealings with any broker or agent in connection with this Second Amendment, other than Aldene “Dee” Creech Osborne, SIOR of NAI Carolantic Realty and Matthew Cooke of Jones Lang LaSalle Brokerage, Inc., and covenants to pay, hold harmless and indemnify Landlord from and against, any and all cost, expense or liability for any compensation, commissions and charges claimed by any other broker or agent with respect to this Second Amendment or the negotiation thereof.

Except as herein amended, the terms and conditions of said Lease shall remain in full force and effect. Each person signing as Landlord or Tenant warrants and represents that she or he is authorized to execute and deliver this Second Amendment and to make it a binding obligation of Landlord or Tenant.

IN WITNESS WHEREOF, the parties hereto have caused this instrument to be executed the date and year first above written.

LANDLORD:
SOUTHPORT BUSINESS PARK LIMITED PARTNERSHIP, a North Carolina limited partnership
By: SOUTHPORT BUSINESS PARK
INVESTORS CORPORATION, a North Carolina corporation, its general partner
BY:	/s/ Richard G. Sullivan
	Richard G. Sullivan
	Vice President
TENANT:
CHARLES & COLVARD, LTD, a North Carolina corporation
By:	/s/ Randy McCullough
	Randy McCullough
	President & CEO

EXHIBIT A — CHANGES TO LANDLORD’S WORK

The changes to Landlord’s Work required by the Town of Morrisville are depicted below:

EX-31.1

Exhibit 31.1

CERTIFICATION PURSUANT TO SECURITIES AND EXCHANGE ACT OF 1934

RULE 13a-14(a) AS ADOPTED PURSUANT TO SECTION 302

OF THE SARBANES-OXLEY ACT OF 2002

I, Randy N. McCullough, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2014 of Charles & Colvard, Ltd.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

	By:	/s/ Randy N. McCullough
August 6, 2014		Randy N. McCullough
		President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION PURSUANT TO SECURITIES AND EXCHANGE ACT OF 1934

RULE 13a-14(a) AS ADOPTED PURSUANT TO SECTION 302

OF THE SARBANES-OXLEY ACT OF 2002

I, Kyle Macemore, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2014 of Charles & Colvard, Ltd.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

	By:	/s/ Kyle Macemore
August 6, 2014		Kyle Macemore
		Senior Vice President and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Charles & Colvard, Ltd. (the “Company”) on Form 10-Q for the quarterly period ended June 30, 2014 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Randy N. McCullough, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Randy N. McCullough

Randy N. McCullough

President and Chief Executive Officer

August 6, 2014

This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing.

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Charles & Colvard, Ltd. (the “Company”) on Form 10-Q for the quarterly period ended June 30, 2014 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Kyle Macemore, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Kyle Macemore

Kyle Macemore

Senior Vice President and Chief Financial Officer

August 6, 2014

This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing.

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

XML

SEGMENT INFORMATION AND GEOGRAPHIC DATA, Data by Geographic Area (Details) (USD $)	3 Months Ended		6 Months Ended						3 Months Ended		6 Months Ended						3 Months Ended		6 Months Ended
	Jun. 30, 2014	Jun. 30, 2013	Jun. 30, 2014	Jun. 30, 2013	Jun. 30, 2014 Property and Equipment, Net [Member]	Dec. 31, 2013 Property and Equipment, Net [Member]	Jun. 30, 2014 Intangible Assets, Net [Member]	Dec. 31, 2013 Intangible Assets, Net [Member]	Jun. 30, 2014 Reportable Geographical Components [Member] United States [Member]	Jun. 30, 2013 Reportable Geographical Components [Member] United States [Member]	Jun. 30, 2014 Reportable Geographical Components [Member] United States [Member]	Jun. 30, 2013 Reportable Geographical Components [Member] United States [Member]	Jun. 30, 2014 Reportable Geographical Components [Member] United States [Member] Property and Equipment, Net [Member]	Dec. 31, 2013 Reportable Geographical Components [Member] United States [Member] Property and Equipment, Net [Member]	Jun. 30, 2014 Reportable Geographical Components [Member] United States [Member] Intangible Assets, Net [Member]	Dec. 31, 2013 Reportable Geographical Components [Member] United States [Member] Intangible Assets, Net [Member]	Jun. 30, 2014 Reportable Geographical Components [Member] International [Member]	Jun. 30, 2013 Reportable Geographical Components [Member] International [Member]	Jun. 30, 2014 Reportable Geographical Components [Member] International [Member]	Jun. 30, 2013 Reportable Geographical Components [Member] International [Member]	Jun. 30, 2014 Reportable Geographical Components [Member] International [Member] Property and Equipment, Net [Member]	Dec. 31, 2013 Reportable Geographical Components [Member] International [Member] Property and Equipment, Net [Member]	Jun. 30, 2014 Reportable Geographical Components [Member] International [Member] Intangible Assets, Net [Member]	Dec. 31, 2013 Reportable Geographical Components [Member] International [Member] Intangible Assets, Net [Member]
Net sales [Abstract]
Net sales	$ 7,841,647	$ 6,512,500	$ 13,909,200	$ 13,017,574					$ 7,267,441	$ 5,373,178	$ 12,976,474	$ 10,485,467					$ 574,206	$ 1,139,322	$ 932,726	$ 2,532,107
Assets by geographical area [Abstract]
Total					$ 2,163,187	$ 1,717,692	$ 305,955	$ 325,867					$ 2,163,187	$ 1,717,692	$ 54,090	$ 70,830					$ 0	$ 0	$ 251,865	$ 255,037

XML

FAIR VALUE MEASUREMENTS

6 Months Ended

Jun. 30, 2014

FAIR VALUE MEASUREMENTS [Abstract]

FAIR VALUE MEASUREMENTS

4. FAIR VALUE MEASUREMENTS

Under U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy consists of three levels based on the reliability of inputs, as follows:

 Level 1 - quoted prices in active markets for identical assets and liabilities

 Level 2 - inputs other than Level 1 quoted prices that are directly or indirectly observable

 Level 3 - unobservable inputs that are not corroborated by market data

The Company evaluates assets and liabilities subject to fair value measurements on a recurring and non-recurring basis to determine the appropriate level to classify them for each reporting period. This determination requires significant judgments to be made by management of the Company. The instruments identified as subject to fair value measurements on a recurring basis are cash and cash equivalents, trade accounts receivable, trade accounts payable, and accrued expenses. All instruments are reflected in the consolidated balance sheets at carrying value, which approximates fair value due to the short-term nature of these instruments.

XML

LINE OF CREDIT (Details) (USD $)	6 Months Ended		0 Months Ended
	Jun. 24, 2014 PNC Bank [Member] Line of Credit Note [Member]	Sep. 20, 2013 PNC Bank [Member] Line of Credit Note [Member]	Jun. 30, 2014 Wells Fargo [Member] Line of Credit [Member]
Line of Credit Facility [Line Items]
Revolving line of credit		$ 10,000,000	$ 10,000,000
Line of credit maturity date	Jun. 15, 2015		Jun. 25, 2017
Line of credit facility, sublimit for letter of credit			1,000,000
Line of credit facility, sublimit for advances			5,000,000
Percentage of Advances, Guaranteed by bank (in hundredths)			90.00%
Maximum advances against inventory			3,000,000
Minimum Excess Availability Of Inventory At All Times Required For Advances			1,000,000
Line of credit, description of variable rate basis	One-month LIBOR rate		Wells Fargo’s 3-month LIBOR rate
Line of credit, spread on variable rate (in hundredths)	1.50%		2.50%
Basis for calculation of LIBOR rate (adjusted daily)	actual / 360		actual / 360
Legal Fees	19,000
Interest rate in event of default in excess of standard rate (in hundredths)			3.00%
Prepaid advance fee for reduction in first year after closing (in hundredths)			2.00%
Prepaid advance fee for reduction in Second year after closing (in hundredths)			1.00%
Prepaid advance fee for reduction, thereafter (in hundredths)			0.00%
Number of business day within which guaranteed advances to be repaid			2 days
Maximum indebtedness to be maintained in the event of default to avoid triggering of default terms			200,000
Advances against line of credit			$ 0

XML

COMMITMENTS AND CONTINGENCIES (Details) (USD $)	0 Months Ended	3 Months Ended		6 Months Ended
	Dec. 09, 2013 sqft	Jun. 30, 2014 sqft	Jun. 30, 2013	Jun. 30, 2014 RentHoliday sqft	Jun. 30, 2013	May 23, 2014	Oct. 31, 2013
Lease Commitments [Abstract]
Period of lease				7 years
Land subject to leases (in square feet)	36,350	16,500		16,500
Number of rent holidays				2
Percentage of rent abatement (in hundredths)				50.00%
Period for which rent is abated	7 months			12 months
Annual rent escalations (in hundredths)				3.00%
Cost to terminate lease							$ 112,000
Number of months included in costs to terminate lease				2 months
Leasehold improvements offered by landlord						550,000
Lease signing and moving incentives offered by landlord						73,000
Future minimum payments under operating lease [Abstract]
2014		0		0
2015		553,905		553,905
2016		569,138		569,138
2017		584,789		584,789
2018		600,871		600,871
Thereafter		1,793,725		1,793,725
Total		4,102,428		4,102,428
Rent expense		84,000	77,000	115,000	133,000
Purchase Commitments [Abstract]
Period of exclusive supply agreement				10 years
Percentage committed to be purchased (in hundredths)				50.00%
Minimum purchase commitment in initial new order		4,000,000		4,000,000
Minimum purchase commitment under the amendment		7,640,000		7,640,000
Maximum purchase commitment under amendment		18,560,000		18,560,000
Actual purchases under purchase amendment				$ 3,580,000	$ 4,990,000

XML

STOCK-BASED COMPENSATION (Details) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2014	Jun. 30, 2013	Jun. 30, 2014	Jun. 30, 2013
Components of the Company's stock based compensation included in net income [Abstract]
Income tax benefit	$ (78,349)	$ (162,247)	$ (146,046)	$ (201,184)
Total	355,630	334,720	664,444	542,449
Stock Options [Member]
Components of the Company's stock based compensation included in net income [Abstract]
Allocated share-based compensation expense	209,698	161,227	392,422	300,497
Stock-based compensation capitalized as a cost of inventory	0	0	0	0
Shares [Roll Forward]
Outstanding, December 31, 2013 (in shares)			1,204,297
Granted (in shares)			215,000
Exercised (in shares)			0
Forfeited (in shares)			(15,775)
Expired (in shares)			(37,576)
Outstanding, March 31, 2014 (in shares)	1,365,946		1,365,946
Weighted Average Exercise Price [Roll Forward]
Outstanding (in dollars per share)			$ 3.14
Granted (in dollars per share)			$ 2.89
Exercised (in dollars per share)			$ 0
Forfeited (in dollars per share)			$ 2.85
Expired (in dollars per share)			$ 3.84
Outstanding (in dollars per share)	$ 3.09		$ 3.09
Fair value of stock options (in dollars per share)			$ 2.06
Fair value of stock options vested			445,000
Weighted average assumptions for stock options [Abstract]
Dividend yield (in hundredths)			0.00%
Expected volatility (in hundredths)			92.90%
Risk-free interest rate (in hundredths)			1.61%
Expected lives			5 years
Options Outstanding [Abstract]
Balance as of 3/31/2013 (in shares)	1,365,946		1,365,946
Weighted Average Remaining Contractual Life			7 years 8 months 19 days
Weighted Average Exercise Price (in dollars per share)	$ 3.09		$ 3.09
Options Exercisable [Abstract]
Balance as of 3/31/2013 (in shares)	892,453		892,453
Weighted Average Remaining Contractual Life			6 years 11 months 26 days
Weighted Average Exercise Price (in dollars per share)	$ 2.63		$ 2.63
Options Vested or Expected to Vest [Abstract]
Balance as of 3/31/2013 (in shares)	1,302,584		1,302,584
Weighted Average Remaining Contractual Life			6 years 11 months 26 days
Weighted Average Exercise Price (in dollars per share)	$ 3.05		$ 3.05
Unrecognized stock-based compensation expense related to unvested awards	953,000		953,000
Total compensation cost not yet recognized, period for recognition			25 months
Aggregate intrinsic value of stock options outstanding	385,000		385,000
Aggregate intrinsic value of stock options exercisable	383,000		383,000
Aggregate intrinsic value of stock options vested and expected to vest	385,000		385,000
Aggregate intrinsic value of stock options exercised	0		0
Restricted Stock [Member]
Components of the Company's stock based compensation included in net income [Abstract]
Allocated share-based compensation expense	224,281	335,740	418,068	443,136
Options Vested or Expected to Vest [Abstract]
Unrecognized stock-based compensation expense related to unvested awards	$ 967,000		$ 967,000
Total compensation cost not yet recognized, period for recognition			18 months
Shares [Roll Forward]
Unvested (in shares)			350,903
Granted (in shares)			160,032
Vested (in shares)			(175,903)
Canceled (in shares)			0
Unvested (in shares)	335,032		335,032
Weighted Average Grant Date Fair Value [Roll Forward]
Unvested, December 31, 2012 (in dollars per share)			$ 4.26
Granted (in dollars per share)			$ 2.22
Vested (in dollars per share)			$ 4.00
Canceled (in dollars per share)			$ 0
Unvested, March 31, 2013 (in dollars per share)	$ 3.42		$ 3.42

XML

NET LOSS PER COMMON SHARE (Details) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2014	Jun. 30, 2013	Jun. 30, 2014	Jun. 30, 2013
Numerator [Abstract]
Net loss	$ (6,194,083)	$ (491,585)	$ (7,257,477)	$ (185,312)
Weighted average common shares outstanding [Abstract]
Basic (in shares)	20,262,299	19,812,397	20,229,979	19,736,068
Stock options (in shares)	0	0	0	0
Fully diluted (in shares)	20,262,299	19,812,397	20,229,979	19,736,068
Net (loss) income per common share [Abstract]
Basic (in dollars per share)	$ (0.31)	$ (0.02)	$ (0.36)	$ (0.01)
Diluted (in dollars per share)	$ (0.31)	$ (0.02)	$ (0.36)	$ (0.01)
Stock Options [Member]
Antidilutive Securities Excluded from Computation of Earnings Per Share [Line Items]
Stock options to purchase shares (in shares)	1,370,000	289,000	1,370,000	436,000

XML

SEGMENT INFORMATION AND GEOGRAPHIC DATA

6 Months Ended

Jun. 30, 2014

SEGMENT INFORMATION AND GEOGRAPHIC DATA [Abstract]

SEGMENT INFORMATION AND GEOGRAPHIC DATA

3. SEGMENT INFORMATION AND GEOGRAPHIC DATA

The Company reports segment information based on the "management" approach. The management approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of the Company's operating and reportable segments.

The Company manages its business primarily by its two distribution channels that it uses to sell its product lines, loose jewels and finished jewelry. Accordingly, the Company determined its two operating and reporting segments to be wholesale distribution transacted through the parent entity and direct-to-consumer distribution transacted through the Company's wholly owned operating subsidiaries, Moissanite.com, LLC and Charles & Colvard Direct, LLC. The accounting policies for these segments are the same as those described in Note 2, "Basis of Presentation and Significant Accounting Policies," of this Quarterly Report on Form 10-Q and in the Notes to Consolidated Financial Statements in the 2013 Annual Report.

The Company evaluates the financial performance of its segments based on net sales; product line gross profit, or the excess of product line sales over product line cost of goods sold; and operating income (loss). The Company's inventories are maintained in the parent entity's wholesale distribution segment and are transferred without intercompany markup to the operating subsidiaries as product line cost of goods sold when sold to the end consumer. Product line cost of goods sold is defined as product cost of goods sold in each of the Company's wholesale distribution and direct-to-consumer distribution operating segments excluding non-capitalized expenses from the Company's manufacturing and production control departments, comprising personnel costs, depreciation, rent, utilities, and corporate overhead allocations; freight out; inventory valuation allowance adjustments; and other inventory adjustments, comprising costs of quality issues, damaged goods, and inventory write-offs.

The Company allocates certain general and administrative and information technology-related expenses from its parent entity to its two direct-to-consumer operating subsidiaries primarily based on net sales and headcount, respectively. Unallocated expenses, which also include interest and taxes, remain in the parent entity's wholesale distribution segment.

Summary financial information by reporting segment is as follows:

	Three Months Ended June 30,
	2014									2013
	Wholesale			Direct-to- Consumer			Total			Wholesale		Direct-to- Consumer			Total
Net sales
Loose jewels	$	3,837,012		$	173,327		$	4,010,339		$	3,984,058	$	91,238		$	4,075,296
Finished jewelry		3,012,372			818,936			3,831,308			1,905,430		531,774			2,437,204
Total	$	6,849,384		$	992,263		$	7,841,647		$	5,889,488	$	623,012		$	6,512,500
Product line cost of goods sold
Loose jewels	$	2,040,944		$	25,346		$	2,066,290		$	1,334,472	$	11,795		$	1,346,267
Finished jewelry		2,377,715			369,649			2,747,364			1,330,109		290,816			1,620,925
Total	$	4,418,659		$	394,995		$	4,813,654		$	2,664,581	$	302,611		$	2,967,192
Product line gross profit
Loose jewels	$	1,796,068		$	147,981		$	1,944,049		$	2,649,586	$	79,443		$	2,729,029
Finished jewelry		634,657			449,287			1,083,944			575,321		240,958			816,279
Total	$	2,430,725		$	597,268		$	3,027,993		$	3,224,907	$	320,401		$	3,545,308
Operating (loss) income	$	(1,008,146	)	$	(1,032,782	)	$	(2,040,928	)	$	624,419	$	(1,482,730	)	$	(858,311	)
Depreciation and amortization	$	214,021		$	96,926		$	310,947		$	101,876	$	90,486		$	192,362
Capital expenditures	$	928,341		$	-		$	928,341		$	108,645	$	5,968		$	114,613

	Six Months Ended June 30,
	2014									2013
	Wholesale			Direct-to- Consumer			Total			Wholesale		Direct-to- Consumer			Total
Net sales
Loose jewels	$	7,370,756		$	320,269		$	7,691,025		$	8,278,212	$	144,998		$	8,423,210
Finished jewelry		4,632,243			1,585,932			6,218,175			3,634,153		960,211			4,594,364
Total	$	12,002,999		$	1,906,201		$	13,909,200		$	11,912,365	$	1,105,209		$	13,017,574
Product line cost of goods sold
Loose jewels	$	3,816,079		$	47,619		$	3,863,698		$	3,050,412	$	18,542		$	3,068,954
Finished jewelry		3,657,816			727,796			4,385,612			1,931,079		473,467			2,404,546
Total	$	7,473,895		$	775,415		$	8,249,310		$	4,981,491	$	492,009		$	5,473,500
Product line gross profit
Loose jewels	$	3,554,677		$	272,650		$	3,827,327		$	5,227,800	$	126,456		$	5,354,256
Finished jewelry		974,427			858,136			1,832,563			1,703,074		486,744			2,189,818
Total	$	4,529,104		$	1,130,786		$	5,659,890		$	6,930,874	$	613,200		$	7,544,074
Operating (loss) income	$	(1,133,003	)	$	(2,078,428	)	$	(3,211,431	)	$	2,264,325	$	(2,601,109	)	$	(336,784	)
Depreciation and amortization	$	393,693		$	195,052		$	588,745		$	192,855	$	191,894		$	384,749
Capital expenditures	$	956,666		$	-		$	956,666		$	189,316	$	13,294		$	202,610

	June 30, 2014									December 31, 2013
	Wholesale			Direct-to- Consumer			Total			Wholesale			Direct-to- Consumer			Total
Total assets		$	55,724,771		$	803,078		$	56,527,849		$	61,702,449		$	621,403		$	62,323,852

A reconciliation of the Company's product line cost of goods sold to cost of goods sold as reported in the condensed consolidated financial statements is as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Product line cost of goods sold	$	4,813,654	$	2,967,192	$	8,249,310	$	5,473,500
Non-capitalized manufacturing and production control expenses		256,144		208,389		411,167		608,640
Freight out		76,077		51,453		135,976		87,962
Inventory valuation allowances		45,000		94,000		69,000		75,000
Other inventory adjustments		134,106		68,281		122,570		26,191
Cost of goods sold	$	5,324,981	$	3,389,315	$	8,988,023	$	6,271,293

The Company's net inventories by product line maintained in the parent entity's wholesale distribution segment are as follows:

	June 30, 2014		December 31, 2013
Loose jewels
Raw materials	$	5,110,412	$	3,311,375
Work-in-process		6,486,882		9,526,769
Finished goods		21,671,343		20,002,881
Finished goods on consignment		149,142		32,948
Total	$	33,417,779	$	32,873,973
Finished jewelry
Raw materials	$	283,378	$	270,043
Work-in-process		562,916		764,355
Finished goods		6,781,866		8,117,035
Finished goods on consignment		355,735		299,514
Total	$	7,983,895	$	9,450,947

Supplies inventories of approximately $72,000 and $87,000 at June 30, 2014 and December 31, 2013, respectively, included in finished goods inventories in the condensed consolidated financial statements are omitted from inventories by product line because they are used in both product lines and are not maintained separately.

The Company recognizes sales by geographic area based on the country in which the customer is based. A portion of the Company's international wholesale distribution segment sales represents products sold internationally that may be re-imported to United States ("U.S.") retailers. Sales to international end consumers made by the Company's direct-to-consumer distribution segment are included in U.S. sales because products are shipped and invoiced to a U.S.-based intermediary party that assumes all international shipping and credit risks. The following presents certain data by geographic area:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Net sales
United States	$	7,267,441	$	5,373,178	$	12,976,474	$	10,485,467
International		574,206		1,139,322		932,726		2,532,107
Total	$	7,841,647	$	6,512,500	$	13,909,200	$	13,017,574

	June 30, 2014		December 31, 2013
Property and equipment, net
United States	$	2,163,187	$	1,717,692
International		-		-
Total	$	2,163,187	$	1,717,692

	June 30, 2014		December 31, 2013
Intangible assets, net
United States	$	54,090	$	70,830
International		251,865		255,037
Total	$	305,955	$	325,867

XML

MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK (Details) (USD $)	6 Months Ended		6 Months Ended						3 Months Ended		6 Months Ended				3 Months Ended		6 Months Ended			12 Months Ended	6 Months Ended		3 Months Ended
	Jun. 30, 2014	Jun. 30, 2013	Jun. 30, 2014 Minimum [Member]	Jun. 30, 2014 Maximum [Member]	Jun. 30, 2014 Customer A [Member]	Jun. 30, 2013 Customer A [Member]	Jun. 30, 2014 Customer B [Member]	Jun. 30, 2013 Customer B [Member]	Jun. 30, 2014 Customer C [Member]	Jun. 30, 2013 Customer C [Member]	Jun. 30, 2014 Customer C [Member]	Jun. 30, 2013 Customer C [Member]	Jun. 30, 2014 Customer D [Member]	Jun. 30, 2013 Customer D [Member]	Jun. 30, 2014 Customer E [Member]	Jun. 30, 2013 Customer E [Member]	Jun. 30, 2014 Customer E [Member]	Jun. 30, 2013 Customer E [Member]	Jun. 30, 2014 Trade Accounts Receivable [Member] Customer Concentration Risk [Member] Customer 1 [Member]	Dec. 31, 2013 Trade Accounts Receivable [Member] Customer Concentration Risk [Member] Customer 1 [Member]	Jun. 30, 2014 Trade Accounts Receivable [Member] Customer Concentration Risk [Member] Customer 2 [Member]	Jun. 30, 2014 Total Gross Sales [Member]	Jun. 30, 2014 Total Gross Sales [Member] Customer Concentration Risk [Member] Customer A [Member]	Jun. 30, 2013 Total Gross Sales [Member] Customer Concentration Risk [Member] Customer A [Member]	Jun. 30, 2014 Total Gross Sales [Member] Customer Concentration Risk [Member] Customer B [Member]	Jun. 30, 2013 Total Gross Sales [Member] Customer Concentration Risk [Member] Customer B [Member]	Jun. 30, 2014 Total Gross Sales [Member] Customer Concentration Risk [Member] Customer D [Member]	Jun. 30, 2013 Total Gross Sales [Member] Customer Concentration Risk [Member] Customer D [Member]
Concentration Risk [Line Items]
Insurance coverage per depositor at each financial institution	$ 250,000
Interest-bearing amounts on deposit in excess of FDIC insurable limits	3,000,000	6,780,000
Period of customer payments on trade receivables			30 days	90 days
Increase in allowance for doubtful accounts	$ 700,000
Concentration risk, percentage (in hundredths)					30.00%	16.00%	17.00%	7.00%	4.00%	6.00%	13.00%	9.00%	0.00%	10.00%	0.00%	19.00%	0.00%	12.00%	29.00%	21.00%	12.00%		36.00%	1.00%	15.00%	6.00%	9.00%	19.00%
Percentage of gross sales used as benchmark (in hundredths)																						10.00%

XML

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited) (USD $)	Jun. 30, 2014	Dec. 31, 2013
Current assets:
Cash and cash equivalents	$ 3,362,813	$ 2,573,405
Accounts receivable, net	7,816,710	10,244,732
Inventory, net	12,419,064	13,074,428
Prepaid expenses and other assets	1,055,610	951,635
Deferred income taxes	0	1,197,832
Total current assets	24,654,197	28,042,032
Long-term assets:
Inventory, net	29,055,044	29,337,674
Property and equipment, net	2,163,187	1,717,692
Intangible assets, net	305,955	325,867
Deferred income taxes	0	2,841,891
Other assets	349,466	58,696
Total long-term assets	31,873,652	34,281,820
TOTAL ASSETS	56,527,849	62,323,852
Current liabilities:
Accounts payable	3,659,900	3,670,551
Accrued cooperative advertising	196,000	188,000
Accrued expenses and other liabilities	713,860	642,186
Total current liabilities	4,569,760	4,500,737
Long-term liabilities:
Accrued rent	575,907	0
Accrued income taxes	401,496	395,442
Total long-term liabilities	977,403	395,442
Total liabilities	5,547,163	4,896,179
Commitments and contingencies
Shareholders' equity:
Common stock, no par value	53,949,001	53,949,001
Additional paid-in capital - stock-based compensation	10,751,470	9,940,980
Accumulated deficit	(13,719,785)	(6,462,308)
Total shareholders' equity	50,980,686	57,427,673
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$ 56,527,849	$ 62,323,852

XML

DESCRIPTION OF BUSINESS

6 Months Ended

Jun. 30, 2014

DESCRIPTION OF BUSINESS [Abstract]

DESCRIPTION OF BUSINESS

1. DESCRIPTION OF BUSINESS

Charles & Colvard, Ltd. (the "Company"), a North Carolina corporation founded in 1995, manufactures, markets, and distributes Charles & Colvard Created Moissanite^® jewels (hereinafter referred to as moissanite or moissanite jewels), finished jewelry featuring moissanite, and fashion finished jewelry for sale in the worldwide jewelry market. Moissanite, also known by its chemical name of silicon carbide ("SiC"), is a rare mineral first discovered in a meteor crater. Because naturally occurring SiC crystals are too small for commercial use, larger crystals must be grown in a laboratory. Leveraging its advantage of being the sole source worldwide of created moissanite jewels, the Company's strategy is to establish itself with reputable, high-quality, and sophisticated brands and to position moissanite as an affordable, luxurious alternative to other gems, such as diamond. The Company believes this is possible due to moissanite's exceptional brilliance, fire, luster, durability, and rarity like no other jewel available on the market. The Company sells loose moissanite jewels and finished jewelry at wholesale to distributors, manufacturers, and retailers and at retail to end consumers through its wholly owned operating subsidiaries Moissanite.com, LLC and Charles & Colvard Direct, LLC.

XML

NET LOSS PER COMMON SHARE (Tables)

6 Months Ended

Jun. 30, 2014

NET (LOSS) INCOME PER COMMON SHARE [Abstract]

Reconciliation of the differences between the basic and fully diluted earnings per share

The following table reconciles the differences between the basic and diluted earnings per share presentations:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Numerator:
Net loss	$	(6,194,083	)	$	(491,585	)	$	(7,257,477	)	$	(185,312	)
Denominator:
Weighted average common shares outstanding:
Basic		20,262,299			19,812,397			20,229,979			19,736,068
Stock options		-			-			-			-
Fully diluted		20,262,299			19,812,397			20,229,979			19,736,068
Net loss per common share:
Basic	$	(0.31	)	$	(0.02	)	$	(0.36	)	$	(0.01	)
Diluted	$	(0.31	)	$	(0.02	)	$	(0.36	)	$	(0.01	)

XML

SEGMENT INFORMATION AND GEOGRAPHIC DATA (Details) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2014	Jun. 30, 2013	Jun. 30, 2014 Segment	Jun. 30, 2013	Dec. 31, 2013
SEGMENT INFORMATION AND GEOGRAPHIC DATA [Abstract]
Number of operating segments			2
Number of reportable segments			2
Summary information by segment [Abstract]
Net sales	$ 7,841,647	$ 6,512,500	$ 13,909,200	$ 13,017,574
Product line cost of goods sold	4,813,654	2,967,192	8,249,310	5,473,500
Product line gross profit	3,027,993	3,545,308	5,659,890	7,544,074
Operating (loss) income	(2,040,928)	(858,311)	(3,211,431)	(336,784)
Depreciation and amortization	310,947	192,362	588,745	384,749
Capital expenditures	928,341	114,613	956,666	202,610
Total assets	56,527,849		56,527,849		62,323,852
Cost of goods sold	5,324,981	3,389,315	8,988,023	6,271,293
Inventories, net [Abstract]
Raw materials	5,393,790		5,393,790		3,581,418
Work-in-process	7,049,798		7,049,798		10,291,124
Supplies inventories	72,000		72,000		87,000
Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	4,813,654	2,967,192	8,249,310	5,473,500
Non-Capitalized Manufacturing and Production Control Expenses [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	256,144	208,389	411,167	608,640
Freight Out [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	76,077	51,453	135,976	87,962
Inventory Valuation Allowances [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	45,000	94,000	69,000	75,000
Other Inventory Adjustments [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	134,106	68,281	122,570	26,191
Loose Jewels [Member]
Summary information by segment [Abstract]
Net sales	4,010,339	4,075,296	7,691,025	8,423,210
Product line cost of goods sold		1,346,267		3,068,954
Product line gross profit	1,944,049	2,729,029	3,827,327	5,354,256
Inventories, net [Abstract]
Raw materials	5,110,412		5,110,412		3,311,375
Work-in-process	6,486,882		6,486,882		9,526,769
Finished goods	21,671,343		21,671,343		20,002,881
Finished goods on consignment	149,142		149,142		32,948
Total	33,417,779		33,417,779		32,873,973
Loose Jewels [Member] | Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	2,066,290		3,863,698
Finished Jewelry [Member]
Summary information by segment [Abstract]
Net sales	3,831,308	2,437,204	6,218,175	4,594,364
Product line cost of goods sold		1,620,925		2,404,546
Product line gross profit	1,083,944	816,279	1,832,563	2,189,818
Inventories, net [Abstract]
Raw materials	283,378		283,378		270,043
Work-in-process	562,916		562,916		764,355
Finished goods	6,781,866		6,781,866		8,117,035
Finished goods on consignment	355,735		355,735		299,514
Total	7,983,895		7,983,895		9,450,947
Finished Jewelry [Member] | Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	2,747,364		4,385,612
Wholesale [Member]
Summary information by segment [Abstract]
Total assets					61,702,449
Operating and Reporting Segments [Member] | Wholesale [Member]
Summary information by segment [Abstract]
Net sales	6,849,384	5,889,488	12,002,999	11,912,365
Product line cost of goods sold		2,664,581		4,981,491
Product line gross profit	2,430,725	3,224,907	4,529,104	6,930,874
Operating (loss) income	(1,008,146)	624,419	(1,133,003)	2,264,325
Depreciation and amortization	214,021	101,876	393,693	192,855
Capital expenditures	928,341	108,645	956,666	189,316
Total assets	55,724,771		55,724,771
Operating and Reporting Segments [Member] | Wholesale [Member] | Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	4,418,659		7,473,895
Operating and Reporting Segments [Member] | Wholesale [Member] | Loose Jewels [Member]
Summary information by segment [Abstract]
Net sales	3,837,012	3,984,058	7,370,756	8,278,212
Product line cost of goods sold		1,334,472		3,050,412
Product line gross profit	1,796,068	2,649,586	3,554,677	5,227,800
Operating and Reporting Segments [Member] | Wholesale [Member] | Loose Jewels [Member] | Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	2,040,944		3,816,079
Operating and Reporting Segments [Member] | Wholesale [Member] | Finished Jewelry [Member]
Summary information by segment [Abstract]
Net sales	3,012,372	1,905,430	4,632,243	3,634,153
Product line cost of goods sold		1,330,109		1,931,079
Product line gross profit	634,657	575,321	974,427	1,703,074
Operating and Reporting Segments [Member] | Wholesale [Member] | Finished Jewelry [Member] | Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	2,377,715		3,657,816
Operating and Reporting Segments [Member] | Direct-to-Consumer [Member]
Summary information by segment [Abstract]
Net sales	992,263	623,012	1,906,201	1,105,209
Product line cost of goods sold		302,611		492,009
Product line gross profit	597,268	320,401	1,130,786	613,200
Operating (loss) income	(1,032,782)	(1,482,730)	(2,078,428)	(2,601,109)
Depreciation and amortization	96,926	90,486	195,052	191,894
Capital expenditures	0	5,968	0	13,294
Total assets	803,078		803,078		621,403
Operating and Reporting Segments [Member] | Direct-to-Consumer [Member] | Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	394,995		775,415
Operating and Reporting Segments [Member] | Direct-to-Consumer [Member] | Loose Jewels [Member]
Summary information by segment [Abstract]
Net sales	173,327	91,238	320,269	144,998
Product line cost of goods sold		11,795		18,542
Product line gross profit	147,981	79,443	272,650	126,456
Operating and Reporting Segments [Member] | Direct-to-Consumer [Member] | Loose Jewels [Member] | Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	25,346		47,619
Operating and Reporting Segments [Member] | Direct-to-Consumer [Member] | Finished Jewelry [Member]
Summary information by segment [Abstract]
Net sales	818,936	531,774	1,585,932	960,211
Product line cost of goods sold		290,816		473,467
Product line gross profit	449,287	240,958	858,136	486,744
Operating and Reporting Segments [Member] | Direct-to-Consumer [Member] | Finished Jewelry [Member] | Product Line Cost of Goods Sold [Member]
Summary information by segment [Abstract]
Product line cost of goods sold	$ 369,649		$ 727,796

XML

BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

6 Months Ended

Jun. 30, 2014

BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES [Abstract]

BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation - The accompanying unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information. However, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with U.S. GAAP have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). In the opinion of the Company's management, the unaudited statements in this Quarterly Report on Form 10-Q include all normal and recurring adjustments necessary for the fair statement of the results for the interim periods presented. The results for the three and six months ended June 30, 2014 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2014.

The condensed consolidated financial statements as of and for the three and six months ended June 30, 2014 and 2013 included in this Quarterly Report on Form 10-Q are unaudited. The balance sheet as of December 31, 2013 is derived from the audited financial statements as of that date. The accompanying statements should be read in conjunction with the audited financial statements and related notes, together with Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on March 27, 2014 (the "2013 Annual Report").

The accompanying condensed consolidated financial statements as of and for the three and six months ended June 30, 2014 and 2013 include the accounts of the Company and its wholly owned subsidiaries Moissanite.com, LLC, formed in 2011; Charles & Colvard Direct, LLC, formed in 2011; and Charles & Colvard (HK) Ltd., the Company's Hong Kong subsidiary that became a dormant entity in the second quarter of 2009 and the operations of which ceased in 2008. All intercompany accounts have been eliminated.

Significant Accounting Policies - In the opinion of the Company's management, the significant accounting policies used for the three and six months ended June 30, 2014 are consistent with those used for the year ended December 31, 2013. Accordingly, please refer to the 2013 Annual Report for the Company's significant accounting policies.

Use of Estimates - The preparation of financial statements in conformity with U.S. GAAP requires management to 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 the reported amounts of revenues and expenses during the reporting period. The most significant estimates impacting the Company's condensed consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions, stock compensation expense, and cooperative advertising. Actual results could differ materially from those estimates.

Reclassifications - Certain amounts in the prior year's condensed consolidated financial statements have been reclassified to conform to the current year presentation.

Recently Adopted/Issued Accounting Pronouncements - In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.

The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures).  The Company is currently evaluating the impact of the pending adoption of ASU 2014-09 on its consolidated financial statements and has not yet determined the method by which the Company will adopt the standard in 2017.

XML

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited) (Parenthetical) (USD $)	Jun. 30, 2014	Dec. 31, 2013
Shareholders' equity
Common stock, par value (in dollars per share)	$ 0	$ 0

XML

BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (Policies)

6 Months Ended

Jun. 30, 2014

BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES [Abstract]

Basis of Presentation and Principles of Consolidation

Basis of Presentation and Principles of Consolidation - The accompanying unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information. However, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with U.S. GAAP have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). In the opinion of the Company's management, the unaudited statements in this Quarterly Report on Form 10-Q include all normal and recurring adjustments necessary for the fair statement of the results for the interim periods presented. The results for the three and six months ended June 30, 2014 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2014.

The condensed consolidated financial statements as of and for the three and six months ended June 30, 2014 and 2013 included in this Quarterly Report on Form 10-Q are unaudited. The balance sheet as of December 31, 2013 is derived from the audited financial statements as of that date. The accompanying statements should be read in conjunction with the audited financial statements and related notes, together with Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on March 27, 2014 (the "2013 Annual Report").

The accompanying condensed consolidated financial statements as of and for the three and six months ended June 30, 2014 and 2013 include the accounts of the Company and its wholly owned subsidiaries Moissanite.com, LLC, formed in 2011; Charles & Colvard Direct, LLC, formed in 2011; and Charles & Colvard (HK) Ltd., the Company's Hong Kong subsidiary that became a dormant entity in the second quarter of 2009 and the operations of which ceased in 2008. All intercompany accounts have been eliminated.

Use of Estimates

Use of Estimates - The preparation of financial statements in conformity with U.S. GAAP requires management to 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 the reported amounts of revenues and expenses during the reporting period. The most significant estimates impacting the Company's condensed consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions, stock compensation expense, and cooperative advertising. Actual results could differ materially from those estimates.

Reclassifications

Reclassifications - Certain amounts in the prior year's condensed consolidated financial statements have been reclassified to conform to the current year presentation.

Recently Adopted/Issued Accounting Pronouncements

Recently Adopted/Issued Accounting Pronouncements - In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.

The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures).  The Company is currently evaluating the impact of the pending adoption of ASU 2014-09 on its consolidated financial statements and has not yet determined the method by which the Company will adopt the standard in 2017.

XML

Document and Entity Information	6 Months Ended
	Jun. 30, 2014	Aug. 04, 2014
Document and Entity Information [Abstract]
Entity Registrant Name	CHARLES & COLVARD LTD
Entity Central Index Key	0001015155
Current Fiscal Year End Date	--12-31
Entity Well-known Seasoned Issuer	No
Entity Voluntary Filers	No
Entity Current Reporting Status	Yes
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		20,357,333
Document Fiscal Year Focus	2014
Document Fiscal Period Focus	Q2
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Jun. 30, 2014

XML

SEGMENT INFORMATION AND GEOGRAPHIC DATA (Tables)

6 Months Ended

Jun. 30, 2014

SEGMENT INFORMATION AND GEOGRAPHIC DATA [Abstract]

Summary information by segment

Summary financial information by reporting segment is as follows:

	Three Months Ended June 30,
	2014									2013
	Wholesale			Direct-to- Consumer			Total			Wholesale		Direct-to- Consumer			Total
Net sales
Loose jewels	$	3,837,012		$	173,327		$	4,010,339		$	3,984,058	$	91,238		$	4,075,296
Finished jewelry		3,012,372			818,936			3,831,308			1,905,430		531,774			2,437,204
Total	$	6,849,384		$	992,263		$	7,841,647		$	5,889,488	$	623,012		$	6,512,500
Product line cost of goods sold
Loose jewels	$	2,040,944		$	25,346		$	2,066,290		$	1,334,472	$	11,795		$	1,346,267
Finished jewelry		2,377,715			369,649			2,747,364			1,330,109		290,816			1,620,925
Total	$	4,418,659		$	394,995		$	4,813,654		$	2,664,581	$	302,611		$	2,967,192
Product line gross profit
Loose jewels	$	1,796,068		$	147,981		$	1,944,049		$	2,649,586	$	79,443		$	2,729,029
Finished jewelry		634,657			449,287			1,083,944			575,321		240,958			816,279
Total	$	2,430,725		$	597,268		$	3,027,993		$	3,224,907	$	320,401		$	3,545,308
Operating (loss) income	$	(1,008,146	)	$	(1,032,782	)	$	(2,040,928	)	$	624,419	$	(1,482,730	)	$	(858,311	)
Depreciation and amortization	$	214,021		$	96,926		$	310,947		$	101,876	$	90,486		$	192,362
Capital expenditures	$	928,341		$	-		$	928,341		$	108,645	$	5,968		$	114,613

	Six Months Ended June 30,
	2014									2013
	Wholesale			Direct-to- Consumer			Total			Wholesale		Direct-to- Consumer			Total
Net sales
Loose jewels	$	7,370,756		$	320,269		$	7,691,025		$	8,278,212	$	144,998		$	8,423,210
Finished jewelry		4,632,243			1,585,932			6,218,175			3,634,153		960,211			4,594,364
Total	$	12,002,999		$	1,906,201		$	13,909,200		$	11,912,365	$	1,105,209		$	13,017,574
Product line cost of goods sold
Loose jewels	$	3,816,079		$	47,619		$	3,863,698		$	3,050,412	$	18,542		$	3,068,954
Finished jewelry		3,657,816			727,796			4,385,612			1,931,079		473,467			2,404,546
Total	$	7,473,895		$	775,415		$	8,249,310		$	4,981,491	$	492,009		$	5,473,500
Product line gross profit
Loose jewels	$	3,554,677		$	272,650		$	3,827,327		$	5,227,800	$	126,456		$	5,354,256
Finished jewelry		974,427			858,136			1,832,563			1,703,074		486,744			2,189,818
Total	$	4,529,104		$	1,130,786		$	5,659,890		$	6,930,874	$	613,200		$	7,544,074
Operating (loss) income	$	(1,133,003	)	$	(2,078,428	)	$	(3,211,431	)	$	2,264,325	$	(2,601,109	)	$	(336,784	)
Depreciation and amortization	$	393,693		$	195,052		$	588,745		$	192,855	$	191,894		$	384,749
Capital expenditures	$	956,666		$	-		$	956,666		$	189,316	$	13,294		$	202,610

	June 30, 2014									December 31, 2013
	Wholesale			Direct-to- Consumer			Total			Wholesale			Direct-to- Consumer			Total
Total assets		$	55,724,771		$	803,078		$	56,527,849		$	61,702,449		$	621,403		$	62,323,852

Schedule of reconciliation of product line cost of goods sold to cost of goods sold as reported in consolidated financial statements

A reconciliation of the Company's product line cost of goods sold to cost of goods sold as reported in the condensed consolidated financial statements is as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Product line cost of goods sold	$	4,813,654	$	2,967,192	$	8,249,310	$	5,473,500
Non-capitalized manufacturing and production control expenses		256,144		208,389		411,167		608,640
Freight out		76,077		51,453		135,976		87,962
Inventory valuation allowances		45,000		94,000		69,000		75,000
Other inventory adjustments		134,106		68,281		122,570		26,191
Cost of goods sold	$	5,324,981	$	3,389,315	$	8,988,023	$	6,271,293

Schedule of inventories by product line maintained in its wholesale distribution segment

The Company's net inventories by product line maintained in the parent entity's wholesale distribution segment are as follows:

	June 30, 2014		December 31, 2013
Loose jewels
Raw materials	$	5,110,412	$	3,311,375
Work-in-process		6,486,882		9,526,769
Finished goods		21,671,343		20,002,881
Finished goods on consignment		149,142		32,948
Total	$	33,417,779	$	32,873,973
Finished jewelry
Raw materials	$	283,378	$	270,043
Work-in-process		562,916		764,355
Finished goods		6,781,866		8,117,035
Finished goods on consignment		355,735		299,514
Total	$	7,983,895	$	9,450,947

Data by geographic area

 The following presents certain data by geographic area:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Net sales
United States	$	7,267,441	$	5,373,178	$	12,976,474	$	10,485,467
International		574,206		1,139,322		932,726		2,532,107
Total	$	7,841,647	$	6,512,500	$	13,909,200	$	13,017,574

	June 30, 2014		December 31, 2013
Property and equipment, net
United States	$	2,163,187	$	1,717,692
International		-		-
Total	$	2,163,187	$	1,717,692

	June 30, 2014		December 31, 2013
Intangible assets, net
United States	$	54,090	$	70,830
International		251,865		255,037
Total	$	305,955	$	325,867

XML

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2014	Jun. 30, 2013	Jun. 30, 2014	Jun. 30, 2013
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) [Abstract]
Net sales	$ 7,841,647	$ 6,512,500	$ 13,909,200	$ 13,017,574
Costs and expenses:
Cost of goods sold	5,324,981	3,389,315	8,988,023	6,271,293
Sales and marketing	2,171,614	2,532,995	4,366,225	4,779,204
General and administrative	2,376,466	1,344,408	3,752,681	2,193,785
Research and development	9,514	9,041	11,501	15,024
Loss on abandonment of assets	0	95,052	2,201	95,052
Total costs and expenses	9,882,575	7,370,811	17,120,631	13,354,358
Loss from operations	(2,040,928)	(858,311)	(3,211,431)	(336,784)
Other income (expense):
Interest income	20	6,972	49	14,474
Interest expense	(188)	(234)	(318)	(974)
Total other (expense) income, net	(168)	6,738	(269)	13,500
Loss before income taxes	(2,041,096)	(851,573)	(3,211,700)	(323,284)
Income tax net (expense) benefit	(4,152,987)	359,988	(4,045,777)	137,972
Net loss	$ (6,194,083)	$ (491,585)	$ (7,257,477)	$ (185,312)
Net loss per common share:
Basic (in dollars per share)	$ (0.31)	$ (0.02)	$ (0.36)	$ (0.01)
Diluted (in dollars per share)	$ (0.31)	$ (0.02)	$ (0.36)	$ (0.01)
Weighted average number of shares used in computing net loss per common share:
Basic (in shares)	20,262,299	19,812,397	20,229,979	19,736,068
Diluted (in shares)	20,262,299	19,812,397	20,229,979	19,736,068

XML

COMMITMENTS AND CONTINGENCIES

6 Months Ended

Jun. 30, 2014

COMMITMENTS AND CONTINGENCIES [Abstract]

COMMITMENTS AND CONTINGENCIES

7. COMMITMENTS AND CONTINGENCIES

Lease Commitments

In March 2004, the Company entered into a seven-year lease, beginning in August 2004, for approximately 16,500 square feet of mixed-use space from an unaffiliated third party at a base cost with escalations throughout the lease term plus additional common-area expenses based on the Company's proportionate share of the lessor's operating costs. The lease provided for two rent holidays, during which no rent was payable, and a moving allowance. In January 2011, the Company amended the lease effective January 1, 2011 to extend the term through January 2017 in exchange for a reduced rental rate and 50% rent abatement in the first 12 months of the extended term.  The amended lease includes 3% annual rent escalations and a one-time option to terminate the lease effective as of July 31, 2014. The Company exercised this right to terminate the lease by giving notice to the lessor prior to October 31, 2013.  The cost to terminate the lease effective July 31, 2014 was approximately $112,000, which the Company paid at the time notice was given to terminate the lease.  This amount reflects all unamortized lease transaction costs, including, without limitation, all rent abated since January 1, 2011, plus two months' rent at the current rental rate. On December 9, 2013, the Company entered into a Lease Agreement, as amended on December 23, 2013 and April 15, 2014 (the "Lease Agreement")") for a new corporate headquarters, which occupies approximately 36,350 square feet of office, storage, and light manufacturing space. The Company took possession of the leased property on May 23, 2014 once certain improvements to the leased space were completed.  These improvements and other lease signing and moving incentives offered by the landlord totaled approximately $550,000 and $73,000, respectively, which will be amortized over the life of the lease.  Included in the Lease Agreement is a seven-month rent abatement period expected to begin June 2014 through December 2014.

The Company recognizes rent expense on a straight-line basis, giving consideration to the rent holidays and escalations, the lease signing and moving allowance to be paid to the Company, and the rent abatement.

As of June 30, 2014, the Company's future minimum payments under the operating leases were as follows:

2014	$	-
2015		553,905
2016		569,138
2017		584,789
2018		600,871
Thereafter		1,793,725
Total	$	4,102,428

Rent expense for the three months ended June 30, 2014 and 2013 was approximately $84,000 and $77,000, respectively.  Rent expense for the six months ended June 30, 2014 and 2013 was approximately $115,000 and $133,000, respectively.

Purchase Commitments

On June 6, 1997, the Company entered into an amended and restated exclusive supply agreement with Cree, Inc. ("Cree"). The exclusive supply agreement had an initial term of ten years that was extended in January 2005 to July 2015. In connection with the amended and restated exclusive supply agreement, the Company has committed to purchase from Cree a minimum of 50%, by dollar volume, of its raw material SiC crystal requirements. If the Company's orders require Cree to expand beyond specified production levels, the Company must commit to purchase certain minimum quantities. Effective February 8, 2013, the Company entered into an amendment to a prior letter agreement with Cree, which provides a framework for the Company's purchases of SiC crystals under the amended and restated exclusive supply agreement. Pursuant to this amendment, the Company agreed to purchase at least $4.00 million of SiC crystals in an initial new order. After the initial new order, the Company has agreed to issue non-cancellable, quarterly orders that must equal or exceed a set minimum order quantity. The total purchase commitment under the amendment until July 2015, including the initial new order, is dependent upon the grade of the material and ranges between approximately $7.64 million and approximately $18.56 million. During the six months ended June 30, 2014 and 2013, the Company purchased approximately $3.58 million and $4.99 million, respectively, of SiC crystals under the exclusive supply agreement.

XML

INCOME TAXES

6 Months Ended

Jun. 30, 2014

INCOME TAXES [Abstract]

INCOME TAXES

6. INCOME TAXES

The Company recognized an income tax net expense of approximately $4.15 million for the three months ended June 30, 2014 compared to an income tax net benefit of approximately $360,000 for the three months ended June 30, 2013.  The Company recognized an income tax net expense of $4.05 million for the six months ended June 30, 2014 compared to an income tax net benefit of $138,000 for the six months ended June 30, 2013.

As of each reporting date, the Company's management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. The Company's management determined that sufficient positive evidence existed as of March 31, 2014 and December 31, 2013 to conclude that it is more likely than not that deferred tax assets of $4.15 million and $4.04 million, respectively, were realizable. A valuation allowance remained at March 31, 2014 and December 31, 2013 against certain deferred tax assets relating to state net operating loss carryforwards from the Company's e-commerce and home party operating subsidiaries due to the timing uncertainty of when the subsidiaries will generate cumulative positive taxable income to utilize the associated deferred tax assets. A valuation allowance also remained at March 31, 2014 and December 31, 2013 against certain deferred tax assets relating to investment loss carryforwards because the Company does not anticipate it will generate sufficient investment income to utilize the carryforwards.The Company also previously considered various strategic alternatives, resulting in management determining that a valuation allowance was not necessary at that time. During the three months ended June 30, 2014, the Company's management determined that such alternatives were no longer in the best interest of the Company. Accordingly, the Company's management concluded that the positive evidence was no longer sufficient to offset available negative evidence, primarily as a result of the pre-tax operating loss for the three and six months ended June 30, 2014. As a result, management concluded that it was uncertain that the Company would have sufficient future taxable income to utilize its deferred tax assets, and therefore, the Company established a valuation allowance against its deferred tax assets, resulting in a tax expense of $4.15 million and $4.05 million for the three and six months ended June 30, 2014, respectively.  During the three and six months ended June 30, 2014, the Company also recognized approximately $6,000 of income tax expense for estimated tax, penalties, and interest associated with uncertain tax positions.

For the three months ended June 30, 2013, the Company recognized $358,000 of current period income tax benefit, offsetting an income tax expense recorded in the first quarter of 2013 of approximately $211,000. The resulting income tax net benefit of $147,000 for the six months ended June 30, 2013 represents an effective tax rate of 45.4% on the year-to-date pre-tax book loss. The effective tax rate for the six months ended June 30, 2013 differs from the federal statutory rate of 34.0% primarily due to the impact of state income taxes, stock-based compensation expense that is not deductible for tax purposes, and other book-to-tax reconciling items. This effective tax rate increased from December 31, 2012 due to anticipation of higher taxable income in 2013, and an additional $7,000 of income tax expense was accrued and paid in the first quarter of 2013 related to the prior tax year, primarily for adjustment of the federal alternative minimum tax. Additionally, the Company recorded approximately $4,000 of income tax benefit for a discrete permanent tax deduction difference during the three and six months ended June 30, 2013 and approximately $2,000 and $6,000 of income tax expense for estimated tax, penalties, and interest associated with uncertain tax positions during the three and six months ended June 30, 2013, respectively.

XML

MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK (Tables)

6 Months Ended

Jun. 30, 2014

MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK [Abstract]

Summary of customers that represent greater than or equal to 10% of total gross sales

A significant portion of sales is derived from certain customer relationships. The following is a summary of customers that represent greater than or equal to 10% of total gross sales:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Customer A	36	%	1	%	30	%	16	%
Customer B	15	%	6	%	17	%	7	%
Customer C	4	%	6	%	13	%	9	%
Customer D	9	%	19	%	0	%	10	%
Customer E	0	%	19	%	0	%	12	%

XML

INVENTORIES (Tables)

6 Months Ended

Jun. 30, 2014

INVENTORIES [Abstract]

Schedule of inventory, net of reserves

The Company's total inventories, net of reserves, consisted of the following as of June 30, 2014 and December 31, 2013:

	June 30, 2013			December 31, 2013
Raw materials	$	5,393,790		$	3,581,418
Work-in-process		7,049,798			10,291,124
Finished goods		29,185,643			28,771,098
Finished goods on consignment		552,877			407,462
Less inventory reserves		(708,000	)		(639,000	)
Total	$	41,474,108		$	42,412,102
Current portion	$	12,419,064		$	13,074,428
Long-term portion		29,055,044			29,337,674
Total	$	41,474,108		$	42,412,102

XML

NET LOSS PER COMMON SHARE

6 Months Ended

Jun. 30, 2014

NET (LOSS) INCOME PER COMMON SHARE [Abstract]

NET (LOSS) INCOME PER COMMON SHARE

10. NET LOSS PER COMMON SHARE

Basic net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the periods. Diluted net loss per common share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the periods. Common equivalent shares consist of stock options that are computed using the treasury stock method. Antidilutive stock awards are comprised of stock options and unvested restricted shares which would have been antidilutive in the application of the treasury stock method in accordance with "Earnings Per Share" topic of the Financial Accounting Standard Board Accounting Standards Codification.

The following table reconciles the differences between the basic and diluted earnings per share presentations:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Numerator:
Net loss	$	(6,194,083	)	$	(491,585	)	$	(7,257,477	)	$	(185,312	)
Denominator:
Weighted average common shares outstanding:
Basic		20,262,299			19,812,397			20,229,979			19,736,068
Stock options		-			-			-			-
Fully diluted		20,262,299			19,812,397			20,229,979			19,736,068
Net loss per common share:
Basic	$	(0.31	)	$	(0.02	)	$	(0.36	)	$	(0.01	)
Diluted	$	(0.31	)	$	(0.02	)	$	(0.36	)	$	(0.01	)

For the three months ended June 30, 2014 and 2013, stock options to purchase approximately 1.37 million and 289,000 shares, respectively, were excluded from the computation of diluted net loss per common share because the exercise price of the stock options was greater than the average market price of the common shares or the effect of inclusion of such amounts would be anti-dilutive to net loss per common share. For the six months ended June 30, 2014 and 2013, stock options to purchase approximately 1.37 million and 463,000 shares, respectively, were excluded from the computation of diluted net loss per common share because the exercise price of the stock options was greater than the average market price of the common shares or the effect of inclusion of such amounts would be anti-dilutive to net loss per common share.

XML

LINE OF CREDIT

6 Months Ended

Jun. 30, 2014

LINE OF CREDIT [Abstract]

LINE OF CREDIT

8. LINE OF CREDIT

On September 20, 2013, the Company obtained a $10,000,000 revolving line of credit (the "Line of Credit") from PNC Bank, National Association ("PNC Bank") for general corporate and working capital purposes. The Line of Credit was evidenced by a Committed Line of Credit Note, dated September 20, 2013 (the "Note"), which was set to mature on June 15, 2015.  The interest rate under the Note was the one-month LIBOR rate (adjusted daily) plus 1.50%, calculated on an actual/360 basis.

The Line of Credit was also governed by a loan agreement, dated September 20, 2013 (the "Loan Agreement") and was guaranteed by Charles & Colvard Direct, LLC, and Moissanite.com, LLC. The Line of Credit was secured by a lien on substantially all assets of the Company and its subsidiaries.

Effective June 25, 2014, the Line of Credit was terminated concurrent with the Company entering into a new banking relationship with Wells Fargo Bank, National Association ("Wells Fargo").   The Company had not utilized the Line of Credit.  The Company recognized the remaining $19,000 of deferred legal expenses associated with this Line of Credit upon termination.

On June 25, 2014, the Company and its wholly owned subsidiaries, Charles & Colvard Direct, LLC, and Moissanite.com, LLC (collectively, the "Borrowers"), obtained a $10,000,000 asset-based revolving credit facility (the "Credit Facility") from Wells Fargo. The Credit Facility will be used for general corporate and working capital purposes, including transaction fees and expenses incurred in connection therewith and the issuance of letters of credit up to a $1,000,000 sublimit. The Credit Facility will mature on June 25, 2017.

The Credit Facility includes a $5,000,000 sublimit for advances that are supported by a 90% guaranty provided by the U.S. Export-Import Bank. Advances under the Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers' eligible accounts and inventory, less reserves. Advances against inventory are further subject to an initial $3,000,000 maximum. The Borrowers must maintain a minimum of $1,000,000 in excess availability at all times. There are no other financial covenants.

Each advance accrues interest at a rate equal to Wells Fargo's 3-month LIBOR rate plus 2.50%, calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default accrues interest at a rate of 3% in excess of the above rate. Any advance may be prepaid in whole or in part at any time. In addition, the maximum line amount may be reduced by the Company in whole or part at any time, subject to a fee equal to 2% of any reduction in the first year after closing, 1% of any reduction in the second year after closing, and 0% thereafter. There are no mandatory prepayments or line reductions.

The Credit Facility is secured by a lien on substantially all assets of the Borrowers, each of which is jointly and severally liable for all obligations thereunder.

The Credit Facility is evidenced by a credit and security agreement, dated as of June 25, 2014 (the "Credit Agreement"), and customary ancillary documents. The Credit Agreement contains customary covenants, representations and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, contingent obligations, liens, loans, investments, mergers, acquisitions, divestitures, subsidiaries, affiliate transactions, and changes in control.

Events of default under the Credit Facility include, without limitation, (1) any impairment of the Export-Import Bank guaranty, unless the guaranteed advances are repaid within two business days, (2) an event of default under any other indebtedness of the Borrowers in excess of $200,000, and (3) a material adverse change in the ability of the Borrowers to perform their obligations under the Credit Agreement or in the Borrowers' assets, liabilities, businesses or prospects, or other circumstances that Wells Fargo believes may impair the prospect of repayment. If an event of default occurs, Wells Fargo is entitled to take enforcement action, including acceleration of amounts due under the Credit Agreement and foreclosure upon collateral.

The Credit Agreement contains other customary terms, including indemnity, expense reimbursement, yield protection, and confidentiality provisions. Wells Fargo is permitted to assign the Credit Facility.

As of June 30, 2014, the Company had not borrowed against the Credit Facility.

XML

STOCK-BASED COMPENSATION

6 Months Ended

Jun. 30, 2014

STOCK- BASED COMPENSATION [Abstract]

STOCK- BASED COMPENSATION

9. STOCK-BASED COMPENSATION

The following table summarizes the components of the Company's stock-based compensation included in net loss:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Employee stock options	$	209,698		$	161,227		$	392,422		$	300,497
Restricted stock awards		224,281			335,740			418,068			443,136
Income tax benefit		(78,349	)		(162,247	)		(146,046	)		(201,184	)
Totals	$	355,630		$	334,720		$	664,444		$	542,449

No stock-based compensation was capitalized as a cost of inventory during the three and six months ended June 30, 2014 and 2013.

Stock Options - The following is a summary of the stock option activity for the six months ended June 30, 2014:

	Shares			Weighted Average Exercise Price
Outstanding, December 31, 2013		1,204,297		$	3.14
Granted		215,000		$	2.89
Exercised		-		$	-
Forfeited		(15,775	)	$	2.85
Expired		(37,576	)	$	3.84
Outstanding, June 30, 2014		1,365,946		$	3.09

The weighted average grant-date fair value of stock options granted during the six months ended June 30, 2014 was $2.06. The total fair value of stock options that vested during the six months ended June 30, 2014 was approximately $445,000. The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option pricing model with the following weighted average assumptions for stock options granted during the six months ended June 30, 2014:

Dividend yield	0.0	%
Expected volatility	92.9	%
Risk-free interest rate	1.61	%
Expected lives (years)	5.0

Although the Company issued dividends in prior years, a dividend yield of zero was used due to the uncertainty of future dividend payments. Volatility is a measure of the amount by which a financial variable such as share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company estimates expected volatility giving primary consideration to the historical volatility of its common stock. The risk-free interest rate is based on the published yield available on U.S. Treasury issues with an equivalent term remaining equal to the expected life of the stock option. The expected lives of the stock options represent the estimated period of time until exercise or forfeiture and are based on historical experience of similar awards.

The following table summarizes information about stock options outstanding at June 30, 2014:

Options Outstanding						Options Exercisable						Options Vested or Expected to Vest
Balance as of 6/30/2014		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Balance as of 6/30/2014		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Balance as of 6/30/2014		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price
	1,365,946		7.72	$	3.09		892,453		6.99	$	2.63		1,302,584		6.99	$	3.05

As of June 30, 2014, the unrecognized stock-based compensation expense related to unvested stock options was approximately $953,000, which is expected to be recognized over a weighted average period of approximately 25 months.

The aggregate intrinsic value of stock options outstanding, exercisable, and vested or expected to vest at June 30, 2014 was approximately $385,000, $383,000, and $385,000, respectively. This amount is before applicable income taxes and represents the closing market price of the Company's common stock at June 30, 2014 less the grant price, multiplied by the number of stock options that had a grant price that is less than the closing market price. This amount represents the amount that would have been received by the optionees had these stock options been exercised on that date. During the three and six months ended June 30, 2014, no stock options were exercised.

Restricted Stock - The following is a summary of the restricted stock activity for the six months ended June 30, 2014:

	Shares			Weighted Average Grant Date Fair Value
Unvested, December 31, 2013		350,903		$	4.26
Granted		160,032		$	2.22
Vested		(175,903	)	$	4.00
Canceled		-		$	-
Unvested, June 30, 2014		335,032		$	3.42

As of June 30, 2014, the unrecognized stock-based compensation expense related to unvested restricted stock was approximately $967,000, which is expected to be recognized over a weighted average period of approximately 18 months.

Dividends - The Company has not paid any cash dividends in the current year through June 30, 2014.

XML

MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

6 Months Ended

Jun. 30, 2014

MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK [Abstract]

MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

11. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments, and trade accounts receivable. The Company maintains cash and cash equivalents, and investments with high-quality financial institutions and invests in low-risk securities, primarily money market funds or long-term U.S. government agency obligations. At times, cash balances may exceed the Federal Deposit Insurance Corporation ("FDIC") insurable limits of $250,000 per depositor at each financial institution. Amounts on deposit in excess of FDIC insurable limits at June 30, 2014 and 2013 approximated $3.0 million and $6.78 million, respectively.

Trade receivables potentially subject the Company to credit risk. The Company's standard wholesale customer payment terms on trade receivables are generally between 30 and 90 days, though it may offer extended terms with specific customers and on significant orders from time to time. The Company believes its competitors and other vendors in the wholesale jewelry industry have also expanded their use of extended payment terms and, in aggregate, the Company believes that by expanding its use of extended payment terms, it has provided a competitive response in its market and that its net sales have been favorably impacted. The Company is unable to estimate the impact of this program on its net sales, but if it ceased providing extended payment terms in select instances, the Company believes it would not be competitive for some wholesale customers in the marketplace and that its net sales and profits would likely decrease. The Company extends credit to its customers based upon a number of factors, including an evaluation of the customer's financial condition and credit history, the customer's payment history with the Company, the customer's reputation in the trade, and/or an evaluation of the Company's opportunity to introduce its moissanite jewels or finished jewelry featuring moissanite to new or expanded markets. Collateral is not generally required from customers. The need for an allowance for doubtful accounts is determined based upon factors surrounding the credit risk of specific customers, historical trends, and other information. The Company has not experienced any significant accounts receivable write-offs related to revenue arrangements with extended payment terms, but has increased its allowance for doubtful accounts by approximately $700,000 due to one customer that has become past due on its payment arrangement.

As of June 30, 2014 and December 31, 2013, one customer accounted for 29% and 21%, respectively, of trade accounts receivable. No other customers accounted for more than 10% of trade accounts receivable at December 31, 2013. As of June 30, 2014, one other customer accounted for 12% of trade accounts receivable.

A significant portion of sales is derived from certain customer relationships. The following is a summary of customers that represent greater than or equal to 10% of total gross sales:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Customer A	36	%	1	%	30	%	16	%
Customer B	15	%	6	%	17	%	7	%
Customer C	4	%	6	%	13	%	9	%
Customer D	9	%	19	%	0	%	10	%
Customer E	0	%	19	%	0	%	12	%

XML

STOCK-BASED COMPENSATION (Tables)

6 Months Ended

Jun. 30, 2014

STOCK- BASED COMPENSATION [Abstract]

Schedule for components of stock based compensation

The following table summarizes the components of the Company's stock-based compensation included in net loss:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Employee stock options	$	209,698		$	161,227		$	392,422		$	300,497
Restricted stock awards		224,281			335,740			418,068			443,136
Income tax benefit		(78,349	)		(162,247	)		(146,046	)		(201,184	)
Totals	$	355,630		$	334,720		$	664,444		$	542,449

Summary of the stock option activity

Stock Options - The following is a summary of the stock option activity for the six months ended June 30, 2014:

	Shares			Weighted Average Exercise Price
Outstanding, December 31, 2013		1,204,297		$	3.14
Granted		215,000		$	2.89
Exercised		-		$	-
Forfeited		(15,775	)	$	2.85
Expired		(37,576	)	$	3.84
Outstanding, June 30, 2014		1,365,946		$	3.09

Weighted average assumptions for stock options granted

The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option pricing model with the following weighted average assumptions for stock options granted during the six months ended June 30, 2014:

Dividend yield	0.0	%
Expected volatility	92.9	%
Risk-free interest rate	1.61	%
Expected lives (years)	5.0

Information about stock options outstanding

The following table summarizes information about stock options outstanding at June 30, 2014:

Options Outstanding						Options Exercisable						Options Vested or Expected to Vest
Balance as of 6/30/2014		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Balance as of 6/30/2014		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Balance as of 6/30/2014		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price
	1,365,946		7.72	$	3.09		892,453		6.99	$	2.63		1,302,584		6.99	$	3.05

Restricted stock activity

Restricted Stock - The following is a summary of the restricted stock activity for the six months ended June 30, 2014:

	Shares			Weighted Average Grant Date Fair Value
Unvested, December 31, 2013		350,903		$	4.26
Granted		160,032		$	2.22
Vested		(175,903	)	$	4.00
Canceled		-		$	-
Unvested, June 30, 2014		335,032		$	3.42

XML

INVENTORIES (Details) (USD $)	6 Months Ended
	Jun. 30, 2014	Dec. 31, 2013
Total inventories, net of reserves [Abstract]
Raw materials	$ 5,393,790	$ 3,581,418
Work-in-process	7,049,798	10,291,124
Finished goods	29,185,643	28,771,098
Finished goods on consignment	552,877	407,462
Less inventory reserves	(708,000)	(639,000)
Total	41,474,108	42,412,102
Current portion	12,419,064	13,074,428
Long-term portion	29,055,044	29,337,674
Period considered for classification of long term inventory	12 months
Work-in-process inventories issued to active production jobs	2,110,000	4,090,000
Inventory reserve for obsolescence	128,000	128,000
Carrying value of inventory reserve for obsolescence of moissanite	30,000	30,000
Shrinkage reserve for finished goods on consignment	48,000	75,000
Inventory of net loose jewels	33,420,000	32,870,000
Inventory reserve for shrinkage of loose jewels	1,000	2,000
Inventory reserve for shrinkage of loose jewels on consignment	0	0
Inventory reserve for recuts	197,000	172,000
Inventory of net jewelry	7,980,000	9,450,000
Scrap reserve	114,000	106,000
Inventory reserve for shrinkage of finished jewelry	160,000	180,000
Inventory reserve for shrinkage of finished jewelry on consignment	48,000	75,000
Inventory reserve for shrinkage of finished jewelry on repairs	$ 78,000	$ 51,000

XML

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (USD $)	6 Months Ended
	Jun. 30, 2014	Jun. 30, 2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$ (7,257,477)	$ (185,312)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	588,745	384,749
Amortization of bond premium	0	2,706
Stock-based compensation	810,490	743,633
Provision for uncollectible accounts	682,725	(60,805)
Provision for sales returns	(845,000)	(135,000)
Provision for inventory reserves	69,000	75,000
Provision (benefit) for deferred income taxes	4,039,723	(150,832)
Loss on abandonment of assets	2,201	95,052
Changes in assets and liabilities:
Accounts receivable	2,590,297	476,974
Interest receivable	0	(891)
Inventory	868,994	(3,664,506)
Prepaid expenses and other assets, net	(394,745)	(392,819)
Accounts payable	(10,651)	430,126
Accrued cooperative advertising	8,000	108,000
Accrued income taxes	6,054	5,810
Other accrued liabilities	647,581	(40,620)
Net cash provided by (used in) operating activities	1,805,937	(2,308,735)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(956,666)	(202,610)
Patent, license rights, and trademark costs	(59,863)	(91,678)
Net cash used in investing activities	(1,016,529)	(294,288)
CASH FLOWS FROM FINANCING ACTIVITIES:
Stock option exercises	0	13,400
Net cash provided by financing activities	0	13,400
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	789,408	(2,589,623)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	2,573,405	11,860,842
CASH AND CASH EQUIVALENTS, END OF PERIOD	3,362,813	9,271,219
Supplemental disclosures of cash flow information:
Cash paid during the period for interest	318	974
Cash paid during the period for income taxes	$ 0	$ 7,050

XML

INVENTORIES

6 Months Ended

Jun. 30, 2014

INVENTORIES [Abstract]

INVENTORIES

5. INVENTORIES

Assets that are measured at fair value on a non-recurring basis include property and equipment, leasehold improvements, and intangible assets, comprising patents, license rights, and trademarks. These items are recognized at fair value when they are considered to be impaired. Level 3 inputs are primarily based on the estimated future cash flows of the asset determined by market inquiries to establish fair market value of used machinery or future revenue expected to be generated with the assistance of patents, license rights, and trademarks.

The Company's total inventories, net of reserves, consisted of the following as of June 30, 2014 and December 31, 2013:

	June 30, 2013			December 31, 2013
Raw materials	$	5,393,790		$	3,581,418
Work-in-process		7,049,798			10,291,124
Finished goods		29,185,643			28,771,098
Finished goods on consignment		552,877			407,462
Less inventory reserves		(708,000	)		(639,000	)
Total	$	41,474,108		$	42,412,102
Current portion	$	12,419,064		$	13,074,428
Long-term portion		29,055,044			29,337,674
Total	$	41,474,108		$	42,412,102

Inventories are stated at the lower of cost or market on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs. Any inventory on hand at the measurement date in excess of the Company's current requirements based on historical and anticipated levels of sales is classified as long-term on the Company's consolidated balance sheets. The Company's classification of long-term inventory requires it to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized over the next 12 months.

The Company's work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. The Company's moissanite jewel manufacturing process involves the production of intermediary shapes, called "preforms," that vary depending upon the size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of June 30, 2014 and December 31, 2013, work-in-process inventories issued to active production jobs approximated $2.11 million and $4.09 million, respectively.

The Company's jewels do not degrade in quality over time and inventory generally consists of the shapes and sizes most commonly used in the jewelry industry. In addition, the majority of jewel inventory is not mounted in finished jewelry settings and is therefore not subject to fashion trends nor is obsolescence a significant factor. The Company has very small market penetration in the worldwide jewelry market, and the Company has the exclusive right in the U.S. through mid-2015 and in many other countries through mid-2016 to produce and sell created SiC for use in jewelry applications. In view of the foregoing factors, management has concluded that no excess or obsolete loose jewel inventory reserve requirements existed as of June 30, 2014.

In 2010, the Company began manufacturing finished jewelry featuring moissanite. Relative to loose moissanite jewels, finished jewelry is more fashion oriented and subject to styling trends that could render certain designs obsolete. The majority of the Company's finished jewelry featuring moissanite is held in inventory for resale and consists of such basic designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets that tend not to be subject to significant obsolescence risk due to their classic styling. In addition, the Company manufactures small individual quantities of designer-inspired moissanite fashion jewelry as part of its sample line that are used in the selling process to its wholesale customers.

In 2011, the Company began purchasing fashion finished jewelry comprised of base metals and non-precious gemstones for sale through Lulu Avenue^®, the direct-to-consumer home party division of the Company's wholly owned operating subsidiary, Charles & Colvard Direct, LLC. This finished jewelry is fashion oriented and subject to styling trends that may change with each catalog season, of which there are several each year. Typically in the jewelry industry, slow-moving or discontinued lines are sold as closeouts or liquidated in alternative sales channels. The Company reviews the finished jewelry inventory on an ongoing basis for any lower of cost or market and obsolescence issues.  The Company identified certain fashion finished jewelry inventory that could not be sold due to damage or branding issues and established an obsolescence reserve of $128,000 as of June 30, 2014 and December 31, 2013, for the carrying costs in excess of any estimated scrap values.  As of June 30, 2014, the Company identified certain finished jewelry featuring moissanite that was obsolete and established an obsolescence reserve of $30,000 for the carrying costs in excess of any estimated scrap values.

Periodically, the Company ships finished goods inventory to wholesale customers on consignment terms. Under these terms, the customer assumes the risk of loss and has an absolute right of return for a specified period. Finished goods on consignment at June 30, 2014 and December 31, 2013 are net of shrinkage reserves of $48,000 and $75,000, respectively, to allow for certain loose jewels and finished jewelry on consignment with wholesale customers that may not be returned or may be returned in a condition that does not meet the Company's current grading or quality standards.

Total net loose jewel inventories at June 30, 2014 and December 31, 2013, including inventory on consignment net of reserves, were $33.42 million and $32.87 million, respectively. The loose jewel inventories at June 30, 2014 and December 31, 2013 include shrinkage reserves of $1,000 and $2,000, respectively, with no shrinkage reserves on inventory on consignment. Loose jewel inventories at June 30, 2014 and December 31, 2013 also include recuts reserves of $197,000 and $172,000, respectively.

Total net jewelry inventories at June 30, 2014 and December 31, 2013, including inventory on consignment net of reserves, finished jewelry featuring moissanite manufactured by the Company since entering the finished jewelry business in 2010, and fashion finished jewelry purchased by the Company for sale through Lulu Avenue^®, were $7.98 million and $9.45 million, respectively. Jewelry inventories consist primarily of finished goods, a portion of which the Company acquired as part of a January 2009 settlement agreement with a former manufacturer customer to reduce the outstanding receivable to the Company. Due to the lack of a plan to market this inventory at that time, a jewelry inventory reserve was established to reduce the majority of the acquired jewelry inventory value to scrap value, or the amount the Company would expect to obtain by melting the gold in the jewelry and returning to loose-jewel finished goods inventory those jewels that meet grading standards. The scrap reserve established for this acquired inventory at the time of the agreement is adjusted at each reporting period for the market price of gold and has generally declined as the associated jewelry is sold down. At June 30, 2014, the balance increased to $114,000 from $106,000 at December 31, 2013 as a result of a sales return, offset in part by sell down of the inventory during the quarter. Because the finished jewelry the Company began manufacturing in 2010 after it entered that business was made pursuant to an operational plan to market and sell the inventory, it is not subject to this reserve. The finished jewelry inventories at June 30, 2014 and December 31, 2013 also include shrinkage reserves of $160,000 and $180,000, respectively, including shrinkage reserves of $48,000 and $75,000 on inventory on consignment, respectively; and finished jewelry inventories at June 30, 2014 and December 31, 2013 include a repairs reserve of $78,000 and $51,000, respectively.

The need for adjustments to inventory reserves is evaluated on a period-by-period basis.

XML

INCOME TAXES (Details) (USD $)	3 Months Ended			6 Months Ended
	Jun. 30, 2014	Jun. 30, 2013	Mar. 31, 2013	Jun. 30, 2014	Jun. 30, 2013	Mar. 31, 2014	Dec. 31, 2013
INCOME TAXES [Abstract]
Income tax net (expense) benefit	$ (4,152,987)	$ 359,988		$ (4,045,777)	$ 137,972
Deferred tax assets						4,150,000	4,040,000
Current period income tax benefit (expense)		358,000	(211,000)		147,000
Effective income tax rate (in hundredths)					45.40%
Federal statutory income tax rate (in hundredths)					34.00%
Increases related to prior year tax positions			7,000
Income tax benefit for discreet permanent tax deduction	4,000			4,000
Income tax expense for estimated tax, penalties, and interest for other uncertain tax positions	$ 6,000	$ 2,000		$ 6,000	$ 6,000

XML

COMMITMENTS AND CONTINGENCIES (Tables)

6 Months Ended

Jun. 30, 2014

COMMITMENTS AND CONTINGENCIES [Abstract]

Future minimum payments under operating lease

As of June 30, 2014, the Company's future minimum payments under the operating leases were as follows:

2014	$	-
2015		553,905
2016		569,138
2017		584,789
2018		600,871
Thereafter		1,793,725
Total	$	4,102,428