Spy Optics (Orange 21) Sept. 30 Quarter and 9 Month Results

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I  always look forward to Orange 21’s filings. It’s just about the only chance we get to see the numbers from a smaller company in this industry, because there just aren’t many of this size that are public and required to show us their results.

I also like them because since their change in management, when Stone Douglass came in first as a consultant and then as CEO, they’ve done a lot of things right. They’ve controlled their inventory and reduced expenses (employee expenses have been cut 10% in the U.S. and 20 to 30% at their Italian factory on a temporary basis). They raised some capital (About $2.5 million net as of November 16th). The lawsuit with Mark Simo and No Fear has been settled. Their factory in Italy is being rationalized and its overall performance improved. As far as I can tell, the brand is well positioned.
So why are they losing money? Well, to nobody’s surprise, it’s a lot about the lousy economy.   But let’s start with their balance sheet. I went and pulled the balance sheet from a year ago so we can make a reasonable comparison between September 30 2009 and 2008.
Total assets are down 51% from $41.4 to $20.3 million. A huge chunk of that is goodwill (remember, that’s a non cash item) of $9.6 million that’s been written off over the year. Most of the rest is in current assets, and those changes are appropriate to their changing sales level and the overall business environment.
Cash has grown from $413,000 to $717,000. Inventory and receivables are down almost $8 million in total. You’d expect that. Deferred taxes have fallen $1.25 million to $0.00.
Total liabilities, of course, are also way down from $20.3 to $$13.8 million, a decline of 32%. Most of that decline is in current liabilities, down from $18.8 to $12.1 million. The line of credit outstanding, at $2.1 million, is less than half of what it was a year ago. Accounts payable and accrued expenses are down a total of $3.1 million.
The current ratio is basically the same, having fallen only very slightly from 1.31 to 1.26.
Stockholders’ Equity is down 69% from $21.1 to $6.6 million. As a result, total debt to equity has doubled from 0.96 to 2.06.
Net sales for the quarter fell 27% from $12 to $8.8 million. For nine months, they were down from $37.6 to $25.3 million, or 32.7%. The gross margin percentage for the quarter fell from 49% to 33%. The biggest reason for the decline in the quarter’s gross margin was “…a $0.7 million increase in inventory reserves for slow moving and obsolete inventory…” For nine months, it was down from 49% to 42% in the same period the previous year. Expenses in the quarter fell from $5.9 to $4 million, or 32%. The percentage decline was about the same for the nine months, from $19.1 to $12.9 million.
Sales and marketing expenses as a percentage of net sales fell from 25% to 20% in the quarter compared to the same quarter the prior year, and from 25% to 22% for nine months. Those percentages do need to come down, but you’d rather see it happen because of rising sales. Half a million of the decline during the quarter was from reduced commissions due to lower sales. 
In last year’s quarter ended Sept. 30, Orange 21 made $6,000. In the same quarter this year, they lost $1.136 million. The numbers for nine months are a loss of $2,194 million this year compared to a loss of $1,118 million in the nine months last year.
Orange 21 thinks “…its cash on hand and available loan facilities will be sufficient to enable the Company to meet their operating requirements for at least the next 12 months.” If the economy gets worse, or doesn’t improve, there may be a need for some additional capital. I guess we all have that problem.
Orange21 will have a hard time prospering with its existing sales levels and a 33% gross margin. One or both of those just has to improve. As I said, the low gross margin is at least partly the result of writing down some bad inventory, and that impact will go away.
The sunglass business, as we all know, has attracted a lot of competitors because of the historically high gross margins that have been earned both by brands and retailers. Even ignoring the impact of a lousy economy, those high margins didn’t persist in skate shoes or snowboards, and I can’t imagine why they would persist in sunglasses and goggles. But Orange 21, as a smaller company with a 100% focus on sunglasses and goggles, may have some advantages in the market over large companies that look at these products as accessories. Let’s hope that works for them.   

Spy Optics’ 3/31/07 Quarterly Report: Lemonade Out of Lemons

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Until recently, it’s been kind of a tough road for Spy Optics (publically traded under the corporate name of Orange 21). Though sales grew from $22.3 million in 2002 to $42.4 million in 2006, profits of $911,000, $500,000, and $807,000 in 2002 through 2004 gave way to losses of $1.7 and $7.3 million respectively in 2005 and 2006. Gross profit, at 51% in 2002, had fallen to 41% in 2006. In addition, there was the expense of being a public company, the distraction of a shareholder lawsuit, and the usual stresses associated with an acquisition- in this case their primary manufacturer located in Italy.

Apparently the Board of Directors got tired of this and over the last year a number of positive things have happened. The lawsuit was settled in early May. There have been a lot of personal changes over the last year or so. Mark Simo, the Chairman of the Board and former CEO, has stepped in as CEO, replacing former CEO Barry Buchholtz who was sent over to run the Italian operation (Hmmm. Feels a bit like, “You bought it, you go run it!”) Fran Richards, formerly of Transworld and Future USA came in as VP of Marketing in April of 2006. The old CFO resigned (I don’t quite know if that should be in quotes or not) and was replaced by Jerry Collazo in August of 2006. He’s a CPA with 20 years of diversified financial and accounting experience. They hired Jerry Kohlscheen as Chief Operating Officer giving them another 20 years of experience in manufacturing and operations.
 
So, what has all this high powered talent been doing exactly? A lot, I’d say judging from their recent quarterly releases.
 
 They must be making a lot of money now, right? Nope. Still losing it. Almost $1.8 million in the quarter ended March 31, 2007 (they were late filing the report) on sales of $9.4 million. But I am impressed with the way they are losing it. Okay, there’s no good way to lose money. But a lot of what they are doing, which is costing money, has the feel of getting their house in order. Let’s look.
 
They reported that gross profit increased to 52.2% from 48.1% in the same quarter the previous year. It was indicated that the increase was “primarily due to sales during the three months ended March 31, 2007 of some inventory items that were previously written down and efficiencies achieved at LEM S.r.l.  LEM is the acquired Italian manufacturer.
 
This particularly increase in gross margin may be partly a onetime event, but it shows that they are getting their inventory in order and improving operations at LEM.
 
Sales and marketing expense was up 9% while sales didn’t budge. But two-thirds of this increase was the result of additional depreciation on point of purchase store displays. Why is this good? First, it’s a non cash expense. More importantly, it implies a realistic approach to their numbers and balance sheet values much like the inventory write down mentioned above. That’s great to hear. Ever try and run a business without good numbers?
 
General and administrative expenses were up 17%, or $400,000. But half of that was employee related compensation in the US. Yes, these new people who are going to do wonderful things want to be paid. $100,000 was severance for employees at LEM- part of getting that operation working efficiently I assume. Another hundred grand was getting some new systems up and running. Like I said, you can’t run a business without good numbers. They also cut their legal and audit fees by $300,000 but had some additional expenses for depreciation and bank fees related to a new loan agreement.
 
See the trend here. Higher expenses- yes. But spent on the right things.
 
This continues when they talk about warehouse expense being higher because of air freight resulting from manufacturing delays. Well, nobody likes to pay air freight, but the only thing worse it not getting the product to the customer on time.
In the words of their Chairman, Mark Simo, “We continue our efforts to stabilize the business and position it for long term growth.” That’s what it looks like to me.