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Charles lvard : & COLVARD LTD Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-K)

03/27/2014 | 06:03am US/Eastern
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The following discussion is intended to provide a better understanding of our
consolidated financial statements, including a brief discussion of our business
and products, key factors that impacted our performance, and a summary of our
operating results. This information should be read in conjunction with Item 1A,
"Risk Factors" and our consolidated financial statements and the notes thereto
included in Item 8, "Financial Statements and Supplementary Data" of this Annual
Report on Form 10-K. Historical results and percentage relationships among any
amounts in the consolidated financial statements are not necessarily indicative
of trends in operating results for future periods.

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Overview

We manufacture, market, and distribute Charles & Colvard Created Moissanite®
jewels (which we refer to as moissanite or moissanite jewels), finished jewelry
featuring moissanite, and fashion jewelry for sale in the worldwide jewelry
market. Moissanite, also known by its chemical name of silicon carbide, or SiC,
is a rare mineral first discovered in a meteor crater. Because naturally
occurring SiC crystals are too small for commercial use, larger crystals must be
grown in a laboratory. Leveraging our advantage of being the sole source
worldwide of created moissanite jewels, our strategy is to establish Charles &
Colvard with reputable, high-quality, and sophisticated brands and to position
moissanite as an affordable, luxurious alternative to other gemstones, such as
diamond. We believe this is possible due to moissanite's exceptional brilliance,
fire, luster, durability, and rarity like no other jewel available on the
market.

We manage our business primarily by our two distribution channels that we use to
sell our product lines, loose jewels and finished jewelry. Accordingly, we
determined our two operating and reporting segments to be wholesale distribution
transacted through our parent entity and direct-to-consumer distribution
transacted through our wholly owned operating subsidiaries, Moissanite.com, LLC
and Charles & Colvard Direct, LLC. We sell our loose moissanite jewels at
wholesale to some of the largest distributors and manufacturers in the world,
which mount them into fine jewelry to be sold at retail outlets and via the
Internet. We also sell loose moissanite jewels and finished jewelry featuring
moissanite at wholesale to retailers to be sold to end consumers and, in the
third quarter of 2011, we established a direct-to-consumer e-commerce sales
channel through our wholly owned operating subsidiary Moissanite.com, LLC that
sells both loose moissanite jewels and finished jewelry featuring moissanite.
Additionally, in April 2012 we launched a pilot test of a direct-to-consumer
home party sales channel through our wholly owned operating subsidiary Charles &
Colvard Direct, LLC, or Charles & Colvard Direct, that sells fashion and
moissanite finished jewelry. We believe the expansion of our sales channels to
the jewelry trade and the end consumer with branded finished moissanite jewelry
creates a more compelling consumer value proposition to drive increased demand.

We are continuing to focus on our core business of manufacturing and distributing the loose moissanite jewel and finished jewelry featuring moissanite through wholesale sales channels, because this is currently the primary way we reach consumers. We believe there is opportunity to grow our wholesale business and to capture a larger share of the jewelry market as we execute our strategy to increase consumer awareness of moissanite.


The wholesale finished jewelry business that we launched in 2010 is currently
expanding through select retailers and television shopping networks. We believe
there is significant opportunity to further expand our wholesale finished
jewelry business through e-commerce, television shopping, and other retailers.
We also believe our finished jewelry business, including finished jewelry sold
through our direct-to-consumer e-commerce and home party sales channels, allows
us to have more control over the end product and enhance our relationships with
consumers, as well as provide incremental sales and gross profit dollars due to
the higher price points of finished jewelry containing moissanite relative to
loose jewels. To that end, we focused on the following critical aspects of our
strategic plan during 2013:

· Developing brand strategies - Our goal is to build multiple strong brands

around the moissanite jewel and finished jewelry collections in attractive and

desirable jewelry designs, especially those featuring larger center stones that

leverage moissanite's point of differentiation and value proposition. We

believe branding will allow us to increase consumer awareness, which we expect

to help drive sales and develop consumer brand recognition and loyalty.




In June 2012, we launched a moissanite jewel with optical properties that are
significantly whiter than our standard VG "classic moissanite" grade jewels. We
are marketing these whiter jewels under the Forever Brilliant® trademark as a
premier brand to differentiate from other grades of our moissanite as well as
moissanite sold by potential competitors in the future.

We expect demand for our Forever Brilliant® loose jewel and finished jewelry
featuring the Forever Brilliant® jewel to grow, both in our wholesale channel
and on our Moissanite.com e-commerce website, and that Forever Brilliant® will
become an increasingly important brand for Charles & Colvard, Ltd. as we execute
future branding initiatives. We are also exploring additional product lines and
branding strategies that will differentiate our products in the market.

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In October 2012, we partnered with a well-known designer to custom design and
source finished fashion and moissanite jewelry and provide branding direction
for Lulu Avenue®, the home party direct sales brand of Charles & Colvard Direct.
We believe our exclusive fashion and moissanite jewelry designs serve as the
point of differentiation that positions Lulu Avenue® ahead of other jewelry home
party direct sales companies and will excite both consumers and women searching
for unique business ownership opportunities.

In June 2013, we engaged Cindy Riccio Communications, Inc., or CRC, a New
York-based public relations, marketing, and events agency, as our agency of
record to generate optimal exposure with consumer media for both our Lulu
Avenue® and Forever Brilliant® brands, with the goal to increase consumer
awareness of our brands specifically and moissanite generally. Several media
events occurred during 2013 where magazine editors, fashion columnists, and
bloggers were invited to experience first-hand our Lulu Avenue® fashion and
moissanite finished jewelry and our Forever Brilliant® loose jewels. We are also
utlizing CRC to increase exposure for our brands through improved product
placement in leading fashion periodicals and blogging sites, and through
broadcast and print editorial outreach.

We believe our efforts to position Forever Brilliant® as the whitest and
brightest moissanite jewel available anywhere in the world, the introduction of
designer finished jewelry brands, and the engagement of a branding public
relations agency will help us to build brand recognition and increase consumer
awareness of our products. We also expect that this strategy of building brand
recognition will help to support revenue streams as our intellectual property
rights expire in the future.

· Expanding our direct-to-consumer e-commerce business - Our direct-to-consumer

e-commerce website, Moissanite.com, features an intuitive site design with

robust functionality to enhance the customer experience and convert traffic

into sales. We continue to expand the website's jewelry collections and its

loose moissanite jewel assortment by featuring a variety of colors and shapes,

and we are investing resources in targeted advertising and marketing campaigns.

In 2013, we continued fine-tuning such marketing efforts to maximize return on

investment, increasing product assortment, and building new site functionality

designed to increase sales conversion rates. We believe our direct-to-consumer

e-commerce sales channel will not only add to our top-line revenues in a

significant manner, but will also play a key role in our campaign to increase

overall consumer awareness of moissanite. We also envision e-commerce as a part

of a broader effort to establish online connections with consumers that build

our brands and our business with retail partners.

· Developing our direct-to-consumer home party business - In October 2012, our

direct-to-consumer home party business, Lulu Avenue®, began to integrate the

custom designs of a well-known jewelry designer into the current jewelry line.

The first phase of the integration was completed in March 2013. In April 2013,

we hired a President of Lulu Avenue® whose focus is on the scale-up of the

sales force, and in March 2013, we hired a Director of Finance and

Administration, who leads the back office technology and supply chain efforts

of Lulu Avenue®. With these new key personnel, we completed the final phase of

the integration process in 2013. We believe our direct-to-consumer home party

sales channel will provide future sales growth and play a role in our campaign

to increase overall consumer awareness of moissanite.




As we execute our strategy to build and reinvest in our businesses, significant
expenses and investment of cash will be required ahead of the revenue streams we
expect in the future, and this may result in some unprofitable reporting periods
as we experienced in 2013. Despite this, we have maintained as one of our
primary goals to generate positive cash flow to protect our cash position. We
were not successful in achieving this goal during the year ended December 31,
2013 primarily as a result of our significant inventory build of Forever
Brilliant® loose jewels to meet anticipated demand, establish an in-stock
position for future orders and collect on our trade receivables generated from
these sales. We will continue to diligently focus on cost-management and monitor
our cash burn rate as we grow the business.

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Our total consolidated net sales for the year ended December 31, 2013 of $28.49
million were 27% greater than total consolidated net sales during the year ended
December 31, 2012. Wholesale distribution segment net sales for the year ended
December 31, 2013 of $25.57 million were 23% greater than wholesale distribution
segment net sales during the year ended December 31, 2012. Direct-to-consumer
distribution segment net sales for the year ended December 31, 2013 of $2.91
million were 78% greater than direct-to-consumer distribution segment net sales
during the year ended December 31, 2012, which was the year in which operations
commenced.

Loose jewel sales comprised 65% of our total consolidated net sales and
increased 23% to $18.48 million, compared with $14.99 million in the previous
year. Finished jewelry sales comprised 35% of our total consolidated net sales
and increased 34% to $10.0 million, compared with $7.46 million in the previous
year. We expect these increases in sales by product mix to continue as we
execute our strategy of developing new wholesale and direct-to-consumer sales
channels and expanding our finished jewelry business.

The execution of our strategy to grow our company, with the ultimate goal of
increasing consumer awareness and clearly communicating the value proposition of
moissanite, is challenging and not without risk. As such, there can be no
assurance that future results for each reporting period will exceed past results
in sales, operating cash flow, and/or net income due to the challenging business
environment in which we operate, our changing business model, and our investment
in various initiatives to support our growth strategies. However, as we execute
our growth strategy and messaging initiatives, we remain committed to our
current priorities of generating positive cash flow and strengthening our
financial position through cost-management efforts while both monetizing our
existing inventory and manufacturing our new whiter Forever Brilliant® loose
jewel and finished jewelry to meet sales demand. We believe the results of these
efforts will propel our revenue growth and profitability and further enhance
shareholder value in coming years, but we fully recognize the challenging
business and economic environment in which we operate.

2013 Summary

The following is a summary of key financial results and certain non-financial results achieved for the year ended December 31, 2013:

· We grew our total consolidated net sales by $6.04 million, or 27%, to $28.49

million in 2013 from $22.45 million in 2012. The improvement in 2013 sales was

primarily due to the ongoing execution of our growth strategies, including

initiatives to increase consumer awareness of moissanite through marketing

support of our customer base; the addition of several new wholesale customers

and the expansion of existing wholesale customer relationships; the increase in

sales of our new whiter Forever Brilliant® moissanite jewel; and the growth of

our wholesale customers' moissanite finished jewelry lines with styles that

include both Forever Brilliant® and our other grades of loose jewels. The

improvement in 2013 consolidated net sales was also attributable to an over 78%

increase in sales through our direct-to-consumer businesses, Moissanite.com and

Lulu Avenue®, which collectively increased their net sales to $2.91 million.

· Operating expenses increased by $3.25 million, or 27%, to $15.47 million in

2013 from $12.22 million in 2012 primarily as a result of personnel additions

and advertising, marketing, and branding initiatives incurred to position our

company for future growth, especially with respect to the two wholly owned

operating subsidiaries formed in 2011 for our e-commerce and home party direct

sales businesses. As we grow our business, we intend to continue to closely

manage our operating expenses by seeking the most cost effective and efficient

solutions to our operating requirements.

· Net income decreased by $5.67 million, to a loss of $1.29 million in 2013 from

net income of $4.38 million in 2012. Net loss per share was a loss of $0.06 in

2013 compared to net income per diluted share of $0.22 in 2012. Net income for

the year ended December 31, 2012 included a $4.05 million net income tax

benefit, which contributed $0.20 per diluted share, comprised of a reduction of

a valuation allowance on certain deferred tax assets based on our expectation

of their future utilization and the reversal of a liability for an uncertain

tax position resulting from a voluntary disclosure agreement we entered into

with a taxing authority. As discussed above, sales increases in 2013 were

offset by higher operating expenses as we continued the investment in our

   strategic initiatives.



· We generated negative cash flows from operations of $9.31 million in 2013

compared to positive cash flows of $2.78 million in 2012. The primary drivers

of negative cash flow were our net loss of $1.29 million that included $3.33

million of net non-cash charges, an increase in inventory of $9.88 million, an

increase in trade accounts receivable of $2.83 million, and an increase in

prepaid expenses and other assets of $261,000. These factors more than offset

an increase in trade accounts payable of $1.56 million, and a net increase in

   accrued liabilities of $67,000.



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· Cash and liquid government agency investments at December 31, 2013 were $2.57

million compared to $12.37 million at December 31, 2012. The primary reason for

this decrease is the $9.31 million cash flow used from operations.

· Total inventory, including long-term and consignment inventory, was $42.41

million as of December 31, 2013, up from approximately $32.80 million at

December 31, 2012. This increase is primarily a result of purchases in 2013 of

jewelry castings, findings, and other jewelry components; purchases of fashion

finished jewelry in support of our Lulu Avenue® home party direct sales

business; and production of Forever Brilliant® jewels, offset in part by higher

sales. We believe we have a significant opportunity to build our cash position

as we sell down our on-hand loose moissanite jewel inventory.

· We continue to carry no long-term debt and believe we can fund our growth

strategies for the foreseeable future from operating cash flows.

Critical Accounting Policies and Estimates


Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which we prepared in
accordance with accounting principles generally accepted in the United States,
or U.S. GAAP. The preparation of these consolidated financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, and expenses and related disclosures of
contingent assets and liabilities. "Critical accounting policies and estimates"
are defined as those most important to the financial statement presentation and
that require the most difficult, subjective, or complex judgments. We base our
estimates on historical experience and on various other factors that we believe
to be reasonable under the circumstances, the results of which form the basis
for making judgments about the carrying value of assets and liabilities that are
not readily apparent from other sources. Under different assumptions and/or
conditions, actual results of operations may materially differ. The most
significant estimates impacting our consolidated financial statements relate to
valuation and classification of inventories, accounts receivable reserves,
deferred tax assets, uncertain tax positions, cooperative advertising, and
revenue recognition on transactions with extended payment terms. We also have
other policies that we consider key accounting policies, but these policies
typically do not require us to make estimates or judgments that are difficult or
subjective.

Inventories - Inventories are stated at the lower of cost or market on an
average cost basis. Our finished goods inventory consists primarily of
near-colorless moissanite jewels that meet rigorous grading criteria and are of
cuts and sizes most commonly used in the jewelry industry. As of December 31,
2013, we carried only a limited amount of moissanite jewels in finished jewelry
settings, and the carrying value of these jewels is included in the finished
jewelry valuation described below. Our loose moissanite jewel inventories do not
degrade in quality over time and are not subject to fashion trends. We have very
small market penetration in the worldwide jewelry market and have the exclusive
right in the U.S. through mid-2015 and in many other countries through mid-2016
to produce and sell created SiC for use in jewelry applications. In view of the
foregoing factors, we have concluded that no excess or obsolete loose jewel
inventory reserve requirements existed as of December 31, 2013.

Jewelry inventories consist primarily of finished goods, a portion of which we
acquired as part of a January 2009 settlement agreement with a former
manufacturer customer to reduce the outstanding receivable to us. Due to the
lack of a plan to market this inventory at that time, a jewelry inventory
reserve was established to reduce the majority of the acquired jewelry inventory
value to scrap value, or the amount we would expect to obtain by melting the
gold in the jewelry and returning to loose-jewel finished goods inventory those
jewels that meet grading standards. To determine the amount of the jewelry
reserve, we needed to estimate the amount of gold in each piece of jewelry, the
price per ounce we would receive for the gold, and the amount of jewels that
could be returned to finished goods inventory. The scrap reserve of $106,000 and
$132,000 at December 31, 2013 and 2012, respectively, established for this
acquired inventory at the time of the agreement is adjusted at each reporting
period for the market price of gold and has generally declined as the associated
jewelry is sold down. In 2010, we entered the finished jewelry business and
began manufacturing finished jewelry featuring moissanite pursuant to an
operational plan to market and sell the inventory. As a result, the moissanite
finished jewelry we currently produce is not subject to this reserve.

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Relative to loose moissanite jewels, finished jewelry is more fashion oriented
and subject to styling trends that could render certain designs obsolete. The
majority of our finished jewelry featuring moissanite is held in inventory for
resale and consists of such basic designs as stud earrings, solitaire and
three-stone rings, pendants, and bracelets that tend not to be subject to
significant obsolescence risk due to their classic styling. In addition, we
manufacture small individual quantities of designer-inspired moissanite fashion
jewelry as part of our sample line that are used in the selling process to our
wholesale customers.

In 2011, we began purchasing fashion finished jewelry comprised of base metals
and non-precious gemstones for sale through Lulu Avenue®, the direct-to-consumer
home party division of our wholly owned operating subsidiary, Charles & Colvard
Direct. This finished jewelry is fashion oriented and subject to styling trends
that may change with each catalog season, of which there are several each year.
Typically in the jewelry industry, slow-moving or discontinued lines are sold as
closeouts or liquidated in alternative sales channels. We review the finished
jewelry inventory on an ongoing basis for any lower of cost or market and
obsolescence issues and have concluded that no such finished jewelry inventory
reserve requirements relating to our new line of finished jewelry featuring
moissanite and fashion finished jewelry products existed as of December 31,
2012.  During the year ended December 31, 2013, we identified certain fashion
finished jewelry inventory that could not be sold due to damage or branding
issues, and established an obsolescence reserve of $128,000 for the carrying
costs in excess of any estimated scrap values.  No reserve requirement relating
to our finished jewelry featuring moissanite existed as of December 31, 2013.

We also maintain loose jewel and finished jewelry inventory reserves for
shrinkage, recuts, and repairs. Shrinkage refers to loose jewels and finished
jewelry on review with customers and vendors that may not be returned to us. The
recuts reserve is for the projected material loss resulting from the recutting
of damaged jewels into smaller loose jewels to remove the damage. The repairs
reserve is for finished jewelry in need of repair before it can be returned to
finished goods inventory and be available for sale.

Any inventory on hand at the measurement date in excess of our current
requirements based on historical and anticipated levels of sales is classified
as long-term on our consolidated balance sheets. Our classification of long-term
inventory requires us to estimate the portion of inventory that can be realized
over the next 12 months and does not include precious metal, labor, and other
inventory purchases expected to be both purchased and realized over the next 12
months.

Accounts Receivable Reserves - Estimates are used to determine the amount of two
reserves against trade accounts receivable. The first reserve is an allowance
for sales returns. At the time revenue is recognized, we estimate future returns
using a historical return rate that is reviewed quarterly with consideration of
any contractual return privileges granted to customers, and we reduce sales and
trade accounts receivable by this estimated amount. The allowance for sales
returns was $1.19 million and $463,000 at December 31, 2013 and 2012,
respectively.

The second reserve is an allowance for doubtful accounts for estimated losses
resulting from the failure of our customers to make required payments. This
allowance reduces trade accounts receivable to an amount expected to be
collected. Based on historical percentages of uncollectible accounts by aging
category, changes in payment history, and facts and circumstances regarding
specific accounts that become known to management when evaluating the adequacy
of the allowance for doubtful accounts, we determine a percentage based on the
age of the receivable that we deem uncollectible. The allowance is then
calculated by applying the appropriate percentage to each of our accounts
receivable aging categories, with consideration given to individual customer
account activity subsequent to the current period, including cash receipts, in
determining the appropriate allowance for doubtful accounts in the current
period. Any increases or decreases to this allowance are charged or credited,
respectively, as a bad debt expense to general and administrative expenses. We
generally use an internal collection effort, which may include our sales
personnel as we deem appropriate. After all internal collection efforts have
been exhausted, we generally write off the account receivable.

Any accounts with significant balances are reviewed separately to determine an
appropriate allowance based on the facts and circumstances of the specific
account. During our reviews for 2013 and 2012, we analyzed several of our
slower-paying customers and determined that no additional reserves were
necessary. Based on these criteria, we determined that allowances for doubtful
accounts receivable of $522,000 and $549,000 at December 31, 2013 and 2012,
respectively, were required.

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Deferred Tax Assets - U.S. GAAP guidance requires that all deferred tax assets
of the company be assessed to determine if a valuation allowance is required. A
valuation allowance is required if it is determined that it is more likely than
not, or greater than a 50% probability, that some portion or all of the deferred
tax assets will not be realized. The guidance states further that "forming a
conclusion that a valuation allowance is not needed is difficult when there is
negative evidence such as cumulative losses in recent years." Based on our tax
losses in tax years prior to 2012 and the lack of verifiable positive evidence
of sufficient future taxable income to fully use our net operating loss
carryforward and other deferred tax assets, we established valuation allowances
against all U.S. deferred tax assets of $4.43 million as of December 31, 2011.
As of each reporting date, management considers new evidence, both positive and
negative, that could impact its view with regard to future realization of
deferred tax assets. For the years ended December 31, 2013 and 2012, cumulative
positive taxable income over the last three years had been generated, offsetting
the negative evidence of cumulative losses in previous years. We also determined
that our expectations of future taxable income in upcoming tax years would be
sufficient to result in full utilization of these net operating loss
carryforwards and deferred tax assets prior to any statutory expiration. As a
result, management determined that sufficient positive evidence exist as of
December 31, 2013 and 2012 to conclude that it is more likely than not deferred
tax assets of $4.04 million and $3.73 million, respectively, are realizable, and
we reduced our valuation allowance accordingly. The reduction of the valuation
allowances against these deferred tax assets resulted in an income tax benefit
during the years ended December 31, 2013 and 2012 of $1,000 and $3.73 million,
respectively. A valuation allowance remained at December 31, 2013 and 2012
against certain deferred tax assets relating to state net operating loss
carryforwards from our e-commerce and home party operating subsidiaries due to
the timing uncertainty of when the subsidiaries will generate cumulative
positive taxable income to utilize the associated deferred tax assets. A
valuation allowance also remained at December 31, 2013 and 2012 against certain
deferred tax assets relating to investment loss carryforwards because our
current investments were classified as held-to-maturity as of December 31, 2012,
indicating they would be redeemed at par value, and they did not generate gains
sufficient to utilize the associated deferred tax assets when they matured in
2013.

Our deferred tax assets in Hong Kong were fully reserved with a valuation
allowance of $996,000 as of December 31, 2013 and 2012 and had been fully
reserved in all prior periods due to the uncertainty of future taxable income in
this jurisdiction to utilize the deferred tax assets. Our Hong Kong subsidiary
ceased operations during 2008 and became a dormant entity during 2009. If we use
any portion of our deferred tax assets in future periods, the valuation
allowance would need to be reversed and may impact our future operating results.

Uncertain Tax Positions - Effective January 1, 2007, we adopted U.S. GAAP
guidance regarding the de-recognition, classification, accounting in interim
periods, and disclosure requirements for uncertain tax positions. Determining
which tax positions qualify as uncertain positions and the subsequent accounting
for these positions requires significant estimates and assumptions. Our net
accrued income tax liability under the provisions of this guidance was $395,000
and $384,000 at December 31, 2013 and 2012, respectively. This liability is only
resolved when we obtain an official ruling from the tax authority on the
positions or when the statute of limitations expires.  Our liability increased
by $11,000 for accrued interest on these positions.

Cooperative Advertising - We offer a cooperative advertising program to many of
our wholesale customers that reimburses, via a credit towards future purchases,
a portion of their marketing costs based on their net purchases from us. At the
end of any given period, we estimate the amount of cooperative advertising
expense that has not yet been submitted for credit by our customers. These
amounts were $188,000 and $200,000 at December 31, 2013 and 2012, respectively.
We estimate this amount based on our historical experience with each customer
and the related contractual arrangements to provide certain levels of
cooperative advertising for our customers. Any differences in actual amounts to
our estimates will result in a charge or credit to sales and marketing expenses.

Revenue Recognition - Revenue is recognized when title transfers at the time of
shipment from our or a third-party fulfillment company's facility, excluding
consignment shipments as discussed below; evidence of an arrangement exists;
pricing is fixed and determinable; and collectability is reasonably assured. Our
standard wholesale customer payment terms are generally between 30 and 90 days,
though we may offer extended terms with specific customers and on significant
orders from time to time. Some wholesale customers and all direct-to-consumer
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 loose jewels and finished jewelry for credit generally within 30
days of shipment and must be returned for a valid reason, such as quality
problems or an error in shipment. From time to time, some wholesale customers
may have a contractual right to return a certain percentage of goods for any
reason for specified periods of time. In these instances, we only recognize
revenue when the contractual right of return is exhausted. Periodically, we ship
finished goods inventory to wholesale customers on consignment terms. Under
these terms, the customer assumes the risk of loss and has an absolute right of
return for a specified period that typically ranges from six months to one year.
Our wholesale customers are generally required to make payments on consignment
shipments within 60 days upon the customer informing us that it will keep the
inventory. Accordingly, we do not recognize revenue on these consignment
transactions until the earlier of (1) the customer informing us that it will
keep the inventory or (2) the expiration of the right of return period.

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Recent Accounting Pronouncements - See Note 2 to our consolidated financial
statements in Item 8, "Financial Statements and Supplementary Data" of this
Annual Report on Form 10-K for a description of recent accounting
pronouncements, including the expected dates of adoption and estimated effects,
if any, on our consolidated financial statements.

Results of Operations

The following table sets forth certain consolidated statements of operations data for the years ended December 31, 2013 and 2012.

                                                 Year Ended December 31,
                                                  2013             2012
          Net sales                           $ 28,487,187     $ 22,450,498
          Costs and expenses:
          Cost of goods sold                    14,600,177        9,971,663
          Sales and marketing                    9,867,425        7,443,784
          General and administrative             5,476,939        4,756,432
          Research and development                  24,903           17,013
          Loss on abandonment of assets             98,027            2,016
          Total costs and expenses              30,067,471       22,190,908
          (Loss) income from operations         (1,580,284 )        259,590
          Other income (expense):
          Interest income                           22,007           69,520
          Interest expense                          (2,106 )         (1,260 )
          Total other income                        19,901           68,260
          (Loss) income before income taxes     (1,560,383 )        327,850
          Income tax net benefit                   269,285        4,049,804
          Net (loss) income                   $ (1,291,098 )   $  4,377,654



Consolidated Net Sales

Consolidated net sales for the years ended December 31, 2013 and 2012 comprise
the following:

                                  Year Ended December 31,                 Change
                                   2013             2012           Dollars        Percent
Loose jewels                   $ 18,483,995     $ 14,991,398     $ 3,492,597            23 %
Finished jewelry                 10,003,192        7,459,100       2,544,092            34 %
Total consolidated net sales   $ 28,487,187     $ 22,450,498     $ 6,036,689            27 %



Consolidated net sales were $28.49 million for the year ended December 31, 2013
compared to $22.45 million for the year ended December 31, 2012, an increase of
$6.04 million, or 27%. The improvement in 2013 consolidated net sales was due
primarily to an increase in loose jewel sales to our wholesale customer base
resulting from the June 2012 launch of our new whiter Forever Brilliant®
moissanite jewel and the growth of our wholesale customers' moissanite finished
jewelry lines with styles that include both Forever Brilliant® and our loose
jewel standard grades. The improvement in 2013 consolidated net sales was also
attributable to a significant increase in loose jewel sales to our domestic and
international distributors; and the growth of our direct-to-consumer businesses,
Moissanite.com and Lulu Avenue®, which collectively increased 78% to $2.91
million. We anticipate orders and related sales of both loose moissanite jewels
and finished jewelry in both our wholesale distribution segment and
direct-to-consumer distribution segment will improve as we continue to execute
our growth strategies.

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Sales of loose jewels represented 65% and 67% of total consolidated net sales
for the years ended December 31, 2013 and 2012, respectively. For the year ended
December 31, 2013, loose jewel sales were $18.48 million compared to $14.99
million for the year ended December 31, 2012, an increase of $3.49 million, or
23%. This increase was primarily attributable to orders received from our
wholesale customer base upon the June 2012 launch of our new whiter Forever
Brilliant® moissanite jewel as well as increased orders for Forever Brilliant®
and other grades of loose jewels resulting from the growth of our wholesale
customers' moissanite finished jewelry lines.

Sales of finished jewelry represented 35% and 33% of total consolidated net
sales for the years ended December 31, 2013 and 2012, respectively. For the year
ended December 31, 2013, finished jewelry sales were $10.0 million compared to
$7.46 million for the year ended December 31, 2012, an increase of $2.54
million, or 34%. This increase was attributable to our ongoing expansion into
the finished jewelry business through the creation of new sales channels,
including televised home shopping networks in our wholesale distribution segment
and the growth of our e-commerce and home party businesses in our
direct-to-consumer distribution segment. In the years ended December 31, 2013
and 2012, we experienced a higher degree of seasonality in the fourth quarter
than we have previously experienced in prior years primarily as a result of
Christmas and holiday season wholesale finished jewelry sales to television
shopping networks. In the fourth quarter of 2012 and 2013, we also experienced a
higher level of sales to end consumers through our direct-to-consumer e-commerce
website, Moissanite.com. In future periods as sales of our finished jewelry
increase to retailers and directly to consumers, both in dollars and as a
percent of total sales, we anticipate a seasonality trend more typical with the
retail jewelry industry, and these factors may significantly affect our results
of operations in a given quarter.

U.S. net sales accounted for approximately 73% and 75% of total consolidated net
sales during the years ended December 31, 2013 and 2012, respectively. U.S. net
sales increased 23% during 2013 primarily due to an increase in loose jewel
sales to our wholesale customer base resulting from the launch of our new whiter
Forever Brilliant® moissanite jewel and the growth of our wholesale customers'
moissanite finished jewelry lines. The increase in U.S. sales was also
attributable to an increase in  our direct-to-consumer businesses,
Moissanite.com and Lulu Avenue®.

Our largest U.S. customer during the year ended December 31, 2013 accounted for
19% of our total consolidated sales compared to 27% during the year ended
December 31, 2012.  A second U.S. customer accounted for 11% of our total
consolidated sales during the year ended December 31, 2012 but did not account
for more than 10% of our total consolidated sales during the year ended December
31, 2013. No additional U.S. customers accounted for more than 10% of total
consolidated sales in 2013 or 2012. We expect that we will remain dependent on
our ability, and that of our largest customers, to maintain and enhance retail
programs. A change in or loss of any of these customer or retailer relationships
could have a material adverse effect on our results of operations.

International net sales accounted for approximately 27% and 25% of total
consolidated net sales during the years ended December 31, 2013 and 2012,
respectively. International net sales increased 40% during 2013 primarily as a
result of restocking orders from our existing international wholesale customer
base due to the growth of their moissanite businesses. No international
customers accounted for more than 10% of total consolidated sales in 2013 or
2012. A portion of our international consolidated sales represents jewels sold
internationally that may be re-imported to U.S. retailers. Our top three
international distributors by sales volume during the year ended December 31,
2013 were located in Hong Kong.

Costs and Expenses

Cost of Goods Sold


Cost of goods sold for the years ended December 31, 2013 and 2012 are as
follows:

                                             Year Ended December 31,                  Change
                                               2013            2012           Dollars         Percent
Product line cost of goods sold
Loose jewels                               $  7,646,375     $ 4,686,526     $ 2,959,849              63 %
Finished jewelry                              5,299,572       3,587,458       1,712,114              48 %

Total product line cost of goods sold 12,945,947 8,273,984

   4,671,963              56 %
Non-product line cost of goods sold           1,654,230       1,697,679         (43,449 )            -3 %
Total cost of goods sold                   $ 14,600,177     $ 9,971,663     $ 4,628,514              46 %



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Total cost of goods sold was $14.60 million for the year ended December 31, 2013
compared to $9.97 million for the year ended December 31, 2012, an increase of
$4.63 million, or 46%. Product line cost of goods sold is defined as product
cost of goods sold in each of our wholesale distribution and direct-to-consumer
distribution operating segments excluding non-capitalized expenses from our
manufacturing and production control departments, comprising personnel costs,
depreciation, rent, utilities, and corporate overhead allocations; freight out;
inventory valuation allowance adjustments; and other inventory adjustments,
comprising costs of quality issues, damaged goods, and inventory write-offs.

The increase in cost of goods sold was primarily due to a $2.96 million increase
in loose jewel product line cost of goods sold resulting from the 23% increase
in loose jewel sales and lower margins on loose jewel sales, a $1.71 million
increase in finished jewelry product line cost of goods sold resulting from the
34% increase in finished jewelry sales and lower margins on finished jewelry
sales, offset partially by a net decrease in non-product line cost of goods sold
of $43,000. The net decrease in non-product line cost of goods sold comprises a
$510,000 net increase in other inventory adjustments related to costing and
quantity corrections; a $171,000 increase in inventory valuation adjustments,
including inventory shrinkage, recuts, repairs, and scrap reserves; and a
$90,000 increase in freight out; offset by a decrease of $815,000 in
non-capitalized manufacturing and production control expenses primarily due to
higher overhead capitalization rates to reflect increased inventory production
and levels at year end.

Information technology-related costs were historically included in general and
administrative expenses. Beginning in 2013, as our information technology
expenses increased to support a larger organization, our management determined
that certain information technology shared resource expenses should be contained
in one department, with these expenses then allocated based on headcount to
other departments to more accurately assign operating costs between our
wholesale and direct-to-consumer operating segments. The net result of this
allocation of operating expenses in the year ended December 31, 2013 compared to
the prior year were a $1.18 million aggregate decrease in general administrative
expenses; a $698,000 aggregate increase in sales and marketing expenses; and a
$484,000 aggregate increase in cost of goods sold. For the year ended December
31, 2013, the allocation to cost of goods sold, which is included as non-product
line cost of goods sold, comprised $273,000 of compensation costs; $104,000 of
depreciation and amortization expense; $67,000 of professional services; $36,000
of office-related expenses; and $4,000 of travel-related expenses.

Sales and Marketing


Sales and marketing expenses for the years ended December 31, 2013 and 2012 are
as follows:

                               Year Ended December 31,                 Change
                                 2013            2012           Dollars        Percent
       Sales and marketing   $  9,867,425     $ 7,443,784     $ 2,423,641            33 %




Sales and marketing expenses were $9.87 million for the year ended December 31,
2013 compared to $7.44 million for the year ended December 31, 2012, an increase
of $2.42 million, or 33%.

The increase in sales and marketing expenses was primarily due to an $864,000
net increase in compensation costs; $582,000 net increase in advertising
expenses; a $377,000 increase in professional services related to the addition
of temporary personnel, consulting services, and the maintenance of software
platforms for our direct-to-consumer e-commerce and home party lines of
business; a $305,000 increase in office-related expenses to support a larger
sales and marketing organization; a $214,000 increase in depreciation expense
related to the Moissanite.com and Lulu Avenue® e-commerce websites; and a
$73,000 increase in travel-related expenses resulting from new sales and
marketing personnel and expanding business opportunities.  Compensation costs
increased primarily as a result of merit salary adjustments that became
effective in the first quarter of 2013 and new sales and marketing personnel
added during 2013 in the aggregate of $563,000; an increase in stock-based
compensation expense of $223,000; and an increase in bonus expense of $184,000.
These increases in compensation costs were offset in part by a decrease in
commissions expense of $66,000, due to decreased sales and the timing of orders
by specific customers under which commission plans of sales representatives are
based; a decrease in severance expenses of $29,000; and a decrease in employee
relocation costs of $11,000.

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The increase in advertising expenses was primarily due to an increase in
cooperative advertising expenses of $400,000 resulting primarily from the
increase in sales of loose jewels compared to the same period in the prior year
and management's estimate of future utilization based on our historical
experience with each customer and the related contractual arrangements to
provide certain levels of cooperative advertising for our customers. Also
contributing to the increase in advertising expenses were a $190,000 increase in
agency expenses in support of brand awareness campaigns for all of our
distribution channels; a $50,000 increase in targeted marketing, trade shows,
and sponsorships; and a $2,000 increase in internet marketing, primarily in
support of our Moissanite.com and Lulu Avenue®e-commerce websites.  These
increases were offset by a $42,000 decrease in television media advertising due
to a special allowance granted to a customer in 2012 in exchange for additional
televised hours; and a decrease in print media advertising of $18,000 due
primarily to a trade awareness campaign in late 2012 for our whiter Forever
Brilliant® moissanite jewel.

As previously discussed, beginning in 2013, certain information
technology-related costs historically included in general and administrative
expenses are now allocated to sales and marketing expenses and cost of goods
sold. For the year ended December 31, 2013 compared to the prior year, $698,000
in aggregate of information technology-related costs were allocated to sales and
marketing expenses, comprising $392,000 of compensation costs; $151,000 of
depreciation and amortization expense; $97,000 of professional services; $52,000
of office-related expenses; and $6,000 of travel-related expenses.

We expect our total sales and marketing expenses will continue to increase as
sales increase, but the rate of growth should slow and become a lower percentage
of sales as expenses more variable in nature, such as advertising and
commissions, increase as part of our strategy to build sales; but fixed
expenses, such as compensation costs, grow at a slower rate.

General and Administrative


General and administrative expenses for the years ended December 31, 2013 and
2012 are as follows:

                                   Year Ended December 31,                Change
                                     2013            2012          Dollars       Percent
    General and administrative   $  5,476,939     $ 4,756,432     $ 720,507            15 %



General and administrative expenses were $5.48 million for the year ended December 31, 2013 compared to $4.76 million for the year ended December 31, 2012, an increase of $721,000, or 15%.


The increase in general and administrative expenses was primarily due to an
$849,000 net increase in compensation costs; a $121,000 increase in legal
professional services; a $72,000 increase in rent primarily related to a payment
required to exit our existing lease; a $95,000 increase in consulting and
professional services primarily relating to investor and public relations; a
$26,000 increase in travel-related expenses associated with investor, customer,
and supplier meetings; and a $21,000 increase in commercial insurance expenses.
These increases were offset in part by a $214,000 decrease in bad debt expense
associated with our allowance for doubtful accounts reserve policy; a $105,000
decrease in depreciation and amortization expense; a $43,000 decrease in audit
and tax professional services due to the completion of a voluntary disclosure
agreement engagement in 2012; a $41,000 decrease in software maintenance
agreements; a $30,000 decrease in office-related expenses; a $19,000 decrease in
Board-related expenses as a result of fewer meetings than in the previous year
and one less Board member; and a $11,000 decrease in personal property and
franchise taxes.

Compensation costs increased due to an increase in stock-based compensation expense of $427,000, primarily due to the addition of two new executive officers; an increase in severance expense of $230,000 associated with the departure of an executive officer; an increase in salaries and related employee benefits in the aggregate of $120,000; and an increase in bonus expense of $83,000; offset in part by a decrease in employee relocation costs of $11,000.


As previously discussed, beginning in 2013, certain information
technology-related costs historically included in general and administrative
expenses are now allocated to sales and marketing expenses and cost of goods
sold. For the year ended December 31, 2013 compared to the same period in the
prior year, $1.18 million in aggregate of information technology-related costs
were allocated from general and administrative expenses, comprising $665,000 of
compensation costs; $255,000 of depreciation and amortization expense; $164,000
of professional services; $88,000 of office-related expenses; and $10,000 of
travel-related expenses.

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Research and Development

Research and development expenses for the years ended December 31, 2013 and 2012
are as follows:

                                   Year Ended December 31,                Change
                                     2013             2012        Dollars       Percent
      Research and development   $     24,903       $  17,013     $  7,890            46 %



Research and development expenses were $25,000 for the year ended December 31,
2013 compared to $17,000 for the year ended December 31, 2012, an increase of
$8,000, or 46%.

The increase in research and development expenses was primarily due to a $14,000
increase in compensation, offset by a $5,000 decrease in professional services
and $1,000 decrease in office-related expenses.

Loss on Abandonment of Assets


Loss on abandonment of assets for the years ended December 31, 2013 and 2012 is
as follows:

                                      Year Ended December 31,               Change
                                        2013              2012       Dollars      Percent

Loss on abandonment of assets $ 98,027 $ 2,016 $ 96,011 4,762 %




Loss on abandonment of assets was $98,000 for the year ended December 31, 2013
compared to $2,000 for the year ended December 31, 2012, an increase of $96,000,
or 4,762%. During the second quarter of 2013, we transitioned our Lulu Avenue®
direct sales front-end and back-office system to a new platform and abandoned
the prior capitalized software modifications with a remaining book value of
approximately $95,000 associated with the previous platform.  In addition,
during the fourth quarter of 2013, we upgraded our phone systems, resulting in
the disposal of our previous phone system and other related assets with a
remaining book value of approximately $3,000.

Interest Income


Interest income for the years ended December 31, 2013 and 2012 is as follows:

                              Year Ended December 31,                Change
                                2013             2012         Dollars       Percent
          Interest income   $     22,007       $  69,520     $ (47,513 )         -68 %


Interest income was $22,000 for the year ended December 31, 2013 compared to $70,000 for the year ended December 31, 2012, a decrease of $48,000, or 68%.


The decrease in interest income resulted primarily from investing less cash in
U.S. government agency securities due to the $3.25 million in such securities
called during the year ended December 31, 2012 and holding on average less cash
in interest-bearing money market accounts during 2013 as compared to 2012 with
our continued investments in the direct-to-consumer distribution channels and
additional inventory.

Provision for Income Taxes

We recognized an income tax net benefit of approximately $269,000 and $4.05 million for the years ended December 31, 2013 and 2012, respectively.


As of each reporting date, management considers new evidence, both positive and
negative, that could impact its view with regard to future realization of
deferred tax assets. For the years ended December 31, 2013 and 2012, cumulative
positive taxable income over the last three tax years had been generated,
offsetting the negative evidence of cumulative losses in previous years. We also
determined that our expectations of future taxable income in upcoming tax years
would be sufficient to result in full utilization of these net operating loss
carryforwards and deferred tax assets prior to any statutory expiration. As a
result, management determined that sufficient positive evidence existed as of
December 31, 2013 and 2012 to conclude that it is more likely than not deferred
tax assets of $4.04 million and $3.73 million, respectively, are realizable, and
we reduced our valuation allowance accordingly. The reduction of the valuation
allowances against these deferred tax assets resulted in an income tax benefit
during the years ended December 31, 2013 and 2012 of approximately $1,000 and
$3.73 million, respectively. A valuation allowance remained at December 31, 2013
and 2012 against certain deferred tax assets relating to state net operating
loss carryforwards from our e-commerce and home party operating subsidiaries due
to the timing uncertainty of when the subsidiaries will generate cumulative
positive taxable income to utilize the associated deferred tax assets. A
valuation allowance also remained at December 31, 2013 and 2012 against certain
deferred tax assets relating to investment loss carryforwards because our
current investments were classified as held-to-maturity as of December 31, 2012,
indicating they would be redeemed at par value, and they did not generate gains
sufficient to utilize the associated deferred tax assets when they matured in
2013.

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During the year ended December 31, 2013, we recorded approximately $12,000 of
income tax expense for estimated tax, penalties, and interest for other
uncertain tax positions.

During the year ended December 31, 2012, we also entered into a voluntary
disclosure agreement with a taxing authority for which we had previously
recorded a liability for an uncertain tax position. As a result of the
agreement, we reduced our total recorded liabilities relating to uncertain tax
positions by approximately $374,000, paid approximately $48,000 to the taxing
authority, and recognized a corresponding income tax benefit of $326,000. This
benefit was offset by approximately $16,000 of net income tax expense for the
year ended December 31, 2012 for estimated tax, penalties, and interest for
other uncertain tax positions. We also reduced our net liability for uncertain
tax positions by approximately $24,000 and recognized a corresponding income tax
benefit due to the expiration of a portion of research and development tax
credits included in our deferred tax assets.

Our statutory tax rate is 37% and consists of the federal income tax rate of 34% and a blended state income tax rate of 3%, net of the federal benefit.

Liquidity and Capital Resources


We require cash to fund our operating expenses and working capital requirements,
including outlays for capital expenditures. As of December 31, 2013, our
principal sources of liquidity were cash and cash equivalents totaling $2.57
million, trade accounts receivable of $10.24 million, and short-term inventory
of $13.07 million, as compared to cash and cash equivalents totaling $11.86
million, trade accounts receivable of $8.14 million, and short-term inventory of
$8.44 million as of December 31, 2012. We had $500,000 of highly liquid U.S.
government agency securities that matured during the year.  As described more
fully below, we also have access to the $10 million Line of Credit.

During the year ended December 31, 2013, our working capital decreased by
approximately $4.47 million to $23.54 million from $28.01 million at December
31, 2012. As described more fully below, the decrease in working capital at
December 31, 2013 is primarily attributable to a decrease in cash and cash
equivalents, a decrease in held-to-maturity investments, an increase in trade
accounts payable, a net increase in accrued expenses and other liabilities, and
a decrease in interest receivable, offset in part by an increase in trade
accounts receivable, a greater allocation of inventory to short-term, and an
increase in prepaid expenses and other assets.

During the year ended December 31, 2013, $9.31 million of cash was used in
operations.  The primary drivers of negative cash flow were our net loss of
$1.29 million that included $3.33 million of net non-cash charges, an increase
in inventory of $9.88 million, an increase in trade accounts receivable of $2.83
million, and an increase in prepaid expenses and other assets of $261,000. These
factors more than offset an increase in trade accounts payable of $1.56 million,
and a net increase in accrued liabilities of $67,000.  Inventories increased
primarily as a result of new raw material SiC crystals purchased during the year
ended December 31, 2013 pursuant to the Cree Exclusive Supply Agreement;
purchases of jewelry castings, findings, and other jewelry components; and
production of moissanite gemstones, offset in part by sales during the year.
Prepaid expenses and other assets increased primarily as a result of deposits
made during the year in advance of goods or services received. Accounts payable
increased primarily as a result of the timing of costs incurred but not yet paid
as of December 31, 2013 associated with inventory-related purchases and
professional services incurred but not yet due under our vendors' payment terms.
Accounts receivable increased primarily as a result of extended wholesale
customer payment terms that we offer from time to time that may not immediately
increase liquidity as a result of current-period sales, offset in part from
collection efforts during the year ended December 31, 2013.  We believe our
competitors and other vendors in the wholesale jewelry industry have also
expanded their use of extended payment terms and, in aggregate, we believe that
by expanding our use of extended payment terms, we have provided a competitive
response in our market and that our net sales have been favorably impacted. We
are unable to estimate the impact of this program on our net sales, but if we
ceased providing extended payment terms in select instances, we believe we would
not be competitive for some wholesale customers in the marketplace and that our
net sales and profits would likely decrease. We have not experienced any
significant accounts receivable write-offs related to revenue arrangements with
extended payment terms.

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We manufactured approximately $13.86 million in loose jewels and $9.20 million
in finished jewelry, which includes the cost of the loose jewels and the
purchase of precious metals and labor in connection with jewelry production,
during the year ended December 31, 2013. We expect our purchases of fashion
finished jewelry, precious metals, and labor to increase as we increase our
finished jewelry business. In addition, from the beginning of 2006 through the
end of 2013, the price of gold has increased significantly (approximately 127%),
resulting in higher retail price points for gold jewelry. Because the market
price of gold and other precious metals is beyond our control, the recent upward
price trends could continue and have a negative impact on our operating cash
flow and margins as we manufacture finished jewelry.

Historically, our raw material inventories of SiC crystals had been purchased
under exclusive supply agreements with a limited number of suppliers. Because
the supply agreements restricted the sale of these crystals exclusively to us,
the suppliers negotiated minimum purchase commitments with us that, when
combined with our reduced sales during the periods when the purchase commitments
were in effect, have resulted in levels of inventories that are higher than we
might otherwise maintain. As of December 31, 2013, $29.34 million of our
inventories were classified as long-term assets. Loose jewel sales and finished
jewelry that we manufacture will utilize both the finished good loose jewels
currently on hand and, as we deplete certain shapes and sizes, our on-hand raw
material SiC crystals of $3.31 million and new raw material that we are
purchasing from Cree.

In connection with the Cree Exclusive Supply Agreement, which expires in July
2015, we have committed to purchase from Cree a minimum of 50%, by dollar
volume, of our raw material SiC crystal requirements. If our orders require Cree
to expand beyond specified production levels, we must commit to purchase certain
minimum quantities.

In February 2013, we entered into an amendment to a prior letter agreement with
Cree, which provides a framework for our purchases of SiC crystals under the
Cree Exclusive Supply Agreement. Pursuant to this amendment, we agreed to
purchase at least $4.00 million of SiC crystals in an initial new order. After
the initial new order, we have agreed to issue non-cancellable, quarterly orders
that must equal or exceed a set minimum order quantity. Our total purchase
commitment under the amendment (as subsequently  amended) until July 2015,
including the initial new order, is dependent upon the grade of the material and
ranges between approximately $7.64 million and approximately $18.56 million.
During the year ended December 31, 2013, we purchased $12.56 million of raw
material SiC crystals from Cree. We expect to use existing cash and cash
equivalents and other working capital, together with future cash expected to be
provided by operating activities and, if necessary, the Line of Credit, to
finance this purchase commitment.

We made approximately $6,000 of income tax payments during the year ended
December 31, 2013, consisting of an approximate $6,000 federal alternative
minimum tax payment. As of December 31, 2013, we had approximately $881,000 of
remaining federal income tax credits, $533,000 of which expire between 2018 and
2021 and the balance without an expiration, which can be carried forward to
offset future income taxes. As of December 31, 2013, we also had a federal tax
net operating loss carryforward of approximately $5.66 million expiring between
2020 and 2033, which can be used to offset against future federal taxable
income, a North Carolina tax net operating loss carryforward of approximately
$11.28 million expiring between 2023 and 2028, and various other state tax net
operating loss carryforwards expiring between 2016 and 2033, which can be used
to offset against future state taxable income.

On August 6, 2013, the Board authorized the extension of the Company's share
repurchase program for an additional 12 months. The program, which was
originally authorized on November 13, 2009, authorizes the Company to repurchase
up to 1,000,000 shares of the Company's common stock until August 12, 2014 in
open market or in privately negotiated transactions. The Company expects to use
available cash to finance these purchases and will determine the timing and
amount of stock repurchases based on the Company's evaluation of market
conditions, the market price of the Company's common stock, and management's
assessment of the Company's liquidity and cash flow needs. The Company has no
obligations to repurchase shares under the program and the program may be
suspended or terminated at any time. As of December 31, 2013, 809,213 shares of
the Company's common stock remain available for repurchase under the program.
We have not repurchased any shares under this program during the year ended
December 31, 2013.

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On September 20, 2013, we obtained the $10 million Line of Credit from PNC Bank
for general corporate and working capital purposes. The Line of Credit is
evidenced by a Committed Line of Credit Note, dated September 20, 2013, or the
Note, which matures on June 15, 2015. Amounts outstanding under the Note accrue
interest at the 1-month LIBOR rate (adjusted daily) plus 1.50%, calculated on an
actual / 360 basis and payable monthly in arrears. Amounts outstanding during an
event of default accrue interest at a rate 3.00% in excess of the standard rate,
and late payments are subject to a 5.00% late charge. The Note may be repaid in
whole or in part at any time, without penalty or premium.

The Line of Credit is also governed by a loan agreement, dated September 20,
2013, or the Loan Agreement, and is guaranteed by Charles & Colvard Direct and
Moissanite.com, , as our wholly-owned subsidiaries. The Line of Credit is
secured by a lien on substantially all of our assets, including those of our
subsidiaries.  Under the Loan Agreement, we are required to comply with the
following financial covenants, each tested on a quarterly basis: (1) interest
coverage ratio, (2) funded debt to EBITDA ratio, and (3) ratio of current assets
to funded debt. The Loan Agreement contains other customary covenants and
representations, including a financial reporting covenant and limitations on
dividends, debt, contingent obligations, liens, loans, investments, mergers,
acquisitions, divestitures, subsidiaries, and change in control.

The events of default under the Line of Credit include, without limitation, (1)
a material casualty or material adverse change in the collateral value or
business and (2) an event of default under any other indebtedness. If an event
of default occurs, PNC Bank is entitled to take various enforcement actions,
including acceleration of amounts due under the Note.  The Loan Agreement also
contains other customary provisions, such as yield protection, expense
reimbursement, and confidentiality. PNC Bank has indemnification rights and the
right to assign the Line of Credit.

As of March 24, 2014, we have not taken any advances against the Line of
Credit.  We believe that our existing cash and cash equivalents and other
working capital, together with future cash expected to be provided by operating
activities, will be sufficient to meet our working capital and capital
expenditure needs over the next 12 months. Our future capital requirements and
the adequacy of available funds will depend on many factors, including our rate
of sales growth; the expansion of our sales and marketing activities, including
the operating capital needs of our wholly owned subsidiaries; the timing and
extent of raw materials and labor purchases in connection with loose jewel
production to support our moissanite jewel business and precious metals and
labor purchases in connection with jewelry production to support our finished
jewelry business; the timing of capital expenditures; and risk factors described
in more detail in "Risk Factors" in this report and in Part I, Item 1A of this
Annual Report on Form 10-K. We obtained the Line of Credit to mitigate these
risks to our cash and liquidity position.  Also, we may make investments in, or
acquisitions of, complementary businesses, which could also require us to seek
additional equity or debt financing.

Off-Balance Sheet Arrangements


We do not use off-balance sheet arrangements with unconsolidated entities or
related parties, nor do we use other forms of off-balance sheet arrangements.
Accordingly, our liquidity and capital resources are not subject to off-balance
sheet risks from unconsolidated entities. As of December 31, 2013, we did not
have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of
Regulation S-K.

We have entered into an operating lease for approximately 16,500 square feet of
mixed-use space, which we currently occupy, from an unaffiliated third party for
our offices and manufacturing facility in the normal course of business. We have
also entered into an operating lease that has not yet commenced, for
approximately 36,350 square feet of mixed-use space, of which we will not take
occupancy until 2014, from an unaffiliated third party for our offices and
manufacturing facility in the normal course of business. These types of
arrangements are often referred to as a form of off-balance sheet financing.

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08/06 CHARLES LVARD : & COLVARD LTD Management's Discussion and Analysis of Financial ..
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