During the third quarter, Orange 21 ran into some manufacturing and supply delays at its newly acquired Italian manufacturing subsidiary, LEM, which caused the company to post its first organic sales decline since going public two years ago. Total net sales for the third quarter of 2006 increased 5.2% to $11.4 million, but LEM accounted for $1.1 million of the total. Excluding these sales, the company's organic sales declined 5%. Sunglass unit shipments during the quarter increased 8%, but this was offset by a 1% decline in goggle shipments.

Gross margins decreased 240 basis points to 48.5% compared to 50.9% last year due to the lower margins on revenue from LEM's outside customers and an increase in inventory reserves. This lower margin business was partially offset by the effect of efficiencies at LEM boosting gross margin earned on Spy products. Orange 21 management expects that its gross profit will fluctuate from quarter to quarter in the future based on product mix and variable product costs.

Operating expenses as a percentage of sales were 56.2% as compared to 49.2% in the prior-year period. The increase was primarily attributable to a substantial increase in G&A expenses due to incremental costs associated with LEM, as well as higher professional fees in the third quarter versus a year ago. Due to these higher expenses, the company reported an operating loss of $869,000 compared to an operating income of $183,000 in Q3 of 2005.

During the quarter, the company began a significant number of new initiatives to turn its performance around. Some of these include stopping production of a significant number of unproductive SKUs; a program to eliminate unproductive inventory and better manage working capital; a full review of internal cost structures with the goal of substantially reducing overhead; intensifying efforts to improve efficiency and operating structure at LEM; and a review of accounts and sales processes, with the goals of focusing sales activities on the highest ROI partners and minimizing the capital outlays associated with opening new accounts, as well as maintaining existing accounts.

Management said that they expect Orange 21 to miss previously announced guidance due to the ongoing integration at LEM. At the same time, they declined to update the company’s guidance due to their lack of visibility going forward.