CTHR: Get Ready for the Bounce

Last month The Motley Fool published an article entitled “Get Ready for the Bounce”, that ponders whether Charles & Colvard's (NASDAQ:CTHR) stock price has bottomed and is about to reverse. The stock got hammered in 2006. It fell from $16.03 at the start of the year to finish the year at $8.00. Investors fled the stock last year because Charles & Colvard reported declining growth rates in 2006 after growing 82% in 2005.

Articles that attempt to report on the stock price decline tend to focus on Charles & Colvard's failure to meet their investors' grandiose growth expectations. The December 2005 mid-quarter conference call triggered the sell off, but the company also missed reasonable revenue expectations in the first and third quarters of 2006, which sent the price of the stock lower. Unfortunately these articles fail to identify the main reason for the revenue growth decline. Actually, the decline resulted from diminished orders from a major direct customer of Charles & Colvard -- K&G Creations.

K&G Creations is a major supplier of Moissanite Jewelry to Finlay Fine Jewelry. Finlay had operated the licensed jewelry counters for the May Corporation department store chain. However in 2005, Federated Department Stores purchased May and renamed the May branded stores to Macy’s. The resulting consolidation reduced the total number of doors serviced by Finlay by approximately 25%.

This reduction caused a surplus of inventory that Finlay had to redistribute among their remaining counters. It also circumvented Finlay's ability to replenish existing stock with new orders. The resulting domino effect of Finlay's surplus inventory caused K&G Creations to dramatically reduce their direct orders from Charles & Colvard in 2006.

Not only is this important aspect missing in these reports, but the addition of Samuel Aaron International in the second quarter of 2006 as a new direct customer of Charles & Colvard is completely overlooked. Samuel Aaron is a major jewelry manufacturer that supplies major retailers worldwide, and is the major suppler of moissanite jewelry to Kohl's Department Stores. Samuel Aaron offers 50 years of established success, and they're delivering acceptance of moissanite to the rest of the Jewelry Industry.

Despite Charles & Colvard reporting only 7% revenue growth in 3Q2006, the quarter was the largest revenue quarter in its history. Clearly, Charles & Colvard would not have been able to set a new record, considering K&G Creation diminished orders, without the addition of Samuel Aaron.

Prior to the addition of Samuel Aaron, Charles & Colvard relied heavily on their two major direct customers, K&G Creations and Reeves Park. Having gained Samuel Aaron enables Charles & Colvard to weather inventory vagaries among their direct customers.

Despite a difficult year, 2006 was also transitional for Charles & Colvard. They were still able to increase their distribution channels despite encountering the major setback in expected revenue. Going into 2007, Charles & Colvard should have smoother quarterly revenue comparatives, and they also expect to add other major retailers.

The Motley Fool article is fair, and it offers both pros and cons going forward. To my surprise, their article quotes my own analysis that provided a supportive outlook for the company. Before taking any investment position in Charles & Colvard, I recommend that you do thorough due diligence.

Thanks,
WB