MARKET WATCH: Orange 21 Quarter Ended September 30

Jeff Harbaugh

• December 01 2008
• 416 views
• 4 comments

You probably recall I wrote at some length about the letter from former Orange 21 CEO Mark Simo to the Orange board of directors requesting/recommending strongly talks between Orange and No Fear, of which Mr. Simo is the CEO and 37% shareholder, about a merger between the two.  Orange said, “No thanks.”

I said in that article that I understood the tactical financial reasons to consider such a merger and thought they were valid, but that I couldn’t see any strategic rationale for it.  Subsequent to the publication of that article, I spoke with Mr. Simo, who repeated the tactical rationales, but didn’t seem to have a good strategic explanation of the value of the merger.

Since then the Orange quarterly report has come out.  I’ll get to the numbers in a couple of paragraphs (summary- Orange is doing the right things but is impacted by our lousy economy like everybody else) but first I want to highlight a couple of things in the report that I think relate to the proposed and rejected merger.

Mr. Simo’s letter to the Orange board pointed out that Orange wasn’t shipping product to No Fear, its largest customer.  Strange, I thought.  Not so strange when you read footnote 11 to the financial statements.  It states in part, “Accounts receivable due from the No Fear Retail stores amounted to $459,000 and $642,000 at September 30, 2008 and December 31, 2007, respectively. Approximately $313,000 of the $459,000 due at September 30, 2008 was past due and as a result, the Company has temporarily ceased shipments to No Fear Retail on credit terms until the account is brought current. In the meantime, No Fear Retail may obtain shipments if they prepay for their orders.”

You may speculate yourselves on why No Fear isn’t paying.

So Orange isn’t shipping to No Fear because No Fear isn’t paying them is what the document says.  That’s not so strange.  Most people like to get paid when they sell something.

Under Footnote 12, we learn about a contingent liability.  It seems that “Mark Simo… has asserted that the Company owes him approximately $600,000 for compensation related to his services as CEO from October 2006 through September 2008. Mr. Simo previously refused to accept compensation for his services with respect to approximately the first year of his term as CEO, and no agreement was ever reached with him as to compensation arrangements for the period thereafter. The Company has recorded a liability of approximately $300,000 with respect to Mr. Simo’s compensation claim.”

Now, I have no idea what they owe him or don’t owe him, but the past due receivables and the claim for past compensation don’t really seem to me to create fertile ground for merger negotiations.
I can’t wait to see what happens next, if anything.

Meanwhile, back to the financial statements. You can see the whole report here.

Net sales for the quarter fell 9% to $12.0 million. They think the drop is “largely due to a decline in the economy and consumer discretionary spending.” Me too. Gross profit decreased 10% to $5.9 million. Gross margin was down one percent to 49%. They cut their operating expenses 9.2% to $5.87 million.  Other income/expense went from ($106,000) to $23,000 due to falling interest expense and a larger foreign currency transaction gain. They earned $6,000 after taxes compared to losing $58,000 in the same quarter the previous year. It’s not a big profit obviously, but it shows continuing improvement.

On the balance sheet, total equity has declined by $5.2 million to $21.1 million at Sept. 30, 2008 compared to the restated Sept. 30, 2007 balance sheet.  Total liabilities are nearly identical on both balance sheets, so I guess we’d better focus on the assets.

Total Assets fell from $46.6 to $41.4 million. Cash fell from $996,000 to $413,000.  Net accounts receivables fell from $10.3 to $6.8 million. According to the note… oh, never mind- just look at this table.

The allowance for returns is pretty large and suggests some issues with inventory, but on the positive side, it suggests they have recognized and are dealing with the issue.

Inventories increased over the year from $13 million to $14.3 million.  Those balances are “net of an allowance for obsolescence of approximately $1,429,000 and $2,264,000 at September 30, 2008 and December 31, 2007, respectively.”  That’s all the discussion of inventory there is.

There’s not that much change in other current asset categories. Current assets, in total, fell 11% to $24.7 million. The current ratio, the most commonly used measure of liquidity (higher is better) fell from 1.52 to 1.31. Total debt to equity rose from 0.77 to 0.96 (lower is better).

If the balance sheet appears to have deteriorated slightly over the course of a year, it’s partly because they have addressed some issues that needed addressing. But it’s largely because they’ve lost $7.3 million in total over the last four quarters. Hopefully, the turnaround continues and the losing ways are done.

Jeff Harbaugh is a consultant for the action sports industry and works with companies to identify and focus on critical business issues and opportunities fundamental to the bottom line. For more information, visit www.jeffharbaugh.com.