Orange 21 Inc. net sales for the third quarter of 2006 increased 5.2% to $11.4 million compared to $10.8 million in the third quarter of 2005. LEM, acquired in January of 2006, accounted for $1.1 million of the total. Excluding the sales from LEM, the Company's sales declined approximately 5% due to ongoing manufacturing and supply delays. The Company reported a net loss for the third quarter of 2006 of approximately $778,000, or 10 cents per share, compared to net income of approximately $192,000, or two cents per diluted share.
Gross profit for the third quarter was essentially flat at $5.5 million for the 2006 and 2005 periods; however, gross margins decreased to 48.5% in the third quarter of 2006 from 50.9% in the prior-year period. The decrease in gross margins was due primarily to the comparatively lower gross margins on revenue from LEM's non-Spy customers and an increase in inventory reserves, partially offset by the effect of LEM S.r.l.'s gross margin earned on Spy products.
The Company expects that its gross profit will fluctuate from quarter to quarter in the future based on product mix and variable product costs. The Company also expects gross profit margins to continue to be affected by its January 2006 acquisition of LEM S.r.l., which has substantially lower margins than its other business segments, and the impact of the Euro on product purchases.
Operating expenses in the third quarter increased to $6.4 million from $5.3 million in the prior-year period. 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 general and administrative (G&A) expenses due to incremental costs associated with LEM, as well as higher professional fees in the third quarter versus a year ago. Additionally, as of January 1, 2006, the Company adopted SFAS 123R, which resulted in the recognition of $100,000 of non-cash, share-based compensation expense for the third quarter of 2006. Due to the higher expenses, the Company reported an operating loss of approximately $869,000 as compared to operating income of approximately $183,000 in the third quarter of 2005. Additionally, the Company reported non-operating expenses of $157,000 compared to a non-operating gain of $256,000 in the third quarter of 2005. The greater expense is attributable to higher interest expense and a greater foreign currency translation loss.
Net sales for the nine months ended September 30, 2006, increased 4.5% to $31.0 million compared to $29.7 million in the prior-year period. LEM S.r.l. accounted for $2.8 million of the total. The Company reported a net loss for the nine-month period of $3.3 million, or $0.40 per share on 8.1 million weighted-average shares, compared to net income of $59,000, or $0.01 per diluted share on 8.4 million weighted-average shares.
Gross profit increased to $15.5 million compared to $15.2 million in the prior-year period. Gross margin was 50.1% for the nine-month period, down from 51.2% in the prior-year period. The decrease in gross profit as a percentage of sales was due primarily to the comparatively lower gross margins on revenue from LEM's non-Spy customers and an increase in tooling depreciation. Partially offsetting this decrease was the favorable effect of LEM S.r.l.'s gross margin earned on Spy products.
Operating expenses for the nine-month period increased to $19.5 million, from $15.0 million in the prior-year period. Operating expenses as a percentage of sales increased to 62.7% as compared to 50.5% during the same period a year ago. The increase was due to higher sales and marketing, G&A, and research and development costs. Additionally, non-cash, share-based compensation expenses, due to the adoption of SFAS 123R, were $150,000 for the nine-month period. Due to the higher expenses, the Company reported an operating loss of $3.9 million as compared to operating income of approximately $209,000 for the nine months ending September 30, 2005. Additionally, the Company reported non-operating expenses of $230,000 compared to a non-operating gain of $294,000 in the same nine-month period of 2005. The greater expense is attributable to higher interest expense, and a greater foreign currency translation loss.
Cash, cash equivalents, and short-term investments at September 30, 2006, totaled approximately $4.0 million. The Company has an additional $857,000 of restricted cash which is held in an escrow account in accordance with its purchase agreement of LEM. The Company has $4.4 million in short- and long-term debt, including its line of credit and capital leases, compared to $32,000 at December 31, 2005. The increase is due, primarily, to debt and capital leases assumed as a result of the completion of the LEM acquisition in January 2006.
“As Orange 21's largest investor, and the Company's founder, I am disappointed in our performance in 2006,” said Mark Simo, Co-Chairman and CEO. “In Spy Optic, we have a terrific brand that continues to resonate with our core action sports customer, but we have suffered a variety of setbacks in execution. We will be working hard to address these issues in the coming quarters.”
Mr. Simo continued, “Our key issues are relatively straightforward. In the past year, our product vision became less focused, and the business became too complicated and costly. In the next twelve months our core initiatives will be to refocus the product, reduce costs and complexity, and improve accountability and execution in the organization. After being back at the Company for five weeks, I believe that we are making daily progress and heading in the right direction. Specifically, we have:
- Stopped production of a significant number of unproductive
SKUs - Increased production of our key, core styles to respond to the
Spring 2007 needs of our major accounts - Begun an aggressive program to eliminate unproductive
inventory and better manage working capital - Begun a full review of our cost structure with the goal of
substantially reducing overhead - Begun to reduce costs and improve the effectiveness of our
marketing efforts - Begun a review of our foreign sales operations with the goal
of eliminating unproductive activities and territories - Intensified our efforts to improve efficiency and operating
structure at LEM - Begun a review of our accounts and sales process, with the
goals of focusing our sales activities on our highest ROI
partners and minimizing the capital outlays associated with
opening new accounts as well as maintaining existing accounts.
“As these initiatives take hold I expect to see our business metrics come back into alignment,” Mr. Simo added. “In the next quarter, we expect to report results that will be below our previous guidance, reflecting both the legacy business dynamics that we are working to change and decisions that we will need to make, including realigning our inventory levels by selling through our less productive legacy SKUs. I expect that we will be working to redirect the Company through the first half of next year. Going forward from there, we will have significant opportunities to reinvigorate growth in the business through initiatives, including new, effective marketing programs and new capital-efficient channels of distribution.”
John Pound, Orange 21's Co-Chairman, commented, “I'm glad to be working with Mark and the Orange 21 management and board to address the Company's current performance shortfalls and position the business for future success. I invested in the Company because of its strong core franchise. Under Mark's guidance, I believe the Company has a clear direction. We have a number of talented new members of the senior management team working with Mark, and I believe that together they will make significant progress in the 2007 fiscal year.”
Mr. Pound added, “While Orange 21 has historically given guidance to the public market, the Company will not be doing so at the current time. We do not mean to imply any reduction in our commitment to our public shareholders but we feel that, given the transitional state of the business, we simply do not yet have the visibility to provide reliable forecasts. We expect that in the future Spy Optic will once again demonstrate growth and will also achieve profitability on a sustained basis. We will monitor our progress and keep you appraised as best we can in the coming quarters.”
