Orange 21’s (Spy Optics) June 30 Quarter; What Doesn’t Kill You Makes You Strong

Orange 21 turned a profit of $408,000 in the quarter ended June 30 after losing $254,000 in the same quarter last year. For six months, a loss of $1.058 million was reduced to $529,000. For the quarter, they did it by increasing sales 4.5% and increasing their gross profit margin from 45.9% to 57.8%. And they did it while incurring two hundred thousand dollars of expenses for new sales initiatives that haven’t generated the first dollar of revenue.

If you’ve followed my earlier comments on Orange, you know that they had a lawsuit with a big shareholder and former CEO, some problems with inventory (at the end of the quarter they had an allowance for obsolete inventory of $966,000), expenses that needed to be brought under control, losses that resulted in cash flow issues (managed at least partly by a rights offering to existing shareholders and a $3.0 million loan from the biggest shareholder), a factory in Italy that needed to be better managed, and some pretty heavy duty management transitions.  Oh, and there was (is?) a little recession going on, but I guess we all have to deal with that.

You can see the better management of the factory this quarter in the fact that it generated operating income of $218,000 compared to a loss of $338,000 in the same quarter last year. There’s some exchange rate impact in there, but that’s a $550,000 different in a quarter compared to a year ago.
 
Anyway, the company’s circumstances are improving and if the war isn’t over, they have certainly won some key battles.
 
The new sales initiatives that cost them $200,000 during the quarter but aren’t generating revenue yet are the Margaritaville and Melody by MJB brands.   They’ve also entered into a license agreement to develop and sell O’Neill branded eyewear.
 
Without saying how much is for which brand, the company noted that it had a minimum payment of $478,000 payable under various licensing agreements through the end of the end of the year, of which $178,000 has been paid as of August 10. During the next three calendar years, the company has minimum amounts of $1.4 million, $1.1 million, and $0.8 million, respectively, payable. They better get to selling those new brands.
 
They further noted that if they achieve certain minimum sales of some products, they will have to pay a percentage of net profits under the license agreements.
 
I would speculate that it wasn’t all that easy for Orange 21 to negotiate these agreements with these brands given their recent history. Wish I knew the back story to those discussions. But I think it’s a great thing for them to do. They need more volume to be solidly profitable and can’t sit around and wait for big sales increases through their traditional channels to bring that volume in our new economic reality.
 
90% of sales during the quarter were sunglasses, and domestic sales represented 81% of the total. The company believes the sales increase was due to improvement in the economy and consumer confidence as well as “…efforts with certain key accounts and focus on close out sales.” Hmmm. Does that mean close out sales to key accounts?
 
The explanation for the big increase in gross margin percentage is worth spending a little time on. First, there was only a $13,000 decrease in overhead allocation for the quarter compared to a $346,000 decrease in the quarter last year. What I think that means is that due to their cost controls they had a lot less expenses that got put on cost of goods sold. Well, gross margin is way up, so that’s obviously a good thing even if I’m not entirely sure what it means. And an allocation can simply be from one place to another even lacking any cost reductions. That could improve one category at the expense of another but not change the overall financial result. But in this case, it obviously did change the result, so there’s more to it than an allocation.
 
Opps, I’m rambling on about cost accounting and guessing you’ve heard enough. Sorry.
 
Next they were able to increase inventory reserves by $200,000 compared to $100,000 in the same quarter last year “…as a result of the sale and disposal of previously reserved inventory.” Selling it sounds good; disposing of it not so good.
 
They got some product cost reductions due to more favorable exchange rates against the Euro for product made in their factory and product cost decreases due to the addition of a lower cost manufacturer in China.
 
Finally, they had a decrease in sales returns of about $0.2 million and “…a slightly larger decrease in our sales return reserve.”
Overall then, you have to applaud their gross profit margin improvement. But you also have to notice that some of the improvements are accounting adjustments that reflect the hangover from and resolution of old problems. Others, like exchange rates, are out of their control. Let’s hope they can maintain the high margin going forward.
 
General and administrative expenses were reduced an impressive 7% for the quarter. Sales and marketing and research and development expense were both up, but if they weren’t you’d worry about the prospects for the new brands.
 
Over on the balance sheet, the current ratio has improved only slightly from 1.3 to 1.4. The total liabilities to equity ratio rose from 2.0 to 3.2 mostly, I think, as a result of the $3 million loan from the shareholder. Of course, when the lender owns 44% of your shares, practically speaking you might call that $3 million equity whatever the accounting treatment.
 
I’ll watch the launch of the new brands with interest. For all the things they’ve done right, the company’s ability to grow significantly, become consistently profitable, and improve its balance sheet may depend on those brands.