Charles & Colvard's Filing: Turning Potential Into Money

Jul.29.10 | About: Charles & (CTHR)

Reading Charles & Colvard's (NASDAQ:CTHR) 8K with earnings and revenue info, all I have to say is "Wow. This has the potential to be really impressive. They sold a ton of stuff, but didn't get paid for it."

This quarter, over the same one from a year ago, revenue is up 152%. Accounts receivable are up by over 700%; from $.363 million, to $2.59 million. The bottom line improved by $1.5 million, meaning that the company earned 2 cents a share. For a different perspective on revenues, accounts receivable are up over the last 6 months from $1.04 million, when they had $2.36 million in revenue, to $2.58 million at the end of the present filing period, on revenue of $3.32 million.

Note how the company recognizes revenue from the last 10K:

Revenue Recognition - Revenue is recognized and title passes when products are shipped from our facility, excluding consignment, or memo, shipments as discussed below. Our standard payment terms are generally between 30 and 90 days. Some customers are required to prepay prior to shipment. At the time revenue is recognized, an allowance for estimated returns is established. Any change in the allowance for returns is charged against net sales. Our return policy allows for the return of jewels for credit within 30 days of shipment and must be returned for a valid reason, such as quality problems or a shipment of the wrong jewels. Some customers have a contractual right to return a certain percentage of goods for any reason. In these instances, we only recognize revenue when the contractual right of return is exhausted.

Periodically, we sell jewels to customers on memo terms. For shipments on memo terms, the customer assumes the risk of loss and has an absolute right of return for a specified period. Our customers are generally required to make payments on memo shipments within 60 days upon the customer informing us that it will keep the jewels. Accordingly, we do not recognize revenue on these memo transactions until the earlier of (1) the customer informing us that it will keep the jewels or (2) the expiration of the right of return period.

As I read it, the earnings of 2 cents a share are not yet cash. They really are reliant upon jewelry stores and distributors selling (what I will sarcastically refer to as) a mine's load of Moisonite. This is a typical company that is in the process of making a niche for itself, and without said niche, is screwed.

With that said, insiders have been buying, which gives a shareholder some level of comfort. To get rid of $2.5 million in product, it would be like 250 stores selling $10K of Moisonite jewelry each. Which, with margins that are acceptable for the jewelry industry, seems like it could be sustainable (to just pull a number out of the air for the illustration).

In the conference call, CTHR management was sure to note that costs are getting under control due to cost saving initiatives and that cash levels are up. The company changed accounting for inventory, from FIFO to average cost. This, I suppose, makes sense when you are dealing with something that is essentially a branded/non-essential/commodity that doesn't have a shelf life. It could be a way of hiding cost increases or decreases of the item, though.

The company is distributing to military stores, mail marketing catalogs, the Home Shopping Network (starting in October), and it has also opened a store in Asia. Reorders for loose stones are up month over month. And CTHT is working to grow its foreign markets, such as Russia and India.

On the call, a whopping 3 1/2 questions were asked by 1 guy... I should have been on the line, rather than streaming, but oh well... Here is a summary of the Q&A:

Q: Opening of Jewelry Outlet, is it part of the business model?

A: Would love to see it expand, more of a test.

Q: Do distributors mind the fact that they compete with you?

A: No, they are open with the distributors, and generally don't compete with them in the same channels (eg military bases and HSN)

Q: Christmas season distribution?

A: Hopeful for the prospects, but when working with big companies, things tend to move slowly. Very hopeful for the future of the company due to the shows they have been a part of.

We are way out of net-net turnaround territory. Now, it seems that we are betting on the marketing that the firm can do for what De Beers and every other diamond vendor will call "fake diamonds". With that said, if there is any company that can pull this off, I think that CTHR is a likely one. The only problem is that it is so hard to quantify what the company is worth that I wouldn't want to think about buying shares at these prices. There is no doubt that there is less of a margin of safety than last year. Things were a lot easier and more clear when the company was at (and below!) net cash, all while in the midst of getting some great executives... It was obvious that it was worth more than that!

Thursday, it will be interesting to see how the market reacts to the filing. I will look forward to seeing if Ollin Sykes continues on his buying spree.

Disclosure: Long CTHR. This is not investment advice. Always do a ton of research and thinking before you do anything that I say, think, or do.