CHARLES & COLVARD LTD - 10-Q Quarterly Report

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 ¨

	Three Months Ended September 30,				Nine Months Ended September 30,
	2002		2001		2002		2001
Net sales	$	3,180,043	$	2,138,435	$	11,405,791	$	7,501,151
Cost of goods sold		970,276		878,923		4,642,131		3,225,711

Gross profit		2,209,767		1,259,512		6,763,660		4,275,440
Operating expenses:
Marketing and sales		1,178,472		715,843		3,357,848		2,021,981
General and administrative		510,373		446,221		1,849,648		1,623,774
Other expense		—		34,463		—		128,566

Total operating expenses		1,688,845		1,196,527		5,207,496		3,774,321
Operating income		520,922		62,985		1,556,164		501,119
Interest income, net		51,382		98,235		154,137		266,319

Net income	$	572,304	$	161,220	$	1,710,301	$	767,438

Net income per share:
Basic	$	0.04	$	0.01	$	0.13	$	0.06

Diluted	$	0.04	$	0.01	$	0.13	$	0.06

Weighted-average common shares:
Basic		13,344,973		13,447,714		13,365,296		12,257,860

Diluted		13,630,395		13,459,121		13,637,681		12,265,970

	September 30, 2002			December 31, 2001
	(Unaudited)
ASSETS
Current Assets:
Cash and equivalents	$	12,747,320		$	10,236,319
Accounts receivable		2,335,158			2,803,117
Interest receivable		14,482			13,824
Inventory, net		21,551,692			21,341,071
Prepaid expenses		307,918			214,749

Total current assets		36,956,570			34,609,080
Equipment, net		409,491			342,281
Patent and license rights, net		270,137			290,569

Total assets	$	37,636,198		$	35,241,930


LIABILITIES AND SHAREHOLDERS’ EQUITY

Current Liabilities:
Accounts payable:
Cree, Inc.	$	984,770		$	405,020
Other		117,890			154,831
Accrued payroll		424,461			202,012
Accrued expenses and other liabilities		245,188			272,490
Deferred revenue		218,451			129,801

Total current liabilities		1,990,760			1,164,154

Commitments

Shareholders’ Equity:
Common stock		54,972,302			55,182,692
Additional paid-in capital—stock options		2,031,757			1,964,006
Accumulated deficit		(21,358,621	)		(23,068,922	)

Total shareholders’ equity		35,645,438			34,077,776

Total liabilities and shareholders’ equity	$	37,636,198		$	35,241,930

	Nine Months Ended September 30,
	2002			2001
Operating Activities:
Net income	$	1,710,301		$	767,438
Adjustments:
Depreciation and amortization		94,665			117,801
Stock option compensation		70,543			20,244
Loss on disposal of long-term assets		—			120,860
Change in allowance for returns		75,000			(50,000	)
Change in operating assets and liabilities:
Net change in assets		88,511			808,044
Net change in liabilities		826,606			(1,441,159	).

Net cash provided by operating activities		2,865,626			343,228

Investing Activities:
Purchase of equipment		(146,513	)		(22,693	)
Patent and license rights costs		(26,014	)		(12,747	)
Proceeds from sale of long term assets		31,084			70,000

Net cash (used) provided by investing activities		(141,443	)		34,560

Financing Activities:
Stock options exercised		10,839			—
Purchase of common stock		(224,021	)		—
Proceeds from stock rights offering, net		—			6,031,995

Net cash (used) provided by financing activities		(213,182	)		6,031,995

Net change in cash and equivalents		2,511,001			6,409,783
Cash and equivalents, beginning of period		10,236,319			3,826,402

Cash and equivalents, end of period	$	12,747,320		$	10,236,185

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information. However, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the financial statements include all normal recurring adjustments which are necessary for the fair presentation of the results of the interim periods presented. Interim results are not necessarily indicative of results for the year. Certain reclassifications have been made to prior year’s financial statements to conform to the classifications used in fiscal 2002. These financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2001, as set forth in the Company’s Form 10-K, filed with the Securities and Exchange Commission on March 25, 2002.

In preparing financial statements that conform with accounting principles generally accepted in the United States of America, management must make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses reflected during the reporting period. Actual results could differ from those estimates.

All the Company’s activities are within a single business segment. During the three and nine months ended September 30, 2002, export sales aggregated approximately $400,000 and $1,800,000, respectively. Export sales aggregated approximately $400,000 and $1,600,000 for the three and nine months ended September 30, 2001, respectively.

Inventories are stated at the lower of cost or market determined on a first in, first out basis. Based on current estimates and assumptions, the Company believes that a substantial amount of inventories will be sold or consumed during its operating cycle. However, to be prepared to react to possible customer demand for large purchases and for a variety of jewel styles, a significant amount of inventory must be maintained at all times.

The Company currently sells one grade of jewel. The grade is classified as “very good” and consists of near colorless jewels that meet certain standards. Only “very good” jewels are valued in inventory. There is a substantial amount of jewels, including colored jewels, that have not met the quality standards and are not valued in inventory. In the future, management might determine that there is a market for a portion of this unvalued inventory.

Finished goods are shown net of a reserve for excess jewelry inventory of $235,000 and $170,000 at September 30, 2002 and December 31, 2001, respectively. Test instruments are shown net of a reserve for excess inventory of $465,000 at December 31, 2001. During the three months ended September 30, 2002, the Company completed a sale of its entire test instrument inventory.

	September 30, 2002		December 31, 2001
Moissanite:
Raw materials	$	91,100	$	131,525
Work-in-process		3,408,505		1,604,699
Finished goods		18,052,087		19,588,295

		21,551,692		21,324,519
Test instruments		—		16,552

Total Inventory	$	21,551,692	$	21,341,071

In September 2002, the repurchase program authorized by the Board of Directors expired. The program authorized management to repurchase up to 1,300,000 shares of the Company’s common stock through open market or privately negotiated transactions. For the three months ended September 30, 2002, the Company repurchased 57,800 shares at an average price of $3.88. Since inception of the program in September 2001, there were 133,800 shares repurchased at an average price of $2.24 per share.

On October 22, 2002, the Board of Directors authorized a follow-on repurchase program for up to 1,100,000 shares of the Company’s common stock. At the discretion of management, the repurchase program can be implemented through open market or privately negotiated transactions at prices at or below prevailing prices. The Company will determine the time and extent of repurchases based on its evaluation of market conditions and other factors.

In accordance with Accounting Principles Board Opinion No. 25 and Statement of Financial Accounting Standards (FAS) No. 123, the Company recorded compensation expense due to stock options of $8,185 and $70,543 during the three and nine months ended September 30, 2002, respectively. The Company recorded a reversal of $5,023 in compensation expense related to stock options during the three months ended September 30, 2001, and compensation expense of $20,244 for the nine months ended September 30, 2001. This compensation expense is recorded in general and administrative expense in the Statements of Operations.

In July 2001, FAS No. 142, Goodwill and Other Intangible Assets, was issued. This statement requires that goodwill and other intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. This statement was effective for the Company on January 1, 2002. The Company does not have goodwill or other intangible assets with indefinite useful lives and the adoption of this statement did not have an effect on its consolidated financial statements.

In August 2001, FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was issued. This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets and how the results of a discontinued operation are to be measured and presented. FAS 144 is effective for the Company’s year ended December 31, 2002 and adoption of this statement did not have an effect on its consolidated financial statements.

In August 2001, FAS No. 143, Accounting For Asset Retirement Obligations, was issued. This statement requires recording the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying value of the related long-liv

North Carolina		56-1928817
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


Part I.	Financial Information

Item 1.	Financial Statements	3

	Condensed Consolidated Statements of Operations—Three Months and Nine Months Ended September 30, 2002 and 2001	3

	Condensed Consolidated Balance Sheets—September 30, 2002 and December 31, 2001	4

	Condensed Consolidated Statements Of Cash Flows—Nine Months Ended September 30, 2002 and 2001	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	8

Item 3.	Quantitative And Qualitative Disclosures About Market Risk	12

Item 4.	Controls and Procedures	12

Part II.	Other Information

Item 5.	Other Information	12

Item 6.	Exhibits And Reports On Form 8-K	12

Signatures		13

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