Suzanne Miglucci - President and Chief Executive Officer Clint Pete - Chief Financial Officer.

Eric Landry - BML Capital Management, LLC Andrew Beeli - Aristides Capital Rodney Baber - Paulson Investment Company, LLC.

Good day, and welcome to the Charles & Colvard Third Quarter 2018 [sic] [First Quarter 2019] Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions.

[Operator Instructions] This earnings call may contain forward-looking statements as defined in Section 27A of the Securities Act of 1933 as amended, including statements regarding, among other things, the company’s business strategy and growth strategy.

Expressions which identify forward-looking statements speak only as of the date the statement is made. These forward-looking statements are based largely on our company’s expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond our control.

Future development and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking statement information will prove to be accurate.

This earnings call does not constitute an offer to purchase any securities nor a solicitation of a proxy, consent, authorization or an agent designation with respect to a meeting of the company’s shareholders.

Accompanying today’s call is a supporting PowerPoint slide deck, which is available in the Investor Relations section of the company’s website at ir.charlesandcolvard.com/events. Please note that this event is being recorded. I would now like to turn the conference over to Suzanne Miglucci, President and CEO, Chief Executive Officer. Please go ahead..

Good afternoon, and thank you for joining us as we summarize Charles & Colvard’s results for the quarter ended September 30, 2018, the first quarter of our new fiscal year 2019.

We are pleased to deliver today’s results, which include a significant net sales growth in our Online Channels segment, strong gross margin and positive net income, all indicators of the strength and scalability we’ve built into our business model at Charles & Colvard.

We believe our strategy is working and that we’re at an inflection point in our quarterly performance. Clint Pete, our CFO, will begin today’s call with an overview of our financials and then I’ll return to discuss key highlights from the quarter and the status of our 2019 initiatives.

Clint?.

Thank you, Suzanne. Good afternoon, everyone, and thank you for joining us. My comments today will be focused on highlighting the key financial trends we saw in Q1 2019. Additional detail can be found in our Form 10-Q for the quarter ended September 30, 2018. Beginning on Slide 5.

We reported net income for Q1 2019 of approximately $110,000, or $0.01 per share, compared with a net loss of approximately $170,000, or $0.01 per share in the year-ago quarter. Slide 6 summarizes our net sales for Q1 2019 compared to the year-ago quarter. Net sales increased 6% versus the year-ago quarter.

We continue to see positive trends in our Online Channels segment net sales, which consist of e-commerce outlets, including charlesandcolvard.com, third-party online marketplaces, drop-ship retailers and other pure-play, exclusively e-commerce customers.

We generated a 49% increase versus the year-ago quarter, with Online Channels representing 47% of total net sales versus 33% in the year-ago quarter. Finished jewelry net sales increased 21% for the quarter.

We believe this increase continues to result from our strategy to drive finished jewelry sales across multiple geographies and channels, including brick-and-mortar retail partners, drop-ship retail partners and our direct-to-consumer initiatives, which includes our charlesandcolvard website, as well as domestic and international marketplaces.

International sales increased 79% versus the year-ago quarter due to increased demand from our international distributor market. In the company’s Traditional segment, which consists of wholesale and retail customers, net sales for the quarter decreased 15%.

We believe this decrease is primarily due to headwinds we’re experiencing with our domestic distributors who serve independent jewelers. The decline was partially offset by significant improved performance of our international distributors. On Slide 7. In the first quarter of 2019, our gross margin was 45%, compared to 44% in the year-ago quarter.

Stabilized gross margin resulted from strong sales of our Forever One product on our transactional website, charlesandcolvard.com, and through retail and commercial outlets. Forever One net sales of finished jewelry and loose gemstones represented 87% of total net sales, compared to 86% in the year-ago quarter. Slide 8.

At the top of each bar, we show operating expenses as a percentage of net sales. The dollar level of our operating expenses for each quarter is presented inside each bar. For Q1 2019, operating expenses as a percentage of net sales was 44%, which decreased from 47% in the year-ago quarter and 51% in Q2 2018.

Overall, operating expenses were flat compared to the year-ago quarter, with increased marketing investments offset by reduced professional services fees and decreased software costs from our migration to the cloud-based data storage.

We believe the trend line of our operating expenses as a percentage of net sales continues to reflect the scalability that we have built into our business by controlling costs, while continuing to grow our top line. Slide 9 presents a snapshot of our balance sheet.

At September 30, 2018, we had $2.2 million of cash, cash equivalents and restricted cash, compared to $3.4 million at June 30, 2018. We continue to have no long-term debt and have not accessed funds through our credit facility. Drilling down on inventory.

At September 30, 2018, compared to June 30, 2018, total inventory was $32.8 million, compared to $31.8 million. Loose jewels inventory was $24.1 million, flat to June 30, and finished jewelry inventory increased to $8.6 million, compared to $7.8 million.

This increase reflects our intentional inventory buildup to prepare for the upcoming holiday season, typically our largest sales volume quarter of the year. On Slide 10. We’ve provided detail regarding the classification of our new versus legacy materials.

At September 30, 2018, 71% of our inventory was classified as new inventory, leaving just 29% of our inventory classified as legacy inventory. This represents significant progress at moving out that legacy inventory, which is now down 17% from December 31, 2017, and down 43% from December 31, 2016.

In summary, we are focused on executing our fiscal year 2019 strategic initiatives. We saw encouraging trends in our business during the recent quarter and we believe we are well-positioned as we are entering the key holiday selling season.

We believe that over time, our strategic accomplishments and continued improvements in performance will be reflected in the valuation of our stock. I would now like to turn it back over to Suzanne..

Amazon, eBay and Catch. Let’s turn to our Traditional segment on Slide 15 to discuss brick-and-mortar. I’m pleased to report that we are once again expanding our presence in Helzberg Diamonds stores. As we’ve discussed previously, we’re in nearly all Helzberg stores with a case line that features bridal and fine Forever One jewelry selections.

In October, we doubled our case line in the top 100 performing stores. We’ve filled that additional space with new bridal and fine jewelry options, as well as a selection of loose gemstones. We’re thrilled to support this expanded product presence. We’re also excited to now be included in the coveted bridal section of these top 100 Helzberg stores.

And, remember, we continue to serve helzberg.com through our drop-ship program. This retail relationship is an excellent example of how validating our products with a retailer’s customer through an online presence can evolve into a diverse omnichannel relationship.

In addition to Helzberg, we’ve also recast our brick-and-mortar presence with Boscov’s department stores. Boscov’s has a fleet of 47 stores in the Northeast. We’ve outfitted this retailer with a new curated collection of Moissanite by Charles & Colvard jewelry set in 14-carat gold. Let’s touch on product innovation on Slide 16.

We continue to evolve our product line to attract a broad audience with a wide variety of gemstone and jewelry offerings. In fiscal Q1, we introduced the Charles & Colvard Signature Collection, an exclusive and unique assortment of bridal and fine jewelry featuring Forever One set in patent-pending designs inspired by the company’s logo.

In the jewelry industry, it’s hard to develop something completely unique and protected. In this case, we want to protect the representation of our logo, what we call our floret, which is an integral part of Signature Collection designs. Therefore, we believe it’s worth a small investment to create long-term enterprise value by applying for patent.

We intend to make future intellectual property investments on a case-by-case basis. This is our very first collection, which we delivered in an inspirational campaign to engage consumers. We’re pleased with the interest in the collection and the audience engagement it’s created.

We believe collections may be a viable way to package new products for our customers going forward and we’re exploring how to integrate collections into our go-forward product strategy. Last quarter, we introduced Moissanite by Charles & Colvard, a new branded line of created moissanite gemstones which are value priced.

As we roll into the 2018 holiday season, we expect Moissanite by Charles & Colvard to have a strong representation in our drop-ship program, replacing some of our legacy Forever Classic and Forever Brilliant products and elevating the quality and breadth of moissanite jewelry for all of our drop-ship partners.

Rounding out our portfolio, Charles & Colvard’s Forever One continues to be our flagship product, commanding a premium price, given what we believe to be its unrivaled clarity, color, cut and polish. Forever One represented 81% of our jewelry sales in fiscal one and 87% of our total net sales.

As you can see, this has been a very busy and productive quarter. In particular, we’ve developed new revenue channels as we grow our global footprint. Since our relaunch in October of 2016, and as noted on Slide 17, we believe in deploying an omnichannel strategy.

This means having our products everywhere the consumer may be when they’re researching products or making buying decisions. From our own website, charlesandcolvard.com, to marketplaces, social media outlets, search engines and traditional retail outlets, it’s our intention to have a multi-threaded market position.

We’ve received several inquiries about the investments necessary to support these channels and the relative time to profitability. So I’d like to walk you through how we view the various channels and tradeoffs in those investments. Slide 18 outlines our primary approaches to expanding our business.

Across the top of this chart are four primary channels that represent key areas of growth. You’ll note we’ve not listed social media or search engines. These are essentially no initiation costs, only ongoing advertising costs.

Therefore, we have not included them in this analysis, but they remain important and critical paths in a holistic revenue picture. The first two rows provide the definition and benefits for each of these channels.

In short, cross-border trade is done on our own charlesandcolvard.com site; marketplaces are outlets such as Amazon, eBay and walmart.com; drop-ship supports retailers online sites such as overstock.com, helzberg.com and macys.com; and lastly, brick-and-mortar retailers include such organizations as Helzberg Diamonds stores and Boscov’s.

The third and fourth rows outline the inventory investments and costs associated with launching and maintaining programs within these channels. Let’s turn our attention to the last row, where we summarize our return on investment. There’s a very low cost of entry to offer our goods via cross-border trade.

We leverage our existing transactional website and incur minimal investments in subscription and transaction fees. Essentially our time to profitability was nearly immediate. Marketplaces and drop-ship retail follow a transactional model. Fees are paid when a transaction takes place, at which time we share the revenue with the channel partner.

Some marketplaces require an upfront integration fee and there are times when we need to make an investment in special inventory for a drop-ship partner. But the main cost to manage these channels is our minimal ongoing monthly subscription and transaction fees related to goods as they are purchased.

Our time to profitability is related to how quickly we create awareness for moissanite in these new channels, which can range from weeks to several months. All of these online channels, cross-border, marketplaces and drop-ship, share product inventory, and this is an important point.

We can produce one piece of jewelry and share it across all of the aforementioned online channels. It can sit in a vault at our North Carolina distribution center, but remain visible across dozens of online channels globally and be shipped only when an order is confirmed.

This shared inventory helps us control our inventory development costs, while supporting global exposure for our products. Now let’s review entering new brick-and-mortar retail accounts. This is very different than serving online channels. As is common in the jewelry space, these programs are sometimes built on consignment terms.

That means, we’re required to provide inventory at our cost, ship it to our retail partner stores and await payment once goods have sold. This requires substantial upfront investment in the inventory that is now dedicated to one retail channel, compared to those online channels where one set of inventory is shared across all online channels.

A typical inventory turn for jewelry in a brick-and-mortar store is 1x annually, meaning it generally takes one year for the value of the inventory to be sold. And that’s often contingent on additional investments in advertising and exposure to ensure the brand and products are properly marketed to the retailer’s end consumer.

If done well, brick-and-mortar can be a highly lucrative opportunity over time, but it does take significant upfront investment and patience to achieve that potential return.

We remain very interested in brick-and-mortar and believe there are meaningful opportunities for us to leverage in-store programs to put our brilliant product in front of potential customers.

At the same time, we will very carefully evaluate each opportunity for its alignment with our potential customer and the cash and inventory implications it has for our business and our shareholders.

Overall, we believe the low overhead and agile manner in which we can grow through cross-border trade, on marketplaces and with our drop-ship retailers is a smart and viable growth strategy for the immediate future.

And in the case of our drop-ship program, it can be the prelude to a deeper relationship that can lead to brick-and-mortar opportunities with a partner and customer we already know. I’ll close on Slide 19, which outlines our strategic initiatives for fiscal year 2019.

From these initiatives, we’ve launched multiple new revenue programs that are just now bearing fruit, and we’re excited to track their progress throughout fiscal 2019. Our strategy is working, as evidenced by our Online Channels growth, the product adoption we’re seeing with consumers and retail partners and our profitability.

Our inventory is under control. Our balance sheet is strong. We carry no debt, and we’ve resolved how to do all of this while turning a profit. We’re excited to head into the anticipated high-performing 2018 holiday season with these strong underpinnings. This concludes our prepared remarks. I’d now like to open the call to take your questions.

Cole, would you please poll for questions from our listening audience?.

We will now begin the question-and-answer session. [Operator Instructions].

While we’re waiting for you to fill the queue, we did have an email question that we thought we’d begin with. One of our shareholders inquired how we’ll work with international marketplaces to create brand awareness? Thank you very much for your inquiry and for the timely question.

So it’s one thing for a brand to upload product listings to a marketplace website and it’s really quite another for the building of the brand. Thankfully, we have digital marketing to help us with this endeavor. We have several opportunities to utilize digital advertising to drive awareness and to grow our brand while driving international sales.

So much like we do in the U.S., we plan to buy key words on search engines and engage consumers on social media. But importantly, we plan to place product ads within the marketplace. So with marketplaces, we have the advantage of reaching all of the consumers the marketplace has already engaged.

With digital ads within the marketplace, it will boost our exposure and the effective – we can measure the effectiveness of our investments in real-time. If something is performing we keep doing it; if it’s not performing we can dial it back. Meanwhile, we expect to learn a tremendous amount about our opportunity in these regions.

We’ll figure out what ads convert. We’ll figure out what kind of products the consumer likes. And with minimal subscription and integration fees, it’s an inexpensive way to test these new waters. Cole, looks like we may have some folks in the queue. Let’s go to our first caller, please..

And our first question comes from Eric Landry with BML Capital. Please go ahead with your question..

Hi, thank you.

Can you hear me?.

I can, Eric.

How are you?.

Okay, great, great. So the 49% in Online was again, very, very impressive. But I’d like to hone in a little bit on the other segment.

Was there an issue again with the distributor that you mentioned in the prior quarter?.

No, actually there was not. So in the prior quarter, we had a one-time issue with a distributor who had rebalanced their inventory, and that has been resolved and we’re on our way. We are, however, experiencing some headwinds with all of our U.S. distributors.

What we’re hearing is that, there are some challenges with selling into and through the independent jeweler market. We think that part of the challenge here – and we’re doing some speculation. But part of the challenge is that, it’s a new consumer out there. This consumer is very demanding.

She goes online, she’s on social media, and she expects that her brands that she’s engaging with engage with her on social. She’s expecting to go to a very robust website in order to review your products and understand your brand better. And then she wants that seamless online-to-in-store experience. These independent jewelers are mom-and-pop shops.

These are folks that are right around the corner from you. These are people that are used to foot traffic. And so challenging for them to live into this digital age and to engage this consumer in quite the way that she’s used to. And in the meantime, it’s very noisy out there and a lot of other brands are vying for her attention.

So it’s challenging for these jewelers and we can say it was challenging for us. It took us quite sometime to revamp our own model in order to have that online presence. And we believe some of those pressures are creating these headwinds in the domestic distributors.

Now, it’s offset by very nice performance from our international distributors who are, I think, in a very different space. Most of those dollars are coming from greater Asia Pacific. It’s a consumer that really does understand the online space and these distributors understand it as well.

So that performance is actually different and we believe that’s sort of at the core to what’s happening with our domestic distributors..

Okay.

So do you think – excuse me, is there a program in place to sort of help these mom-and-pop shops, or is this something that you’re willing to accept as you grow faster and faster and more so online?.

Well, Eric, we want more always. So we are here with a program to support our distributors and, in turn, what we call their authorized retailers. We actually support them with a portal. And in that portal, we have several materials to help with their promotion out into the marketplace. We provide assets.

We provide programmatic outlines that actually help the brands represent Charles & Colvard, explain moissanite and then bring it to market..

Okay.

Next question is, do you think that you’ll have to go into the revolver as you build inventory for the holidays, or will you – would that not be likely?.

I’m sorry, could you repeat that question?.

Do you think that you’ll have to use the revolver this year?.

Clint, do you want to answer that question?.

Sure. Eric, good to hear from you again. As you – as I noted, we had about $2.2 million in cash at the end of the quarter.

We anticipate that our existing cash and the cash equivalents and restricted cash and access to other working capital facilities like the facility, together with our future cash expected to be provided through operating activities, will be sufficient to meet our working capital needs over the next 12 months..

Cole….

[Operator Instructions] And our next question comes from Andrew Beeli from Aristides Capital. Please go ahead with your question..

Hi. I have a question about your new channel investments and ROI. Your cross-border trade has a very stable margin profile.

Could you walk us through that a little bit more and explain the rationale for that versus your expansion into the Australian market that you announced recently?.

Sure, Andrew, happy to do that. So cross-border trade happens on our own charlesandcolvard.com website.

And what we’re doing here is, we’re simply extending a similar shopping experience into the international shopper in ways that are familiar to them, like providing for them in their shopping cart the ability to see funds, or to see the cost in their local currency and the ability actually to use localized payment methods that are familiar to them.

The platform also offers the opportunity eventually, should we get there, to personalize and to change things out into local languages and so on.

The reason for the high-margin and the high-return is because we are directly selling to that consumer, as opposed to some of the other channels that you see on the investment slide, where we go through a third party in order to get to that consumer.

Every time we go through another click, if you will, to get down into the consumer chain, we’re sharing that revenue or those dollars with that channel partner. In this case, we’re selling direct and that gives us a much higher margin. Now, you asked also about Australia. There are a couple of parts of the world that are responding very nicely to us.

And it’s those initially that are English-speaking. We’re already selling through cross-border trade. People have been coming to our site and they have been transacting with us. What we do is, we look at the analytics behind it to see where they’re coming from. We have a fairly strong representation of folks from the UK.

We have a strong representation of people from Canada. And we have a strong representation of people from Australia, mainly we believe because they’re English-speaking and then they’re familiar with U.S. brands. It’s easy for them to assimilate and consume these direct brands.

So because of that, we’d like to also be in country with those same consumers and ergo, the reason why we’re in Australia. Amazon is new to Australia. eBay has been there for quite sometime. Catch is relatively new. They are all very sort of forward-thinking marketplaces that reach that local audience.

Now, it’s going to take us sometime to reach into that local audience through our digital marketing efforts in order to gain all those eyeballs. At the same time, we can have listings on Amazon or eBay or Catch and we can engage all of that audience through digital marketing in that local platform.

So double-threading it, we certainly would encourage those consumers to now come to our U.S. site as well and the selection would be broader here than they might see of us directly on those marketplaces. So it’s a balance of the two again, being everywhere the consumer is where they’re shopping..

Excellent. Thank you.

And as a follow-up, can you provide any details on how you guys see or are projecting those marketplace entrances and played over into more cross-border trade as well?.

Yes. We don’t have real numbers that we can share. We usually don’t drill down and provide guidance into any one of our specific channels and we don’t know. The truth of the matter here, Andrew, is that, we really don’t know that consumer well. So we’re not sure how she will respond.

And we consider this almost on market research activity to understand what is she going to buy, what kind of ads does she respond to. She may have a very different merchandise profile than my U.S. customers, for example. So this is exploratory for us. And then the good news is, it’s all digital.

So once we gain in that understanding and we see what’s selling through, we can recurate the goods that are on those marketplaces, attune it more to the things that are selling, advertise more the things that are selling and then that helps us with a bit of an accelerator to speed the revenue along.

But I want to caution everyone, this is very exploratory at this point and we’re like two weeks into some of these. So we just don’t know yet. But we’re excited about it, because again, these marketplaces bring in tens, hundreds of thousands of eyeballs every day, and they will now be exposed to Charles & Colvard’s Moissanite..

Perfect. Thank you..

And our next question comes from Rodney Baber. Please go ahead with your question..

Hi, Suzanne, how are you..

Good, Rodney, thanks for calling in..

Well, I’ve got some background noise. I’m trying to get to a quieter place. I apologize.

You can hear me okay?.

We hear you just fine..

Good. Give us a refresher on a part of your business that’s obviously growing and remind us based on the inventory drawdown that you’re going through, how this all applies.

If I remember correctly, you went into Helzberg’s online first sometime ago and later, because of the success of that, you went into their regular stores and now you’re in 200 something stores. And then you announced a couple of weeks ago that you’re going into Macy’s, which was very nice, it popped the stock up 10%.

But I was wondering what kind of inventory issues would you have with that. And we’ve talked before about the inventory, the issues you have when these things do get into the stores.

Who puts the inventory up? Does the company pay for it on-time or they pay for it as they sell it and all of that? So with the balance sheet challenges we had, refresh my memory for me on how that works, so I can kind of understand what that could mean for cash draw-downs and that kind of thing?.

Sure, Rodney. Thank you for the question. So as a refresher for everyone on the phone, we did begin with Helzberg with an online program, and it started way back when we relaunched the company in October of 2016. We went to a 25-store test, very successful, invited to go to a full 50 by Black Friday.

We were at 100 by the beginning of the next year, and then after that we were in nearly all stores. And only after that very good performance were we then invited to – on the website were we invited to be in stores.

As I had mentioned earlier in this call, when we do online channels the beauty of them is that the inventory sits here with Charles & Colvard. And we put it in our vault here and we share it across multiple channel partners. Sometimes a few curated pieces here and there individually for our partner, but it sits here generally.

And then when it’s sold online, then and only then do we ship it. So it gives us a chance to really control that inventory. When we go into stores, and this is where we become very judicious and careful about bringing the company into brick-and-mortar, there is an upfront inventory investment in most cases.

Retail in the jewelry space is often done on consignment, which means we will not get paid for the goods until they are sold through. But we’re expected, in order to be in the case line in the store, to create the inventory and then to ship it to stores. And then, again, we get paid as sell – as we sell through goods.

Usually, there’s about a one-time annual turn on the goods. So if we were to put – and I’m ballparking here, if we were to put $20,000 worth of jewelry inventory in a particular store, we would probably be paid $20,000 worth within one year.

That requires that upfront investments and physical goods in the store and that’s where we become very careful about making those investments, because it’s a draw on our finances in order to create the product and put it in stores. And that’s why we love the online play. It gives us a chance with very low overhead to dip our toe in various waters.

And we love the idea that we can test online partners and then should we be able to segue into an in-store program it makes sense, because we know we have that common customer. So that’s where this cautious approach to making the segue kind of plays..

And this concludes our question-and-answer session. I would like to turn the conference back over to Suzanne Miglucci for any – President and Chief Executive Officer, for any closing remarks..

Thank you, Cole. Once again, we’d like to thank everyone for taking the time to participate in our call today. Thanks to our incredible Charles & Colvard staff, who deliver everyday, and you have prepared us so beautifully for the upcoming holiday season.

With expanded retail partners, new online channels and a growing international presence, we’re pleased with the early outcomes of our fiscal 2019 performance. We appreciate your time, your interest and investment in Charles & Colvard. We thank you, and good evening..

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect..