Charles & Colvard, Ltd.
Q2 2019 Earnings Call Transcript

Published: 9 Feb 2019

[Operator:]

Good afternoon, and welcome to the Charles & Colvard Second Quarter Fiscal Year 2019 Earnings Conference Call. All participants will be in listen-only mode. [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 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 can 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 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, this event is being recorded. I would now like to turn the conference over to Suzanne Miglucci, President and CEO. Please go ahead.

[Suzanne Miglucci:]

Good afternoon, and thank you for joining us as we summarize Charles & Colvard’s results for the quarter ended December 31, 2018, the second quarter of our 2019 fiscal year. We’re pleased to report today’s results, which include performance from the holiday selling season. We had a robust quarter with strong revenue growth, excellent gross margin, positive cash flow and consecutive quarterly profitability. This underscores the strength and scalability we’ve built into our business model and the growing demand for lab-created gemstones. We’re pleased to see our strategy delivering strong results and look forward to sharing our outcomes with you. Clint Pete, our CFO, will begin today’s call with an overview of our financials, then I’ll return to discuss key highlights from the quarter. Clint?

[Clint Pete:]

Thank you, Suzanne. Good afternoon, everyone, and thank you for joining us. My comments today will focus on highlighting the key financial results in Q2 2019. Additional detail can be found on our Form 10-Q for the quarter ended December 31, 2018, when it becomes available. Beginning on Slide 5. We reported net income for Q2 2019 of approximately $1.2 million or $0.05 per diluted share compared with a net income of approximately $680,000 or $0.03 per diluted share in the year ago quarter. Slide 6 summarizes net sales for Q2 2019 compared to the year ago quarter, which increased 19% to $10.1 million. Our Online Channel segment, which consists of e-commerce outlets, including charlesandcolvard.com, third-party online marketplaces, drop ship and other pure play exclusively e-commerce outlets, generated an increase of 18% in net sales versus a year ago quarter, representing 54% of total net sales. Finished jewelry net sales increased 10% for the quarter, resulting from our strategy to drive finished jewelry sales across multiple geographies and channels such as brick-and-mortar retail partners and our direct-to-consumer initiatives, which include our charlesandcolvard.com website. In the company’s Traditional segment, which consist of wholesale and retail customers, net sales for the quarter increased 19%, largely due to the holiday-related demand from our domestic distributors who serve independent jewelers. International sales increased 124% versus the year ago quarter based on two main drivers

[Suzanne Miglucci:]

Thank you, Clint. I’ll start with a summary of notable highlights for the quarter on Slide 12. Our strong Q2 revenue of $10.1 million was grounded in our sales of Forever One, our flagship moissanite product. Forever One represented 88% of total revenue in Q2 compared to 79% in the year ago quarter. With finished jewelry representing 51% of our total sales, we believe this is a clear indicator that our direct-to-consumer outreach is working and our brand is gaining significant traction. Our compelling gross margin of 47% was fueled by our charlesandcolvard.com website sales and Forever One jewelry sales in select retail channels. We reduced legacy inventory to 26% of total inventory and have transitioned our investments into new Forever One and Moissanite by Charles & Colvard assortments that supported on-time deliveries through holiday and supported our readiness for the Valentine’s Day selling season. And lastly, we’re thrilled to deliver our second profitable quarter in a row, a net profit of $0.05 per diluted share. We’re particularly encouraged that these achievements were accomplished in a shifting industry environment. As you’ll see highlighted on Slide 13, retail, e-commerce and jewelry industry trends continued to evolve. Total U.S. retail sales, excluding automobiles, rose 5.1% between November 1 and December 24, according to Mastercard. Online holiday sales increased 16.5% this year, according to Adobe Analytics. While the traditional jewelry industry continued to consolidate in 2018 with numerous closings, according to the Jewelers Board of Trade. Across this retail landscape, Charles & Colvard had outperformed the industry with 19% sales growth. On Slide 14 and reflecting on our omni-channel strategy, we saw 18% growth in our Online Channels segment, which represented 54% of total net sales for the quarter. A primary contributor to this segment was our own transactional website, charlesandcolvard.com, which generated a 52% increase in sales over the year ago quarter. This site is our flagship storefront and one of the key vehicles for positioning our brands to the market. Site traffic grew significantly over the holiday, an outcome of our aggressive awareness campaign and targeted promotions. We updated and improved the website materially prior to holiday with upgrades designed to improve our customers’ overall user experience, including improvements in site speed, new payment methods, improved on-site search and a new fraud detection solution to upgrade security of our transactions. And of course, we featured an ever-expanding assortment of jewelry from fashion to fine and bridal options to meet most every consumers’ needs. In Q2, we also enhanced the company’s ability to drive international customers to our U.S.-based charlesandcolvard.com website through the implementation of a cross-border trade technology platform. This solution provides streamlined distribution with a personalized on-site experience and seamless buying process for customers outside of the U.S. Cross-border trade sales increased more than 250% in Q2 versus the year ago quarter as a result of our adoption of this new platform, and targeted in-country advertising designed to build brand awareness and demand for products in new territories. Now let’s turn to two other areas of our Online Channels segment

[Operator:]

[Operator Instructions]

[Suzanne Miglucci:]

While we’re waiting for you to fill the queue, we did have an emailed question that we thought we’d begin with. One of our shareholders inquired about the impact of the trade war with China, related new tariffs and how will this impact our future revenue and expenses. So first of all, thanks very much for your question. And for those of you that don’t typically jump into the queue with your questions, please don’t hesitate to email them ahead of time to the IR contact on our press release, and we’ll do our very best to get to everyone’s questions during the call. On the topic of the volatile geopolitical environment we’re all operating in today and in particular, our opportunity in China, we believe it will have a minimal impact on Charles & Colvard. We’ve already taken measures to protect our supply chain and inbound material from China. So our flow of products to consumers shouldn’t be impacted nor our overall cost of goods. But looking at this from a global perspective, this is where the beauty of our omni-channel strategy comes into play. We’re promoting our brand across dozens of sales channels and multiple countries around the world. So our approach is to leverage the best channels to serve a geography at a given time. So as a region of the world is impacted by trade issues or political negotiations or even weather events, we can swiftly adjust our channel approach to best meet the demand for the region. Thanks again for that question. Chad, do we have anyone in the queue?

[Operator:]

Yes, we do. We have Craig Pieringer with Wells Capital. Please go ahead.

[Craig Pieringer:]

Hi, congratulations on a very good quarter. I’m glad to see inventories, especially legacy inventory, coming down quite a bit. What are the prospects for reducing that even further?

[Suzanne Miglucci:]

Thanks for calling in, Craig. We do appreciate it. As we’ve discussed, we constantly look to draw down our legacy inventory. And as we talked in our prepared remarks, we are replacing that legacy inventory with new products in the way of both, certainly Forever One, but our new Moissanite by Charles & Colvard product. We have built out this omni-channel strategy with all of these global and domestic outlets, especially marketplaces where we can now further disposition the rest of these legacy goods. So while we don’t give guidance, I would anticipate a continual and steady drawdown of these goods. We do so at a profit. So we’re not anxious to write them all off. We’re anxious to sell them on marketplaces where we have a meaningful outlet to make some money on them.

[Craig Pieringer:]

Excellent. And I’ll ask a follow-on. So in the past, Suzanne, we’ve spoken about spokespersons and that was deemed not appropriate at this point in the company’s development. But we did talk about influencers of various means in blogosphere and whatnot. Can you update us on – are there those official spokespeople or blog – or influencers?

[Suzanne Miglucci:]

Sure, yes, happy to do that. So we continue to believe, Craig, that a single spokesperson is probably not the right thing for Charles & Colvard. They tend to be very expensive and they tend to be a little bit polarizing, right? Either you like this person or you don’t like this person, and that may reflect on people’s adoption of our brand. So instead, we continue to go down the path of adopting this strategy to work with influencers. And we continue to expand our footprint with the influencer market. We do work from – everyone from micro-influencers, which may be people that have tens of thousands of followers, to more major influencers that may have up to millions of people. So it goes across the range. We also are working with third parties like BabbleBoxx or we’ve work with the folks at The Knot. And we talked with these organizations about influencing as well. So how can we bring them videos that talk about how to wear moissanite and how can we put that on their channels so it can further be influenced by their market. By the way, The Knot reaches about 1 in every 4 millennials, so it’s a great outlet for us to see people there as well. So we’re trying more and more One-to-Many platforms in order to get the brand out there and to give it a little bit more exposure. Just for some basic numbers here. I mentioned BabbleBoxx. It’s an organization that we’ve partnered with. We did have promotion back in December. We had over 15 million blog and social media impressions combined from the work that we did through BabbleBoxx. So something as small as one promotion that we do with an outlet like that can have the impressions of beyond 15 million. So we’re exploring more and more of these, Craig, and finding new nooks and crannies where we can find our way into the market, especially when it means touching on a millennial audience.

[Craig Pieringer:]

Those all sound very positive. Thank you very much for the color.

[Suzanne Miglucci:]

All right. We have anybody else in the queue, Chad.

[Operator:]

Yes. At this time, we have Michael Jacobs with Benchmark. Please go ahead.

[Michael Jacobs:]

Hi, Suzanne, congratulations. Based on your significant track record and expertise before you came to Charles & Colvard, I had no doubt that you’d grow the business into new distribution channels, both online and international. Where the business seemed they have some headwinds over the last couple of quarters was in the Traditional and the brick-and-mortar, but this quarter was very strong in that vertical too. Was it a good Christmas? What drove that this quarter?

[Suzanne Miglucci:]

Thanks for the question, Michael. So it was a good Christmas, although, if you look at some of the statistics on Traditional retail, Traditional retail didn’t necessarily do incredibly well. Certain retailers did, others did not. But for moissanite, most interestingly, it did well. I’ll use Macy’s as an example. Macy’s, I’m sure those of you that track them realize that they didn’t have the best of quarters. They’re busy talking about their performance, yet Moissanite by Charles & Colvard did incredibly well on macys.com. So I think what we’re finding is a bit of a mix. Yes, holiday, but most certainly, the adoption of lab-created. And I will say, across Traditional, we did well, not only in brick-and-mortar, but we did well with our distributors. And in the U.S., that means that there are still independent jewelers out there adopting moissanite and selling it through their stores. In addition, we also recognize our international distributors in that same Traditional number. Now we’ve seen some pretty amazing uptick in our international distributors as well, as I mentioned, specifically in China and certainly other places around the world. So I think it’s a mix, Michael, to answer the question. Certainly, holiday. But I do think we’re at a bit of a critical mass here on the awareness of moissanite, which is really helping us to sort of get that message out there and certainly make sales.

[Michael Jacobs:]

So in terms of percentage of sales, you had 54% from online, 46% Traditional. Do you see that kind of balance going forward? Or would you hope to see Online still grow as a percentage of sales?

[Suzanne Miglucci:]

Yes, that’s a great question. And of course, we don’t give guidance. So I won’t give you a hard number. So what I can say is this, I think we’ve been very consistent in getting our Online Channels sales over that 50% mark in these past couple of quarters. So I think you can expect to see similar performance from us going forward. I think what’s important, for everyone listening, is that we’ve really reached some important milestones here that confirm the health of the business. Our online segment is growing and it’s gaining traction. We have several new revenue channels, domestic and international, and they’re beginning to generate revenue. So the omni-channel strategy is working. So the good news is, where one may have a downturn, again, we may have geopolitical pressures in a particular region of the world. We have lots of other regions where we can make up that difference. But we do expect a healthy mix between the two. We’re still very pleased with our traditional channels and the movement there. And – but we’re a seasonal business, right? So keep that in mind as you model us for future quarters.

[Michael Jacobs:]

Congratulations not only on a nice quarter, but a nice presentation to the investment community. You invested – a very nice job this afternoon.

[Operator:]

Our next question comes from Eric Landry with BML Capital. Please go ahead.

[Eric Landry:]

Hi, thanks. So I just want to clarify. I think there was an inventory correction a couple of quarters ago in the Traditional segment. Is it possible that any of that impressive growth from this quarter was sort of a catch-up?

[Clint Pete:]

Eric, this is Clint. Good to talk to you again. No, the performance of our margin is clearly from the impact of the higher Forever One sales due to both on our transactional website as well as, as Suzanne mentioned, the international distributors and domestic. So that was basically the driver that we also have improved efficiencies in our supply chain that has related to increased productivity and throughput of our – in our supply chain that has really helped us drive that gross margin percentage to the level we saw this quarter.

[Eric Landry:]

All right. But I guess, what I’m asking is, so the growth in the online – a couple of quarters ago, you mentioned that some of the wholesalers had wanted to reduce inventory, and that was the reason that sales had shrunk 30% and 15% in the two prior quarters. I was wondering if perhaps they overshot and this growth was a result of them trying to catch up with what perhaps may have been an over-liquidation of inventory prior to this.

[Suzanne Miglucci:]

We believe, Eric, that we’re at a point where they’ve rightsized their business. And we – they won’t expose necessarily all the ins and outs of their business to us. But we’re seeing generally some consistency across our Traditional partners, certainly an upswing, but that’s more – we’re seeing an upswing in Traditional on our international distributors. But we’re feeling that we reached a homeostasis, if you will, with the distributors here in the U.S. And I – certainly, I think we saw a healthy holiday. But I think in general, I think, we’ve balanced the business now on the U.S. distributorships.

[Eric Landry:]

Okay. Would it be accurate to assume that in that segment, you have lessened your reliance on those two wholesalers?

[Suzanne Miglucci:]

We have more than two. And I think what is fair to say is, in this effort to build an omni-channel strategy, we want to make sure that we’re not putting too many eggs in a single basket. And so what we’re doing is bringing on the right number of distributors to make sure that we are not reliant on any one customer significantly. And then, of course, we’re balancing it with the many, many outlets that we have online. We want to make sure that we don’t have exposure in any one place as we have in the past company history. I would encourage you to look at our Ks and Qs, and we do expose there percentage of business with any one partner and gives you a better feel for just what the percentages are.

[Eric Landry:]

Okay, great. So all right, my next question is regarding the other segment. And the growth, while still very impressive, has actually slowed down from the prior four quarters where it was 40% to 50%. And obviously, that cannot go on forever. But I’m just wondering, has the online segment reached a size such that those type of growth rates are less likely and now we’re sort of in a new run rate here?

[Suzanne Miglucci:]

So short of giving guidance. I would – remember that we posted – we just mentioned 52% growth in our charlesandcolvard.com website. So that is consistently growing at the same rate that we have talked about over the past four quarters. I also mentioned that we have a number of net new online channels that we just opened. There were about eight of them that I just rattled off, and those are all just new in the quarter. So that includes Amazon and eBay in Italy and France and Spain and Australia and a few – eBay and Catch in Australia. Those are just beginning. We have a handful of listings out there. We’re starting to see a little bit of revenue trickle in. But we anticipate that – this is Amazon we’re talking about – and for the most part, these all have tremendous potential. And there are far more online outlets that are still out there that we haven’t yet even scratched surface with. So I would say no, we have not yet met a point where we’ll see diminishing returns or flattened returns from online channels. I still think there is a very huge opportunity ahead of us in that sector.

[Eric Landry:]

All right. Well, that’s all for me. Thanks a lot.

[Operator:]

[Operator Instructions] The next question is a follow-up from Craig Pieringer with Wells Capital.

[Craig Pieringer:]

Yes. So Suzanne, last year, when De Beers came out with their lab-created diamond plans, the quick reaction was, Fabulous will expand the category. We’re not afraid of them, so on and so forth. Is that sort of still the feeling?

[Suzanne Miglucci:]

That is still the feeling, Craig. We are excited to have them in the mix. They and others in the lab-creative space are bringing a tremendous amount of eyeballs and traffic to generally lab-created. What’s interesting for the consumer here as they compare Charles & Colvard moissanites to lab-created, we are the guaranteed product that comes from a lab that is sustainably sourced. There’s still some confusion about lab-created versus mined and where do they come from and what is the source of the goods. For someone that wants a guarantee that they are getting goods that are guaranteed sustainably sourced, that is moissanite. And I would also remind the market that we are the better product, so we have more fire, more brilliance at a better price than what you’ll find in either mined diamond or lab-created. I think one of the statistics that’s interesting to us this past quarter is the surgent of organic traffic on our website. And we talked a little bit about this tremendous traffic that we had over the holiday. It increased by more than 50% over last year’s traffic. And the remarkable part about that is that a good chunk of that additional traffic was organic. And what that means is, it’s not Charles & Colvard advertising and people are clicking through our advertisements necessarily. There’s certainly plenty of that going on. But many of the people coming to the site and eventually converting are actually finding us organically on their own, meaning they go to Google, they search for us, they’ve done their homework and they find their way here by themselves, which says they’re finding us, they’re learning about moissanite, they’re doing their homework, they’re coming here and they’re converting. So we believe these are all very strong indicators and of course, our growth at 19% over last year, all very strong indicators that there is a continued market for moissanite. So we’re very excited about it.

[Clint Pete:]

Yes, I wanted to note that we actually have an emailed question that came in during the call, the session this afternoon. I wanted to summarize the question, and then I’ll address that. Can you please summarize sales and gross margins for the breakdown between loose jewel and finished jewelry sales as well as margins on the online and our Traditional segment? So I want to address first the loose jewel and finished jewelry revenue. Sales of $4.9 million, as I mentioned earlier, in the quarter, that’s up from 30% the year ago quarter. Typically, our loose jewel line is approximately about 50% gross margin. The finished jewelry, we saw net sales of $5.2 million or up 10% versus the year ago quarter, and the gross margins are typically in that 50% range as well. Traditional channels were about $5.4 million, which represents about an increase of 19%. And traditionally, we see, in that Traditional channel gross margins in the range of 45%. Online Channels, we saw that had revenue of $5.4 million. Typically, we see that an increase in 18% – typically, we see about a higher range for the – we’re going right to consumers, so it’s typically in the 55% to 50% – 57% range.

[Suzanne Miglucci:]

Great. Thanks, Craig. Chad, anything further in queue.

[Operator:]

Yes, we do. The next question is from Rodney Baber [Paulson Investment Company]. Please go ahead.

[Rodney Baber:]

Suzanne, how are you?

[Suzanne Miglucci:]

Hey, Rodney. Thanks for call.

[Rodney Baber:]

Yes. I’m really encouraged with the below the top line improvements that you’ve been putting in place. The gross margin expenses have been held tight and all of that, and that’s something you’ve definitely accomplished, we can all be proud of. What I really wanted to know as a stockholder of the company, If I look at the revenues going back last four or five years, during the $26 million – I think, you had $29-something million trailing 12 with this quarter’s release, but they’re still in the $26 million to $29 million run rate, which makes me ask you the question is, how do we get out of that in a meaningful way that creates interest in the stock and excitement for the company? It’s obvious we’re going to grow out of it to some extent, but we’ve also been losing revenues in some of our areas like Traditional and so forth. So I’m just wondering, how do we get this thing to be a much larger company? Are there acquisitions we can make? Are there any other strategies to expand what we’re doing that you can discuss? I’m just trying to get a read on what we can look forward to long run with getting this company out of this $27 million run rate.

[Suzanne Miglucci:]

Sure, Rodney. So I will – going back in your modeling four years, let’s be careful that we’re not modeling in the onetime sale of $6.7 million that was in the first quarter of 2016. That drove us off all a little bit, but...

[Rodney Baber:]

No, no. That was $29 million. And you take out whatever you want to on that, and it brings it back down to $25 million. So you have $25 million, $25 million, $27 million, $26 million and close to $29 million now this year with this quarter out. So it’s still, I mean, this is the biggest year-over-year revenue growth we’ve had if you adjust it for that issue.

[Suzanne Miglucci:]

Right, that’s exactly right. And we’ve gotten here by way of building this omni-channel strategy and doing the direct-to-consumer work that we’re doing. So becoming more a jewelry company than a gemstone alone company has given us far more opportunity to sell, so that’s really worked in our favor. Working our online channels and creating those in this omni-channel strategy, get this there, and opening new channels for revenue opportunity, we believe, is a very big part of the go-forward strategy. And if you look at that last slide of ours, that’s really one of the key strategy for 2019. So that’s an important part. The other thing is to think about the margins that we’re generating right now. If you go back and model previous years, margins were far lower. We’re generating higher margin now with Forever One. And just now, we introduced Moissanite by Charles & Colvard, and that comes in at a higher margin than its predecessors, Forever Brilliant and Classic. So these also become opportunities for us to grow the top line by way of higher margin as we’re generating our sales. And ultimately, that’s where we’re able to get profitability, control the cost, get our margins up and I deliver two consecutive profitable quarters for you.

[Rodney Baber:]

Well, one other thing that relates to your answer, which I appreciate that, is the question about moissanite’s place in the world and with millennials and everybody else coming up the food chain, liking that kind of product, et cetera, how do you feel about where moissanite is? Did you expect it to gain more acceptance and have a bigger part of the market than they have? It seems like they’ve gotten a share, but it’s not really just – it’s not going like we would hope for. So give us a state of the union on where you think moissanite acceptance and future potential is versus where it’s been?

[Suzanne Miglucci:]

Sure. So I think we’re heading in absolutely the direction that we should be in. So I’m not sure that I agree that it’s not where it should be. We’re growing our millennial audience significantly. More than 50% of our audience right now is a millennial audience member. What we’re learning of them and a lot of the market research that just came out recently is pointing to the fact that a millennial – 66% of all consumers are more likely to purchase a good if it comes from a sustainable brand. Millennials actually come in at 73% of that survey. And what they say is this, is they are more likely to buy from our brand that is sustainable. They’re not talking about a product, they’re talking about a brand. And what I love about where we’ve taken Charles & Colvard is that all of our product is sustainably sourced. We have sustainably sourced metals, we have a sustainable gemstone. We’re bringing it to market in a sustainable way. We can’t say the same for a lot of our peers in the industry. While you might be growing lab-created diamonds out of Oregon, you might also be mining the earth in Botswana. And you can’t be doing one thing out of one door and another out of another and think that a millennial consumer is going to feel that you’re a sustainable brand. Charles & Colvard is a sustainable brand. So we’re well positioned for this consumer who is doing their homework and absolutely understanding where we’re taking the brand. And at the same time, we’re working with these marketing outlets, such as The Knot, and they are touching 1 in 4 millennials. So I think Rodney, to finish out the answer to the question, we simply need to do more public relations and have more marketing and do more advertising and be more exposed in the market so that when those millennials are making their choices, Charles & Colvard is there and we’re talking sustainability. So thank you for your questions and for dialing in. I certainly do appreciate it. Chad, is there anyone else in the queue?

[Operator:]

At this time, we have no further individuals in the queue, so I’ll turn it back to you for any closing remarks.

[Suzanne Miglucci:]

All right. Thank you, sir. So once again, we thank everyone for taking the time to participate in our call today. My personal thanks to our incredible Charles & Colvard staff, who delivered an amazing holiday to our customers and to all of you, we appreciate your time, interest and investment in Charles & Colvard. Thank you, and have a good evening.

[Operator:]

And thank you. Today’s conference call will be archived for review on the company’s website at www.charlesandcolvard.com/investor-relations/events. To access the digital replay of this conference, you may dial 1-877-344-7529 or 412-317-0088, beginning approximately 1 hour from now. You will be prompted to enter a conference number, which will be 10128080. Please record your name and company when joining. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.