Orange 21’s Quarter. Sales Improvement, But More Ongoing Cash Needs

As you know, I tend to hate proforma financial statements, but once in a while they make sense. Orange’s quarter ended June 30 is one of those times. They sold their factory in Italy (LEM) on December 31, 2010. The June 30, 2010 quarter contains sales and expenses associated with LEM. The June 30, 2011 quarter does not. 

Happily, Orange has helped us out and provided a pro forma income statement for the June 30, 2010 quarter as if LEM was gone. We’re going to use that one to evaluate what’s going on.

The “as filed” income statement for the June 30, 2010 quarter showed revenue of $9.53 million and a profit of $408,000. The proforma statement for that quarter, taking out the LEM sales and expenses, showed revenue of $8.4 million and a loss of $925,000. Now, most people would think a profit of $408,000 would be better than a loss of $925,000 and they’d be right. But our interest is in figuring out how Orange might do going forward and it’s much easier to see that without the late, not so lamented, LEM in the way.
 
They do a really good job explaining this in their conference call. It might be worth a listen, but I suspect most of you prefer that I listen to it and tell you what they said.
 
Sales for the quarter ended June 30, 2011 were $8.99 million, up 6.8% from the pro forma sales number for last year’s quarter. For the six months ended June 30, sales were essentially flat compared to the previous year excluding the LEM sales.
 
Aside from the Spy brand, we know Orange also has had deals to sell licensed product from Margaritaville, O’Neil, and Mary J. Blige. So far sales from those products haven’t been significant, and I’ve already written about the deal to get out from under the contract with Mary. It’s costing them $1.5 million, but they would have had to pay royalties of $2.5 million if they hadn’t renegotiated. They also indicated that, as a result of the revised deal, that they have more flexibility to get rid of the existing inventory.
 
So most of that sales increase is the Spy brand. Good for the Spy brand. Not so good for the licensed brands effort. They note in the conference call that the management reorganization that started in mid-April put the Margaritaville product sales on hold and that sales of that brand have been “lackluster.” They said they were working together to determine the true value of the Margaritaville eyewear brand.   No, I don’t know what that means exactly.
 
The net loss was $2.95 million, much worse than the same quarter last year whether as filed or proforma. This is progress?
Yes, if you look at some of the charges during the quarter that resulted in the loss. There was non-cash stock and warrant compensation, severance payments, and the settlement with Mary J. Bilge charged to the company during the quarter. Together, these three come close to the total loss.
 
I do see their point that if you ignore all the “stuff” things can be construed to be looking up. But the stuff happened and continues to impact the company. This is like “The Turnaround That Wouldn’t End.” Yet the fact that it hasn’t ended (badly) suggests two things. First, that there is some significant brand strength there.
 
Second, moving over to the balance sheet and cash flow, it suggests that 45% shareholder Seth Hamot has a lot of money. As of June 30, 2011 his company, Costa Brava, had lent Orange $9.5 million and is prepared, under a line of credit established in June, to lend them $3.5 million more if they need it.
 
They say they are going to need it and will borrow it either from the Costa Brava line of credit or from their asset based lender BFI, assuming that line continues to be available. They think these lines will be enough over the next 12 months “If the Company is able to achieve some or a combination of…” sales growth, improved working capital management, reduce inventory, and/or better operating expense management.
 
They do have a lot of money tied up in inventory ($8.5 million down from $9 million a year ago). But a year ago, a bunch of that inventory had to involve LEM. I don’t know how much. Inventory is higher due to purchases “…in anticipation of sales that did not occur,” including for the licensed brands, and product purchased from LEM under a take or pay contract. Orange is required to purchase almost $5 million in product from LEM during 2011.
 
Net receivables have fallen from $6.5 million last June 30 to $5.5 million this June 30. But their gross receivables are $7.4 million. Against that they have an allowance for doubtful accounts of $625,000 and an allowance for returns of $1.25 million. If you happen to look at the whole 10Q, you can see on page 33 a discussion and table of how they calculate the return allowance. You’ll see that the average return percentage at June 30 for the Melodies by MJB brand was 18.8%. Gives you some indication of why they decided to renegotiate that deal. The Spy brand, by way of comparison was 5.4%.
 
The conference call included a rather lengthy discussion of all the operational and marketing changes they are making. These include new sales and marketing initiatives, advertising campaign, online ecommerce and branding platforms, revamping of the marketing mix, a more focused approach to sales, and a newly invigorated sales team.
 
That all sounds good of course, but the devil’s in the details we didn’t get. And when they said, “The rollout of the focused and fun Spy brand identity, with a creative execution in the market that will have a measureable effectiveness which will include a new level of sales and operational performance to meet the new demand for the brand,”  I decided we’d just have to wait and see what happened.
Strategically, I think it’s their plan to take the Spy brand into all the niches they think it fits in. That’s going to include optical retailers, just as an example, and they are looking at some surf space as well.
 
I can imagine a time in the not too distant future where this brand might be for sale. Well, I’m sure it is right now for some price (all brands are), so let me rephrase that. I won’t be surprised to see a sale after the promised turnaround is a little more evident. When that is, I guess, depends on Mr. Hamot’s appetite for continuing to finance Orange 21.