Orange 21’s (Spy Optic) March 31 Quarterly Results; Additional Financing Required.

Really, not that much has changed at Orange 21 since I wrote about their annual report and management restructuring back in April. But its quarterly 10Q “…anticipates that it will need additional capital during the second quarter of 2011 and in subsequent periods to support its planned operations in 2011, and intends to raise cash through a combination of debt and/or equity financing from existing investors.” The discussions with the shareholders had already started at the date of the filing.

With revenues for the quarter of $6.7 million (down from $8.3 million in the same quarter last year) Orange is pretty small for a public company. Frankly, I have no idea why it went public. Probably, when times were better, there was a plan to use it as a base to build a larger company through acquisitions. But it’s to our benefit that it went public because they are required to tell us what’s going on.

Sales for the quarter were below expectations, falling 9% even ignoring the $900,000 decline that resulted from the sale of its factory in Italy (LEM). Gross profit fell, but gross margin rose from 45% to 51%. However, most of that increase resulted from the sale of LEM and the elimination of the lower margin product it produced for third parties.
 
Sales and marketing expenses were up 40% to $2.8million. Around half of the increase was due to the new licensed brands. General and administrative expenses, in contrast, fell by 15% due mostly to the elimination of costs associated with LEM.  There was a net loss of $1.57 million compared with a loss of $937,000 in the same quarter last year.    
 
As you may recall, Orange was a smaller, solid brand that got into some trouble due to a bit of management chaos, and the general economic and competitive environment. I’ve told the complete saga on my web site in various articles as well as the public filings allow me to. More recently, to make a long story short, they decided (correctly I think) that the Spy brand by itself didn’t have enough critical mass to support the expense structure it needed and they didn’t see it getting that mass quickly enough. So they diversified  by making deals to make and market sunglasses for O’Neil, Jimmy Buffet’s Margaritaville brand, and Mary J. Blige.
 
Those deals came with various financial requirements, including minimum royalty payments, research and development expense, marketing costs, and the need to build inventory prior to the launch. As enumerated in other articles, it was a bunch of money. The major shareholder, whose company owns nearly 50% of the stock, has already contributed $7 million to Orange and apparently, along with other shareholders, he’s being asked to put in more.
 
Three things have happened that explain the need for more capital. The first one I’m certain of; the economic recovery just hasn’t gotten the traction we all hoped it would.   The second I don’t know for certain but strongly suspect; sales of the licensed brands haven’t been as strong as was hoped. Finally, the deal to sell LEM included certain minimum purchases from LEM for 2011 and 2012. As of March 31st, the minimum purchase amount for 2011 was almost $5 million at the current exchange rate. For 2012, it’s about $2.5 million. It would be interesting to know what kinds of gross margins those purchases will generate. Certainly part of the reason you get rid of an Italian factory is that the product is expensive- especially when the Euro is fairly strong. We’ll see how long that lasts.
 
The really interesting thing to focus on in the story of Orange 21 is the dynamics of entrepreneurial companies that get into some trouble. That where the learning is for us and it seems to be more or less the same in every turnaround I’ve ever worked with or heard about.
 
It all begins, as I’ve said before, with denial and perseverance in a period of change. It starts with some unrealistic expectations (entrepreneurs are, by definition, optimists). There are frequently some clashes of egos and often an entrepreneur can’t get out of their own way as the business grows and changes. The environment that’s created can be highly charged. Employees can be intimidated and pointing out issues or suggesting that some plans are too aggressive can be viewed as negative.
 
With a bias towards believing that the sky’s the limit and a conviction they can solve any problem, it’s hard to ever get to the point where you don’t see it working out and consider cutting your loses. Suddenly, you find yourself “all in” with no obvious options but to march forward.
 
I don’t know that this describes the evolution at Orange 21. Certain events, such as the purchase of the factory, and the dispute with former CEO Mark Simo might fit the pattern but it’s hard to know. Whatever the internal dynamics, the company finds itself with a weak balance sheet supported by their major shareholder and with additional cash requirements. There’s now a new management team and we’ll have to give them some time to work. But lacking a stronger economic recovery or a takeoff in sales of the licensed brands, one wonders what the next step is.