Charles & Colvard's (CTHR) CEO Marvin Beasley on Q2 2015 Results - Earnings Call Transcript

Aug. 09, 2015 4:34 PM ETCharles & Colvard, Ltd. (CTHR)
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Charles & Colvard, Ltd. (CHTR) Q2 2015 Results Earnings Conference Call August 6, 2015 4:30 PM ET

Executives

Marvin Beasley - President and Chief Executive Officer

Kyle Macemore - Senior Vice President and Chief Financial Officer

Steven Larkin - Chief Operating Officer

Michelle Jones - President, Charles & Colvard Direct LLC

Analysts

Alex Furhman - Craig-Hallum Capital Group

Operator

Good afternoon and welcome to the Charles & Colvard Second Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Today’s event is being recorded.

This webcast may contain forward-looking statements as defined in Section 27A of the Securities Act of 1933, as amended, including statements regarding among other things, the company’s business strategy and growth strategy. Expressions which identify forward-looking statements speak only as of the date 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 developments and actual results could differ materially from those set forth in contemplated by or underlying the forward-looking statements. In light of these risks and uncertainties there can be no assurance that the forward-looking information will prove to be accurate. This webcast does not constitute an offer to purchase any securities, nor a solicitation of a proxy, consent, authorization or agent designation with respect to a meeting of the company’s stockholders.

I’d now like to turn this conference over to Mr. Marvin Beasley, President and CEO. Please go ahead, sir.

Marvin Beasley

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

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

Kyle Macemore

Thank you, Marvin. Good afternoon everyone and thank you for joining us today. As announced in today’s press release, net sales for the second quarter of 2015 decreased 5% to $7.5 million compared with $7.8 million in net sales during the same period of 2014. Net sales for the first six months of 2015 were $15.9 million, an increase of 14% compared to the first six months of 2014.

Wholesale net sales decreased 28% this quarter compared to the second quarter of 2014 to $4.9 million and comprised 66% of net sales. The company’s direct-to-consumer home party business, Lulu Avenue, had net sales of $1.3 million in the second quarter of 2015, an increase of 355% compared to approximately $284,000 in the second quarter of 2014.

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

The company’s net sales of loose jewels increased approximately 6% to $3.8 million in the second quarter and comprised 50% of sales this quarter compared with $4 million or 51% of sales in last year’s second quarter.

Finished jewelry net sales during the second quarter of 2015 were $3.7 million, a decrease of 3% as compared to the same quarter in 2014.

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

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

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

Operating expenses increased to $5.1 million in the second quarter of 2015, compared to $4.6 million in the second quarter of 2014. The increase was primarily driven by an increase in sales and marketing expense of $426.000 for sales to specific customers under which commission plans of sales representatives are based and the direct-to-consumer home party line of business.

The company also incurred a $288,000 increase in severance expense in sales and marketing in the second quarter of 2015, due to personnel trained as wholesale or innovation.

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

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

Inventory at the end of the second quarter of 2015 was $34.5 million, which was a decrease from $4.4 million from $38.9 million at December 31, 2014, and a decrease of $9.2 million from the peak inventory level of $43.7 million at March 31, 2014. Loose jewel inventory at the end of the second quarter was $29.8 million and finished jewel inventory was $4.7million.

The company has no long-term debt and has not utilized the $10 million credit facility it entered with Wells Fargo at the end of June 2014.

I’d now like to turn the call back over to Marvin.

Marvin Beasley

Thank you, Kyle. Having spent considerable time analysizing our operations since our last quarterly call, I’m happy to report on some of the initiatives we have implemented to steer the company forward and to enhance our brand strategy.

Our team has worked towards sundering our sales, reducing our inventory and censoring our cash position. While sales this quarter was $ 7.5 million and that’s about $ 300,000 less than last year’s second quarter, we were up against very strong comments. As last year’s second quarter was the highest quarter of sales for the entire year. Sales increased in our smaller yet without rapidly growing direct to consumer businesses were very strong. With increased revenue increased increasing 355% for the quarter and 442% for the six months. And increasing some of the 8% in the second quarter and sound percent for the first six months compared to 2014.

Together, these two businesses make up about one third of all sales compared with 13% of sales during last year’s second quarter. We expect these two segments to continue to segment forced year over year’s sales gains compared to 2014.

I have the privilege to art and revenue 2015 business and conference in July. That was tremendous excitement and optimism about our that from our at basis. Was a huge focal point for the conference and I believe our solid advisers opportunity. In addition to our dire to consumer strategy, we have also made an impact to continue to make changes to our wholesale organization as I mentioned during the last quarter, steam our seawall in charge of both our wholesale division and.com. While we continue to expect quarterly volatility and no wholesale business, I’m optimistic based on the level of discussion happening with the existing and potential customers in our wholesale division.

We spent a lot of time in emphasis on developing our brand strategy with our ultimate goal of building multiple strong brands are around them. All of them as it is this quarter, with the launch of a platform that increases our awareness of and knowledge of knowledge about this unique stone and lowers existing and new customers to share their stories and images and articles on social media, and do further in some ways inspired by the brilliance of.

Haven’t really visited I invite you to do so at the end of the end of the call. We are also quite excited about rounds of our newest and most innovative gemstone. Whatever one. We introduced samples of at the show in Las Vegas in May. And received very positive feedback. I’m very optimistic about the possibility for this new color was gemstone. We expect questions shipments limited shipments to begin in September, with the last in limit that shapes and sizes with very targeted partners. Interesting these the sad fact is we believe will result in increasing consumer awareness of continued sales growth and clear communication of value proposition that offers.

During the last conference, I told you that inventory was a key focus for me. I can assure you that after the last four months, I understand how inventory a lot better. Understanding and slicing and dicing of inventory has been like shows focus for our team as kind mention, we are able to sell a significant amount of our lower grades of those tools during the second quarter. This was a good strategic opportunity for us and required very close to operations between our team and our customers. We do not like taking this is for serving inventory at or below cost. But we needed to but the intent to take appropriate actions to reduce inventory without disrupting the market.

We are executing on our strategy to grow our company with the ultimate goals of increasing consumer awareness of [indiscernible] and communicating our value proposition. As we pursue these initiatives, we also remain committed to our priorities of generating positive cash flow and strengthening our financial position, while selling existing inventory and manufacturing our Forever Brilliant and Forever One loose jewels and finished jewelry to meet sales demand.

We believe the results of these efforts will help increase our revenue growth and profitability and further enhance shareholder value in the coming years. We look forward to the excitement and the challenges ahead. As I mentioned in my remarks last quarter, we must continue to look for ways to stay ahead of our competition for continuing to innovate. We believe this innovation must come in terms of our product offerings, our partnerships, our distribution and our relationships with our customers. This will require a great deal of hard work and analysis of our current business practices. I continue to make this a priority for our company and of course for me personally.

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

Question-and-Answer Session

Operator

[Operator Instructions] And it appears that our first question comes from Alex Christiansen of Craig-Hallum.

Alex Furhman

A couple of questions. So you mentioned the new for Forever One and I’m interested in that, specifically about how it’s going to affect your inventory in the process on making it, I know there is big upside from Forever Brilliant, but the downside is that it produced a lot of lower grade stores that you had to take on in inventory as a byproduct, is economy different for Forever One?

Marvin Beasley

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

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

So with the help of Cree in producing this new 4H material, it appears that a lot of the problems that we incurred in 2013 will not reoccur. We are early into it, and I caution you to – my comments, we’ve now polished two productions, I believe, this is the third being polished today and – but it’s looking very good. We are really, really excited about that. Does that answer your question properly?

Alex Furhman

Yes, I think so. So just to clarify is there something that doesn’t meet Forever One standards would still – Forever Brilliant standards?

Marvin Beasley

Yes, it will drop a notch. I would add this as well and our launch partners know this. This gemstone will sell at a premium, of course. If it didn’t sell at a premium, everyone would move to this overnight, believe me, we’d be scratching our heads. It will be a high profit opportunity for us. And that needs to happen and it will allow us probably to use that leverage to do some other things with Moissanite Classic. We expect some pressure there and one will allow us to our attack problems with the other.

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

Alex Furhman

And then second and last question, based on the big inventory sale this quarter, is that a path you’re going to be pursuing in the future, is that kind of the model that you are looking at and what kind of expectations you have about how you’re going to be able to draw down from $34 million, $35 million you have now?

Marvin Beasley

I will be happy to do that and I’ll specifically ask Kyle to piggyback because I’m sure that I won’t touch on every aspect of this. Last quarter, I opened by saying, my goodness, I think the 10 questions I had, eight of them had to do with inventory. And probably they should have. This company has carried for some time a lot more inventory than it ought to. And I promise the forks, there was one gentleman on the previous call 90 days ago who was really, really upset by inventory and I promised him that next call I was going to darn well be able to give him a lot more information and answers about this. Since probably there’d be more questions about inventory in this call, let me just give you some data points for your reference.

Out of the $37 million plus in inventory, at the end of quarter one, we really began to look at it very closely and as I use the old retailer term, slicing and dicing, that’s exactly what we’ve done. And Kyle and I have spent many hours along with folks that report to us and other people in this organization understanding this inventory and as I said in my opening remarks, I’m a lot more abated today than ever before. There is about 80% of this inventory, believe me, that is just fine.

It’s just fine. It’s just that we have a lot of it. We have about, correct me, if I’m wrong, Kyle help me, about $10 million dollars either in pre-forms or other material of polished goods in Forever Brilliant. That merchandise we began to see early in 2015. So it’s pretty darn fresh and new. We’ve got about $14 million plus or minus a little in Moissanite Classic that’s the lowest price of base inventory. I can’t tell you the ageing in all that, I can tell you that I believe a lot of it probably came in 2012, 2013, – 2011 and 2012, but there’s obviously some inventory that is old.

As my friend Alan always says, it’s not [indiscernible] it’s not eggs, it doesn’t go bad. I haven’t gone through nor has anyone else in the last 90 days to look at all that merchandise, but I have every confidence that it’s assorted probably, that it’s in the right buckets and it’s in good shape. That takes us up to close to $25 million of today’s $35 million.

At least $10 million and that breaks down in $1.5 million, $2 million in this branded material, roughly, and when we started the quarter about $6 million in finished jewelry and then there was couple of million dollars in stuff that still below the Moissanite Classic. So as you can see, we really began to understand the problems we decided we needed to eliminate the Moissanite material that did not fit the quality going forward, and we really needed to look at the finished jewelry some of which had been here for some time.

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

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

As I said, I don’t like selling things across of, God knows, below cost/ I don’t like taking reserves. We have absolutely shot with a rifle and not a shotgun on this thing. We have in the operating room we’ve taken we’ve taken out a scalpel and we are removing the stuff that needs to be removed and we are trying not to get into anything that’s of high quality. And I’m really proud of this team for the results for these efforts.

So I feel much better about where it is we are going. We need to move the remainder, small remainder of these gemstones that is below the quality and I’m still suspect of some portion of this finished jewelry inventory which we are going to be looking at monthly as we go into the end of the year. The worst is behind us, I believe. Now, that was a lot of data, a lot of information. Kyle, what did I miss?

Kyle Macemore

I think it was a good representation; we definitely focused with a very targeted approach in certain aspects of our inventory. And we continue to do that and we will continue, as we said in the comments, to make decisions that we think makes sense for our company, our customers as well as we’re very aware of the market and making sure we don’t disrupt it.

Marvin Beasley

And by the way on this finished jewelry inventory and everyone in the jewelry business, whether they are selling diamonds or color or whatever, it doesn’t matter, it’s the last thing you want to do was melt a piece of jewelry. What happens here, for every dollar we melt, $0.50 of that dollar vanishes. It just goes away. We sell the metal, we lose the labor, we lose the profit that we pay to somebody to put it together and it’s not a good scenario. We also always had breakage in stones. So the last thing we would want to do is melt it, but quite frankly if it is not saleable, it’s the best thing in the world you could ever do. We will have some cash back for it, we will recycle the gemstones and we will more on with life. So I feel much better about inventory than the day I arrived here almost 5 months ago.

Operator

Our next question comes from [Chuck Lain] a private investor.

Unverified Analyst

Couple of things. One, I think that one of the things that plagues the jewelry industry, people fall in love with their inventory and you guys are doing exactly the right thing. And when you get into finished jewelry game, you’re going to have to suck it up and get away from it. And I think that’s on target. In an effort to understand Lulu and .com business percentage wise have increased substantially, they now represent one third of sales, what Charles & Colvard, what percentage of expenses are dedicated to supporting those two businesses?

Kyle Macemore

When we file our 10-Q in the morning you will see obviously a lot of detailed breakdown. I can’t look at our expenses in overall perspective, so our G&A which basically makes up in this quarter, our G&A was $1.5 million. That expense covers the whole business. It’s IT, its finance, HR, administration. So we’re supporting everybody. We have about $3.5 million this quarter of sales and marketing expense.

A pretty decent size of that is to support the three various businesses being Lulu and the thing to remember about Lulu is revenue growth, there is high level of commissions of variable cost which is a big portion of their expenses. Their infrastructure is a pretty decent size of that, though the Moissanite.com team is a little bit smaller team and our wholesale organization is slightly bigger than that. And in that organization we pay advertising cost and some various other things to outsize sales rep commissions and things like that.

So I think right now, I don’t have the exact split, but it’s pretty evenly spread and we are vesting the most in Lulu with the commissions and the infrastructure, so we will continue to do that and need to be as the business goes. We also are spending more money in our marketing area since we bought Sarah and her team on board, and that marketing is expense is supporting all three business units. Trying to drive the branding, the positioning of Every One and you’re going to see a lot a rollout of the branding for most of the company and we hope that is all about. So we’ve kind of reallocated some of the expenses to that area, because we think it’s necessary to increase awareness.

Unverified Analyst

And I know there are things that we could not disclose previously which I think we probably need to today and we are, I’m just trying to wrap my our arms around the relative profitability of the major business segments, and that’s difficult to come up with, because some of it – that’s across all areas. But I would hope that somewhere along the way, maybe this is coming on tomorrow, that we could say X percentage of our revenue or X percentage of our operating expenses are dedicated to each of these three business units and understand...

Kyle Macemore

Chuck, I would ask you to read footnote 3 of our 10-Q, I guess, filed tomorrow, I think a lot of the information you are looking for will be on that.

Operator

And our next question comes from [Paul Johnson], a private investor.

Unverified Analyst

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

Marvin Beasley

That is true. We are investing in Moissanite.com and Lulu Avenue.

Unverified Analyst

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

Kyle Macemore

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

Unverified Analyst

I understand that. And maybe the wholesale business will be better than expected, but it just – to get $1.6 million increase on these fast-growing businesses, because to spend substantially all of that on increase sales and marketing expense, it’s like we are always chasing that tail?

Kyle Macemore

I understand your point, we have been pretty clear that we continue to invest for the future. We are adding some of the resources we have added, continue to build a foundation, especially for our Lulu Avenue and for Moissanite.com as more of the dollars from our revenue base go to those businesses. So we are investing with the long term in mind, there will be a point where those businesses will start to generate profitability, but we are not at that point yet. And we have been pretty clear that we’ve been committed to those two businesses for the long term.

Unverified Analyst

So going to the wholesale, first, I appreciate what you’re saying, it’s just a little discouraging to see exponential growth in those divisions, basically get swallowed up by sales and marketing expense, but leaving aside for a second, can you talk a little bit about what the wholesale strategy is because we are spending a lot of time on the direct to consumer, but what is the strategy for wholesale?

Steven Larkin

The strategy is to – and again I’ve been overseeing the wholesale division for approximately four months, the strategy is to have a healthy distribution across a multitude of channels, leveraging the different quality of our gemstones, leveraging finished jewelry where appropriate domestically as well as internationally. And that’s everything from e-commerce wholesale, distributor wholesale, brick and mortar retail wholesale, television shopping, domestically and potentially internationally, so those are the things that we are working on in the channels that we are pursuing.

Operator

[Operator Instructions] Our next question comes from [Jay of Retail].

Unverified Analyst

Could you comment on the amount of Lulu reps quarter over quarter, what type of growth we’re seeing and also the Lulu revenue went down from $1.4 million to $1.3 million, if you could comment on the reasons behind that would be great.

Michelle Jones

So yes, we could see we did see a slight decline quarter over quarter and really the reason for that and by the way we do not disclose the number of dollars by this, was because if you recall in Q1 actually December, January and February, we did onboard a significant number of new stall addresses and that was actually a major transition adding so many stall advisers and that did impact our second quarter as just like any business, Lulu Avenue, maybe it was the jewelry.

This definitely impacted our growth as well on the – stall advisers that we did bring on board because it was a whole new program, they have to learn there was a significant learning curve that frankly we did not anticipate and this team is very heavily focused on selling versus recruiting. So our focus right now is pretty clear. It’s teaching them how to sponsor while they keep up their sales, because that’s how they earn instant money and at the same time to helping them really understand the power of Moissanite and how they can embrace more money through that.

We did just come out of an amazing conference where we had a significant number of our active selling stall advisors attend and that was the message very loud and clear as Marvin said we’re a company that is [disrupting] direct sales industry with Moissanite and at the same time we need them to go out and share the opportunity with others.

Operator

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

Marvin Beasley

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

I would tell you that something that came up on the last call and we’re sure that it would on this one and I think I’d make a comment about it, is the patent expiration. And to this point, we’ve buying material where we can. We really – and I’ll underline this statement, I am not cocky to state this issues, because we all here take it seriously.

To this point, we have not seen a great deal that concerns us at all. There are one-offs and we see those popping up on e-bay and places out of China and out of India. And we do not hear from any of our business partners that they’ve seen much as well. That’s not to mean that on September 2 we don’t see more, but quite frankly, due to the nature of this kind of thing, I think we would have seen it long before now. But we feel a little better than we did about this situation as we’ve all known that this was coming for some time.

And please remember, in India, there’s been no patent, and people there don’t pay much attention to it anyway, and we had one of our Indian distributors this week and his description is that there is a lot of cheating going on there, there’s people that are engraving Forever Brilliant on Moissanite there and that will forever happen. They’re mixing it in parcels of diamonds, there is a large business in black material there, which we do not participate in. And so it’s quite a market there. But we just have not seen anything.

I would make a comment as well in the weakness in our wholesale business for the second quarter, we expected that and there’s a number of things going on, some of it we have to look in the mirror and some of it not, the new material with Forever One that’s going to be shipping in September. There’s a lot of folks who are waiting and want to see it, they’re not sure how they’re going to merchandise yet, they want to see this material before they commit orders certainly for the early fall and late fall for sure.

And I can understand that perfectly, I really can. Not everyone understands it will come at a premium as well. So with the angst of the patent expiration and folks hang in on, because they don’t know if they’ll see a new team with [indiscernible] at twice the quality, they just don’t know and they’re playing it very conservatively. And they know that our company is not going to price protect inventory, and they’re being very careful. I think those things are real things and I don’t blame them.

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

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

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

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

Operator

Thank you, sir. Today’s conference will be archived for review on the internet at www.webcaster4.com/webcast/page/346/9363 and on the company’s website at http://www.charlesandcolvard.com/investor-relations/events. It will be archived until Friday, August 21, 2015.

Today’s conference has now concluded and we thank you all for attending today’s presentation. You may now disconnect your lines.

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