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XSPY > SEC Filings for XSPY > Form 10-Q on 7-Aug-2013All Recent SEC Filings

Show all filings for SPY INC.

Form 10-Q for SPY INC.


7-Aug-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
THIS ITEM 2 CONTAINS FORWARD-LOOKING STATEMENTS REGARDING OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS AND PROSPECTS. ALTHOUGH FORWARD-LOOKING STATEMENTS REFLECT THE GOOD FAITH JUDGMENT OF OUR MANAGEMENT, SUCH STATEMENTS CAN ONLY BE BASED ON FACTS AND FACTORS CURRENTLY KNOWN BY US. CONSEQUENTLY, FORWARD-LOOKING STATEMENTS ARE INHERENTLY SUBJECT TO RISKS AND UNCERTAINTIES AND ACTUAL RESULTS AND OUTCOMES MAY DIFFER MATERIALLY FROM THE RESULTS AND OUTCOMES DISCUSSED IN OR ANTICIPATED BY THE FORWARD-LOOKING STATEMENTS. SEE "SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS" AT THE BEGINNING OF THIS REPORT.

The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the related notes and other financial information appearing elsewhere in this Quarterly Report and in the audited Consolidated Financial Statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2012, previously filed with the Securities and Exchange Commission on March 20, 2013.

The terms "we," "us," "our," and the "Company" refer to SPY Inc. and its subsidiaries, unless the context requires otherwise.

Overview

We design, market and distribute premium sunglasses, goggles and prescription frame eyewear. In 1994, we began as a grassroots brand in Southern California with the goal of creating innovative and aesthetically progressive eyewear, and, in doing so, we believe we captured the imagination of the action sports market with authentic, distinctive, performance-driven products marketed and sold under the SPY® brand. Today, we believe the SPY® brand, symbolized by the distinct "cross" logo, is a well recognized eyewear brand in its segment of the action sports industry, with a reputation for its high quality products, style and innovation.

We were incorporated as Sports Colors, Inc. in California in August 1992, but had no operations until April 1994, when we changed our name to Spy Optic, Inc. In November 2004, we reincorporated in Delaware and changed our name to Orange 21 Inc. In February 2012, we changed our name from Orange 21 Inc. to SPY Inc. to better reflect the focus of our business going forward.

References in this report to "we," "our," "us," "SPY," and "SPY Inc." refer to SPY Inc. and its two operating subsidiaries - Spy Optic Inc. ("SPY North America") and Spy Optic Europe S.r.l. S.U. ("SPY Europe") - except where the context clearly indicates that the term refers only to SPY Inc.

SPY® and Spy Optic® are the registered trademarks of SPY Inc. and its subsidiaries. O'Neill®, Margaritaville®, Melodies by MJB®, which were licensed brands previously sold by us, and other brands, names and trademarks contained in this report are the property of their respective owners.

Our Products and Target Markets

We have a happy disrespect for the usual way of looking (at life) and this helps drive our innovative design, marketing and distribution of premium products, especially eyewear for youth minded people who love to be outside doing what makes them feel most alive and happy. We feel a primary strength is our ability to create distinctive products that embody our unique and irreverent point of view, and this has helped us become what we believe is one of the most recognizable action sports brands in the world, with a twenty-year heritage in surfing, motocross, snowboarding, cycling, skateboarding, snow skiing, motorsports, wakeboarding, multi-sports and mountain biking. Our position as a premier brand is underscored by the development of innovative, proprietary, performance-based products with quality materials and lens technologies that have a definitive styling along with an incredible value proposition. Our core products - sunglasses, goggles and prescription frames - marketed under the SPY® brand have allowed us to develop collaborations with important multi-store action sports, sporting goods, sunglass specialty and lifestyle retailers in North America and other strategically-selected, individually owned-and-operated specialty retailers world wide.

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We create products that we believe lead our industry in terms of style and quality, and we continually seek to serve both active lifestyle participants and their aspirational counterparts. We separate our eyewear products into three groups: (i) sunglasses, which includes fashion, Happy Lens™, performance sport and women specific sunglasses; (ii) goggles, which includes snow sport and motocross goggles created for our core demographics, and a new goggle line extension for the SPY® brand that targets new distribution opportunities and customers; and (iii) optical, which includes optical-quality frames and sunglasses for our youthful demographic. In addition, we sell branded accessories for sunglasses and goggles, as well as a variety of other accessories and apparel.

The SPY® brand, as symbolized by the SPY® cross icon [[Image Removed]] is a creative, performance-driven brand that is fueled by collaborative efforts across various facets of youth culture, including competition, art, music and day-to-day athletic performance. We strive to ensure that our products are relevant in function and design, as well as style. We do this, in part, through partnerships with our world class athletes who help us design, then wear and test our products during training and competition. We believe that the intimate knowledge of our customers' lifestyles is what helps us develop a stronger, more relevant product offering for our market. We reinforce our irreverent brand profile through unique and disruptive marketing, using traditional and non-traditional means to convey our branded point of view to both entertain and edify passionate people across a multitude of psychographics.

SPY's newest product innovation is the Happy Lens™, which is a patent-pending proprietary technology that was developed over the course of the last two years and released in February of 2013. We believe the Happy Lens™ enjoyed a successful initial pre-launch marketing and promotion campaign during the fall of 2012, which was followed by strong initial sales of the collection during the first half of 2013. We believe it is the natural product extension of the happy and irreverent SPY® brand positioning and we anticipate that it will be an increasingly more important part of the SPY® collection moving forward.

Results of Operations

Comparison of Three Months Ended June 30, 2013 to the Three Months Ended June 30, 2012

Net Sales

Consolidated net sales increased by $0.5 million or 6% to $10.0 million for the three months ended June 30, 2013 from $9.5 million for the three months ended June 30, 2012.

Sales of our SPY® brand products increased by $0.7 million or 7% to $10.0 million during the three months ended June 30, 2013, compared to $9.3 million for the three months ended June 30, 2012. A significant portion of the SPY® sales growth was from sales of sunglasses into our North American optical and international channels, and from our optical frame product line and Happy Lens™ collection. SPY® sales amounts included approximately $0.8 million and $0.5 million of sales during the three months ended June 30, 2013 and June 30, 2012, respectively, which were considered to be closeouts, defined as (a) older styles not in the current product offering or (b) the sales of certain excess inventory of current products sold at reduced pricing levels.

There were no sales of licensed brands (O'Neill®, Melodies by MJB® and Margaritaville®) during the three months ended June 30, 2013, compared to $0.2 million during the three months ended June 30, 2012. All sales of licensed brands during the three months ended June 30, 2012 were considered to be closeout sales based on our decision during 2011 to cease making purchases of licensed brand inventory. In July 2011, we entered into an agreement with Rose Colored Glasses LLC in which, among other matters, the parties agreed to terminate the existing license agreement for Melodies by MJB® effective March 31, 2012. Additionally, effective June 24, 2012, SPY North America terminated its agreement with O'Neill®. We sold all of our Margaritaville ® products by March 31, 2013 and will have no sales of any of these licensed brand products in the future.

Sunglass sales represented approximately 95% and 94% of net sales during the three months ended June 30, 2013 and 2012, respectively. Goggle sales represented approximately 4% and 5% of net sales during the three months ended June 30, 2013 and 2012, respectively. Apparel and accessories represented approximately 1% of net sales during each of the three months ended June 30, 2013 and 2012, respectively. Sales to customers in North America represented 88% and 89% of total net sales for the three months ended June 30, 2013 and 2012, respectively. Sales to international customers (excluding Canada) represented 12% and 11% of total net sales for the three months ended June 30, 2013 and 2012, respectively.

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Gross Profit

Our consolidated gross profit increased by $0.5 million or 11% to $5.3 million for the three months ended June 30, 2013 from $4.8 million for the three months ended June 30, 2012, primarily attributable to the sales increase at a higher gross profit as a percent of sales in 2013, as discussed below.

Gross profit as a percentage of net sales was 53% for the three months ended June 30, 2013, compared to 50% for the three months ended June 30, 2012. The increase in our gross profit as a percent of net sales during the three months ended June 30, 2013 compared to the same period in 2012 was primarily due to:
(i) improved overall sales mix of our higher margin products partially due to increased levels of sales into optical channels; (ii) a higher percentage of lower cost inventory purchases from China; (iii) lower overhead as a percentage of sales partially due to the consolidation of our European distribution center to North America; and (iv) partially offset by an increase in inventory reserves in 2013 compared to 2012.

Sales and Marketing Expense

Sales and marketing expense decreased by $0.8 million or 22% to $3.0 million for the three months ended June 30, 2013 from $3.8 million for the three months ended June 30, 2012. The decrease is principally attributable to: (i) a $0.6 million decrease in advertising, public relations, marketing events, and related marketing costs; (ii) a $0.3 million decrease in sales and marketing salary and travel related expenses primarily for reductions in headcount. These decreases were partially offset by a $0.1 million increase in sales incentives and commissions associated with the sales growth during the three months ended June 30, 2013.

General and Administrative Expense

General and administrative expense increased by less than $0.1 million or 4% to $1.8 million for the three months ended June 30, 2013 from $1.7 million for the three months ended June 30, 2012. The increase is primarily due to expenses during the three months ending June 30, 2013 for: (i) a modification in the vesting period of certain stock options in connection with the resignation of two Board members which aggregated $0.1 million; and (ii) severance costs of $0.3 million attributable to an officer resignation. These increases were partially offset by a decrease of $0.3 million in expenses related to employee related costs driven by lower headcount, general corporate matters and legal fees.

Shipping and Warehousing Expense

Shipping and warehousing expense decreased by $0.1 million or 55% to $0.1 million for the three months ended June 30, 2013 from $0.2 million for the three months ended June 30, 2012. The decrease was primarily due to a decrease in employee related costs.

Research and Development Expense

Research and development expense was essentially unchanged at $0.1 million for the three months ended June 30, 2013 from $0.1 million for the three months ended June 30, 2012.

Restructure

During the third quarter of 2012, we decided to take certain restructuring actions including (i) reducing the number of our employees, substantially all of which occurred during the second half of 2012, (ii) changing the direct portion of our European business into a distribution model, and (iii) reducing anticipated spending for our marketing programs. These actions were intended to reduce spending and the level of our sales required to break even on an operating basis, and substantial contributing factors to our lower operating expenses during the three months ended June 30, 2013. Total operating expenses were lower by $0.8 million or 14% to $5.0 million for the three months ended June 30, 2013, compared to $5.8 million during the three months ended June 30, 2012.

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Other Net Expense

Other net expense was $0.9 million for the three months ended June 30, 2013 compared to other net expense of $0.6 million for the three months ended June 30, 2012. The difference was primarily due to increased interest expense as a result of increased borrowings from Costa Brava and Harlingwood partially offset by lower average borrowings from BFI. Beginning on January 1, 2012, the interest expense attributable to Costa Brava and Harlingwood borrowings was paid as Accrued PIK Interest, rather than in cash, resulting in an increase to the outstanding principal balances due to Costa Brava and Harlingwood.

Income Tax Provision

Income tax expense was zero for the three months ended June 30, 2013 and 2012, respectively. We have recorded a full valuation allowance for deferred tax assets both in the U.S. and in Italy at June 30, 2013 and 2012. The effective tax rate for the three months ended June 30, 2013 and 2012 was less than 1% in both periods.

We may have incurred one or more ownership changes, as defined by Section 382 of the Internal Revenue Code ("IRC Section 382") in the current and previous years, and, as such, the use of our net operating losses may be limited in future years. We have not completed a formal IRC Section 382 study and analysis to determine the annual limitation on the use of the net operating losses; however, the limitations could be substantial.

Comparison of Six Months Ended June 30, 2013 to the Six Months Ended June 30, 2012

Net Sales

Consolidated net sales increased by $1.4 million or 8% to $19.0 million for the six months ended June 30, 2013 from $17.6 million for the six months ended June 30, 2012.

Sales of our SPY® brand products increased by $1.8 million or 10% to $19.0 million during the six months ended June 30, 2013, compared to $17.2 million for the six months ended June 30, 2012. A significant portion of the SPY® sales growth was from sales of sunglasses into our North American optical and international channels, and from our optical frame product line and Happy Lens™ collection. SPY® sales amounts included approximately $1.4 million and $1.2 million of sales during the six months ended June 30, 2013 and June 30, 2012, respectively, which were considered to be closeouts, defined as (a) older styles not in the current product offering or (b) the sales of certain excess inventory of current products sold at reduced pricing levels.

Sales of licensed brands (O'Neill®, Melodies by MJB® and Margaritaville®) were less than $50,000 during the six months ended June 30, 2013, compared to $0.4 million during the six months ended June 30, 2012. All sales of licensed brands during the six months ended June 30, 2013 and 2012 were considered to be closeout sales based on our decision during 2011 to cease making purchases of licensed brand inventory. In July 2011, we entered into an agreement with Rose Colored Glasses LLC in which, among other matters, the parties agreed to terminate the existing license agreement for Melodies by MJB® effective March 31, 2012. Additionally, effective June 24, 2012, SPY North America terminated its agreement with O'Neill®. We sold all of our Margaritaville® products by March 31, 2013 and will have no sales of any of these licensed brand products in the future.

Sunglass sales represented approximately 92% and 90% of net sales during the six months ended June 30, 2013 and 2012, respectively. Goggle sales represented approximately 7% and 9% of net sales during the six months ended June 30, 2013 and 2012, respectively. Apparel and accessories represented approximately 1% of net sales during each of the six months ended June 30, 2013 and 2012, respectively. Sales to customers in North America represented 88% of total net sales for the six months ended June 30, 2013 and 2012, respectively. Sales to international customers (excluding Canada) represented 12% and of total net sales for the six months ended June 30, 2013 and 2012, respectively.

Gross Profit

Our consolidated gross profit increased by $1.3 million or 16% to $9.9 million for the six months ended June 30, 2013 from $8.5 million for the six months ended June 30, 2012, primarily attributable to the sales increase at a higher gross profit as a percent of sales in 2013, as discussed below.

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Gross profit as a percentage of net sales was 52% for the six months ended June 30, 2013, compared to 49% for the six months ended June 30, 2012. The increase in our gross profit as a percent of net sales during the six months ended June 30, 2013 compared to the same period in 2012 was primarily due to:
(i) improved overall sales mix of our higher margin products partially due to increased levels of sales into optical channels; (ii) a higher percentage of lower cost inventory purchases from China; (iii) the negative effect of higher sales of lower gross margin licensed brand products in 2012 compared to 2013;
(iv) lower overhead as a percentage of sales partially due to the consolidation of our European distribution center to North America; and (v) partially offset by an increase in closeout sales and inventory reserves in 2013 compared to 2012.

Sales and Marketing Expense

Sales and marketing expense decreased by $1.6 million or 22% to $5.8 million for the six months ended June 30, 2013 from $7.4 million for the six months ended June 30, 2012. The decrease is principally attributable to: (i) a $1.3 million decrease in advertising, public relations, marketing events, and related marketing costs; (ii) a $0.4 million decrease in sales and marketing salary and travel related expenses primarily for reductions in headcount. These decreases were partially offset by a $0.1 million increase in sales incentives and commissions associated with the sales growth during the six months ended June 30, 2013.

General and Administrative Expense

General and administrative expense decreased by $0.5 million or 13% to $3.2 million for the six months ended June 30, 2013 from $3.7 million for the six months ended June 30, 2012. The decrease was primarily due to a reduction in expense related to employee related costs driven by lower headcount, general corporate matters and legal fees. The decrease is partially offset by increased expenses during the six months ending June 30, 2013 of $0.4 million related to:
(i) a modification in the vesting period of certain stock options in connection with the resignation of two members of the board of directors which aggregated $0.1 million; and (ii) severance costs of $0.3 million attributable to an officer resignation.

Shipping and Warehousing Expense

Shipping and warehousing expense decreased by $0.1 million or 33% to $0.3 million for the six months ended June 30, 2013 from $0.4 million for the six months ended June 30, 2012. The decrease was primarily due to a decrease in employee related costs.

Research and Development Expense

Research and development expense was essentially unchanged at $0.2 million for the six months ended June 30, 2013 from $0.2 million for the six months ended June 30, 2012.

Restructure

During the third quarter of 2012, we decided to take certain restructuring actions including (i) reducing the number of our employees, substantially all of which occurred during the second half of 2012, (ii) changing the direct portion of our European business into a distribution model, and (iii) reducing anticipated spending for our marketing programs. These actions were intended to reduce spending and the level of our sales required to break even on an operating basis, and substantial contributing factors to our lower operating expenses during the six months ended June 30, 2013. Total operating expenses were lower by $2.3 million or 19% to $9.5 million for the six months ended June 30, 2013, compared to $11.8 million during the six months ended June 30, 2012.

Other Net Expense

Other net expense was $1.7 million for the six months ended June 30, 2013 compared to other net expense of $1.0 million for the six months ended June 30, 2012. The difference was primarily due to increased interest expense as a result of increased borrowings from Costa Brava and Harlingwood. Beginning on January 1, 2012, the interest expense attributable to Costa Brava and Harlingwood borrowings was paid as Accrued PIK Interest, rather than in cash, resulting in an increase to the outstanding principal balances due Costa Brava and Harlingwood.

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Income Tax Provision

Income tax expense was zero for the six months ended June 30, 2013 and 2012, respectively. We have recorded a full valuation allowance for deferred tax assets both in the U.S. and in Italy at June 30, 2013 and 2012. The effective tax rate for the six months ended June 30, 2013 and 2012 was less than 1% in both periods.

We may have incurred one or more ownership changes, as defined by Section 382 of the Internal Revenue Code ("IRC Section 382") in the current and previous years, and, as such, the use of our net operating losses may be limited in future years. We have not completed a formal IRC Section 382 study and analysis to determine the annual limitation on the use of the net operating losses; however, the limitations could be substantial.

Liquidity and Capital Resources

We have financed our net losses, working capital needs, and capital expenditures through a combination of operating cash flows and revolving lines of credit provided by our U.S. based lenders. We have also required debt and equity financing in the past because cash used by operations and net losses were substantial due to ongoing and seasonal working capital requirements.

Cash on hand at June 30, 2013 was $0.9 million. At June 30, 2013, we had a total of $24.3 million in debt under all lines of credit, capital leases and notes payable, of which $3.9 million was classified as short-term liabilities and $20.4 million was classified as long-term liabilities in the Company's Consolidated Balance Sheet. Our primary debt arrangements as of June 30, 2013 are further described below in Short-Term Debt and Long-Term Debt.

Future Capital Requirements and Resources

We incurred significant negative cash flow from operations, operating and net losses and had significant working capital requirements during and prior to the year ended December 31, 2012. During the six months ended June 30, 2013, we had positive cash flow from operations as a result of operating profit and improvements in working capital. However, the Company anticipates that it will continue to have ongoing cash requirements to finance its seasonal and ongoing working capital requirements and net losses.

In order to finance its net losses and working capital requirements, we have relied and anticipate that we will continue to rely on SPY North America's credit line with BFI Business Finance ("BFI") ("BFI Line of Credit") and our credit facilities with Costa Brava Partnership III, L.P. ("Costa Brava"). In addition, we have relied on debt and equity financing from Harlingwood (Alpha), LLC ("Harlingwood"). Costa Brava and Harlingwood are related parties. (See Short-Term Debt and Long-Term Debt below and Note 11 "Related Party Transactions" in the Consolidated Financial Statements).

We believe that we will have sufficient cash on hand and cash available under existing credit facilities to enable us to meet our operating requirements for at least the next twelve months, if we are able to achieve some or a combination of the following: (i) achieve our desired sales growth, (ii) continue the improvements in the management of our working capital, and (iii) continue to manage and operate at reduced levels of our sales, marketing, general and administrative, and other operating expenses. However, we will need to continue to access our existing credit facilities during the next twelve months to support our planned operations and working capital requirements, and intend to:
(i) continue to borrow, to the extent available, from the BFI Line of Credit,
(ii) increase the level of our outstanding principal due to Costa Brava by borrowing up to the maximum amount available, including through the ongoing deferral of interest payments which otherwise would have been payable to Costa Brava periodically provided, in each case, that they remain available and on terms acceptable to us, and (iii) if necessary, we may need to raise additional capital through debt or equity financings.

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We do not anticipate that we can generate sufficient cash from operations to repay the amounts due under the BFI Line of Credit, which is scheduled for its next annual renewal in February 2014, and the borrowings from Costa Brava and Harlingwood when they become due in April 2015. Therefore, we will need to renew the BFI Line of Credit at its annual renewal in February 2014 and obtain permission to extend the maturity date of the Costa Brava and Harlingwood indebtedness beyond April 2015. If we are unable to renew the BFI Line of Credit and further extend the maturity date of the Costa Brava and Harlingwood indebtedness, we will need to raise substantial additional capital through debt or equity financing to continue our operations. No assurances can be given that any such financing will be available to us on favorable terms, if at all. The inability to obtain debt or equity financing in a timely manner and in amounts sufficient to fund our operations, or the inability to renew the BFI Line of Credit or to extend the maturity date of the Costa Brava and Harlingwood indebtedness, if necessary, would have an immediate and substantial adverse impact on our business, financial condition or results of operations.

Our access to additional financing will depend on a variety of factors (many of which we maintain little or no control) such as market conditions, the general availability of credit, the overall availability of credit to its industry, its credit ratings and credit capacity, as well as the possibility . . .

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