UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the Quarterly Period Ended March 31, 2005

		OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 000-51071

ORANGE 21 INC.

(Exact name of Registrant as specified in its charter)

Delaware		33-0580186
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

2070 Las Palmas Drive, Carlsbad, CA 92009		(760) 804-8420
(Address of principal executive offices)		(Registrant’s telephone number, including area code)

Securities registered to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.0001 per share

Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o No ý

As of April 25, 2005, there were 8,012,483 shares of Common Stock, par value $0.0001 per share, issued and outstanding.

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

ORANGE 21 INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	December 31, 2004			March 31, 2005
				(unaudited)
Assets
Current assets
Cash and cash equivalents	$	11,476,828		$	3,336,720
Short-term investments	—			10,907,191
Accounts receivable—net	8,244,910			6,458,807
Inventories	11,814,846			13,111,937
Prepaid expenses and other current assets	1,073,181			1,841,272
Income taxes receivable	—			97,859
Deferred income taxes	1,074,000			857,000
Total current assets	33,683,765			36,610,786
Property and equipment—net	3,687,907			3,863,641

Intangible assets, net of accumulated amortization of $318,332 (2004) and $332,521 (2005)	152,543			192,517
Deferred income taxes	—			173,000

Total assets	$	37,524,215		$	40,839,944
Liabilities and Stockholders’ Equity
Current liabilities
Current portion of notes payable	$	125,000		$	125,000
Current portion of capitalized leases	37,370			37,041
Accounts payable	2,243,955			2,584,549
Accrued expenses and other liabilities	2,433,371			2,356,948
Income taxes payable	443,619			—
Total current liabilities	5,283,315			5,103,538
Notes payable, less current portion	166,667			135,417
Capitalized leases, less current portion	31,369			22,225
Deferred income taxes	143,000			—
Total liabilities	5,624,351			5,261,180
Commitments and contingencies
Stockholders’ equity
Preferred stock; par value $0.0001; 5,000,000 authorized	—			—
Common stock; par value $0.0001; 100,000,000 shares authorized; 7,491,218 and 8,012,483 shares issued and outstanding at 2004 and 2005, respectively	747			799
Additional paid-in capital	31,655,426			35,840,787
Accumulated other comprehensive income	437,673			426,221
Accumulated deficit	(193,982		)	(689,043		)
Total stockholders’ equity	31,899,864			35,578,764
	$	37,524,215		$	40,839,944

The accompanying notes are an integral part of these consolidated financial statements.

ORANGE 21 INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

	Three months ended March 31,
	2004			2005
Net sales	$	6,403,416		$	8,472,553
Cost of sales	3,244,365			4,397,694
Gross profit	3,159,051			4,074,859
Operating expenses
Sales and marketing	2,265,365			2,868,516
General and administrative	984,526			1,299,926
Shipping and warehousing	162,360			292,189
Research and development	89,051			136,075
Total operating expenses	3,501,302			4,596,706
Loss from operations	(342,251		)	(521,847		)
Other (expense) income
Interest (expense) income— net	(121,284		)	64,111
Foreign currency transaction gain (loss)	82,667			(132,274		)
Other expense—net	(14,968		)	(4,051		)
Total other expense	(53,585		)	(72,214		)
Loss before income taxes	(395,836		)	(594,061		)
Income tax benefit	(48,000		)	(99,000		)
Net loss	$	(347,836	)	$	(495,061	)
Net loss per common share
Basic	$	(0.08	)	$	(0.06	)
Diluted	$	(0.08	)	$	(0.06	)
Weighted average common shares outstanding
Basic	4,434,067			8,012,483
Diluted	4,434,067			8,012,483

The accompanying notes are an integral part of these consolidated financial statements.

ORANGE 21 INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	Three months ended March 31,
	2004			2005

Cash flows from operating activities
Net loss	$	(347,836	)	$	(495,061	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	444,243			503,057
Deferred income taxes	—			(99,000		)
Provision for bad debts	62,164			(42,250		)
Stock-based compensation	8,500			—
Change in operating assets and liabilities:
Accounts receivable	1,633,423			1,828,353
Inventories	430,807			(1,297,091		)
Prepaid expenses and other current assets	(241,965		)	(768,091		)
Due from related party	(169,512		)	—
Accounts payable	(641,405		)	340,594
Accrued expenses and other liabilities	(210,146		)	(76,423		)
Income tax payable/receivable	(20,303		)	(541,478		)
Net cash provided by (used in) operating activities	947,970			(647,390		)
Cash flows from investing activities
Purchases of fixed assets	(218,248		)	(519,202		)
Purchases of fixed assets from related parties	(225,895		)	(145,399		)
Purchases of short-term investments	—			(11,411,051		)
Maturities and sales of short-term investments	—			500,000
Purchases of intangibles	(3,528		)	(54,164		)
Net cash used in investing activities	(447,671		)	(11,629,816		)
Cash flows from financing activities
Line of credit borrowings	400,000			—
Line of credit repayments	(950,000		)	—
Principal payments on notes payable	(31,250		)	(31,250		)
Principal payments on capital leases	(11,467		)	(9,473		)
Proceeds from sale of common stock	—			4,181,363
Proceeds from exercise of stock options	—			4,050
Net cash (used in) provided by financing activities	(592,717		)	4,144,690
Effect of exchange rate changes on cash and cash equivalents	(11,268		)	(7,592		)
Net decrease in cash and cash equivalents	(103,686		)	(8,140,108		)
Cash and cash equivalents at beginning of period	581,207			11,476,828
Cash and cash equivalents at end of period	$	477,521		$	3,336,720
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	118,639		$	5,924
Income taxes	$	—		$	545,000

The accompanying notes are an integral part of these consolidated financial statements.

Non-cash Investing and Financing Activities:

The Company converted $25,000 of notes payable into common stock during the three months ended March 31, 2004.

ORANGE 21 INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The accompanying unaudited consolidated financial statements of Orange 21 Inc. and its subsidiaries (the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements.

In the opinion of management, the unaudited consolidated financial statements contain all adjustments, consisting only of normal recurring items, considered necessary for a fair presentation of the consolidated balance sheet as of March 31, 2005, and the consolidated statements of operations and cash flows for the three month periods ended March 31, 2004 and 2005. The results of the operations for the three month period ended March 31, 2005 are not necessarily indicative of the results of operations for the entire year ending December 31, 2005. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Conditions and Results of Operations and the Company’s financial statements and notes thereto included in the Orange 21 Inc. 2004 Form 10-K.

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Significant estimates used in preparing these consolidated financial statements include those assumed in computing the carrying value of displays, allowance for doubtful accounts receivable, reserve for obsolete inventory, reserve for sales returns, and the valuation allowance on deferred tax assets. Accordingly, actual results could differ from those estimates.

2. Recently Issued Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which will be effective for the Company’s first quarterly reporting period in 2006. SFAS No. 123R replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. The new standard requires that the compensation cost relating to share-based payments be recognized in financial statements at fair value. As such, reporting employee stock options under the intrinsic value-based method prescribed by APB No. 25 will no longer be allowed. The Company has historically elected to use the intrinsic value method and has not recognized expense for employee stock options granted. The Company has not yet determined the impact that adopting SFAS No. 123R will have on the financial results of the Company in future periods.

In December 2004, the FASB staff issued FASB Staff Position (“FSP”) SFAS No. 109-1, Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004, to provide guidance on the application of SFAS No. 109 to the provision within the American Jobs Creation Act of 2004 (the “Act”) that provides tax relief to U.S. domestic manufacturers. The FSP states that the manufacturer’s deduction provided for under the Act should be accounted for as a special deduction in accordance with SFAS No. 109 and not as a tax rate reduction. A special deduction is accounted for by recording the benefit of the deduction in the year in which it can be taken in the Company’s tax return, and not by adjusting deferred tax assets and liabilities in the period of the Act’s enactment (which would have been done if the deduction on qualified production activities were treated as a change in enacted tax rates). The proposed FSP also reminds companies that the special deduction should be considered by an enterprise in (a) measuring deferred taxes when the enterprise is subject to graduated tax rates and (b) assessing whether a valuation allowance is necessary as required by SFAS No. 109. The FSP is effective upon issuance. In accordance with the FSP, the Company will record the benefit, if any, of the tax deduction in the year in which the deduction becomes available.

In December 2004, the FASB staff issued FSP FAS No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004, to provide accounting and disclosure guidance for the repatriation provisions included in the Act. The Act introduced a special limited-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer. As a result, an issue has arisen as to whether an enterprise should be allowed additional time beyond the financial reporting period in which the Act was enacted to evaluate the effects of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. The FSP is effective upon issuance. The Company has not yet completed its evaluation of this aspect of the Act and will complete its review in connection with the preparation of its 2004 corporate tax returns.

In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107 to provide public companies additional guidance in applying the provisions of SFAS No. 123(R). Among other things, the SAB describes the staff’s expectations in determining the assumptions that underlie the fair value estimates and discusses the interaction of SFAS No. 123(R) with certain existing staff guidance. SAB No. 107 should be applied upon the adoption of SFAS No. 123(R).

3. Cash, Cash Equivalents and Short-term Investments

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company’s investments, which generally have maturities between three and twelve months at time of acquisition, are considered short-term. Cash, cash equivalents and short-term investments consist primarily of corporate obligations such as commercial paper and corporate bonds, but also include government agency notes, certificates of deposit, bank time deposits and institutional money market funds.

All of the Company’s short-term investments have contractual maturities of twelve months or less at the time of acquisition. Because of the short term to maturity, and hence relative price insensitivity to changes in market interest rates, cost approximates fair value for all these securities. Unrealized losses were $0 and $4,000 at March 31, 2004 and 2005, respectively.

4. Derivative Financial Instruments

The Company periodically enters into foreign currency forward contracts for a portion of its anticipated purchases denominated in foreign currencies to hedge price changes associated with fluctuations in market prices. All derivatives are recorded on the consolidated balance sheet at their fair value. As the Company’s forward contracts do not qualify for hedge accounting, changes in the fair value of the Company’s forward contracts are recorded in the accompanying consolidated statements of operations. For the three months ended March 31, 2004 and 2005, the Company recorded an unrealized loss on its foreign currency hedge contracts of ($96,000) and ($77,000), respectively. This amount is included in the foreign currency transaction gain (loss) on the consolidated statements of operations.

5. Loss Per Share

Basic loss per share is computed using the weighted average number of common shares outstanding during the reporting period. Loss per share assuming dilution is computed using the weighted average number of common shares outstanding and the dilutive effect of potential common shares outstanding. For the three months ended March 31, 2004 and 2005, the Company has excluded all stock options and warrants from the calculation of diluted loss per share because the effect of those securities would be anti-dilutive for these periods. The total number of potential common shares excluded from the calculation of diluted loss per share was 574,346 and 888,706 for the three months ended March 31, 2004 and 2005, respectively.

6. Stock Based Compensation

The Company applies Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for its stock options. Under APB No. 25, compensation cost is recognized for stock options granted to employees when the option price is less than the market price of the underlying common stock on the date of grant.

SFAS No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” require the Company to provide pro forma information regarding net income as if compensation cost for the Company’s stock option plans had been determined in accordance with the fair value based method prescribed in SFAS No. 123. To provide the required pro forma information, the Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model. SFAS No. 148 also provides for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Company has elected to continue to account for stock based compensation under APB No. 25. For stock options granted to employees, the fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rates ranging from 3.0% to 4.9%, volatility ranging from 0% to 50% for all periods and an expected life of 5 years.

If compensation cost for the Company’s stock options had been determined based on their fair value at the grant dates consistent with the method of SFAS No. 123, the Company’s net loss would have been adjusted to the pro forma amounts indicated below:

	Three months ended March 31,
	2004			2005
Net loss, as reported	$	(347,836	)	$	(495,061	)
Pro forma stock-based compensation	(6,025		)	(3,450		)
Pro forma net loss	$	(353,861	)	$	(498,511	)

Basic net loss per share:
As reported	$	(0.08	)	$	(0.06	)
Pro forma	$	(0.08	)	$	(0.06	)
Diluted net loss per share:
As reported	$	(0.08	)	$	(0.06	)
Pro forma	$	(0.08	)	$	(0.06	)

The Company applies SFAS No. 123 in valuing options granted to consultants and estimates the fair value of such options using the Black-Scholes option-pricing model. The fair value is recorded as consulting expense as services are provided. Options granted to consultants for which vesting is contingent based on future performance are measured at their then current fair value at each period end, until vested. The Company used the following weighted average assumptions for consultant options vesting during 2004: risk free interest rates ranging from 3.0% to 4.9%, volatility ranging from 0% to 50%, and expected lives of five years.

7. Accounts Receivable

Accounts receivable consisted of the following:

	December 31, 2004			March 31, 2005
Trade receivables	$	10,002,777		$	7,885,724
Less allowance for doubtful accounts	(567,541		)	(489,086		)
Less allowance for returns	(1,190,326		)	(937,831		)

	$	8,244,910		$	6,458,807

8. Inventories

Inventories consisted of the following:

	December 31, 2004		March 31, 2005
Raw materials	$	455,029	$	335,523
Finished goods	11,359,817		12,776,414

	$	11,814,846	$	13,111,937

The Company’s inventory balances are net of an allowance for obsolescence of approximately $1,109,000 and $1,205,000 at December 31, 2004 and March 31, 2005, respectively.

9. Financing Arrangements

Lines of credit

The Company’s line of credit with Comerica Bank allows for borrowings up to $8 million and matures in June 2005. The Company believes that it will be able to extend or replace its existing credit facility prior to its maturity without significant changes in terms. At December 31, 2004 and March 31, 2005, amounts outstanding under lines of credit were zero.

The Company also has available letter of credit accommodations, with any payments made by the financial institution to any issuer thereof and/or related parties in connection with the letter of credit accommodations to constitute additional revolving loans to the Company and the amount of all outstanding letter of credit accommodations not to exceed $2.0 million. There were no outstanding letters of credit at December 31, 2004 and March 31, 2005, respectively.

Notes Payable

Notes payable consisted of the following:

	December 31, 2004			March 31, 2005
Note payable to bank; interest at prime (5.75% at March 31, 2005); secured by all of the assets of the Company excluding intellectual property rights; principal of approximately $10,000 plus interest is due monthly over a four-year period through March 21, 2007	$	291,667		$	260,417

Less current portion	(125,000		)	(125,000		)
Long-term portion	$	166,667		135,417

The financial agreements contain certain financial and non-financial covenants. At December 31, 2004 and March 31, 2005, management believes the Company was not in violation of any financial covenants.

10. Common Stock

In January 2005, the Company sold 520,000 shares of common stock to cover over-allotments as a result of the Company’s initial public offering. Net proceeds after offering costs of $353,000 and expenses of $16,000 amounted to approximately $4.2 million. In addition, 1,265 shares were issued due to stock options exercised.

11. Commitments and Contingencies

Operating Leases

The Company leases its principal administrative and distribution facilities under an operating lease that expires in May 2005. The Company intends to enter into an agreement to extend the lease at a minimum through December 31, 2005,

with an option to extend beyond that period. The Company also leases an administrative and distribution facility in Italy under an agreement that expires in September 2009, but may be terminated by the Company prior to such time with six-months notice. Rent expense was approximately $65,000 and $86,000 for the three months ended March 31, 2004 and 2005, respectively.

Litigation

From time to time, the Company may be party to lawsuits in the ordinary course of business. Some of these claims may lead to litigation.

On March 7, 2005, Oakley, Inc, a major competitor of the Company, filed a lawsuit alleging patent, trade dress and trademark infringement, unfair competition, and false designation of origin. The lawsuit specifically identifies three of the Company’s product styles which accounted for less than 4% of the Company’s total sales for 2004. While the Company believes that the lawsuit is without merit and that the ultimate outcome of this proceeding will not have a material adverse effect on the Company’s consolidated balance sheet and statements of income and cash flows, litigation is subject to inherent uncertainties. The Company will seek coverage under its insurance policies with respect to these claims, although there can be no guarantee as to the extent that such coverage will be available, if at all. The Company presently has no estimate of any potential loss or range of loss with respect to the lawsuit or any estimate as to the potential costs of defending against the lawsuit.

The Company, its directors and certain of its officers have recently been named as defendants in two stockholder class action lawsuits filed in the United States District Court for the Southern District of California. The complaints purport to seek unspecified damages on behalf of an alleged class of persons who purchased the Company’s common stock pursuant to the registration statement filed in connection with the Company’s public offering of stock on December 14, 2004. The complaints allege that the Company and its officers and directors violated federal securities laws by failing to disclose material information about the status of its European operations and whether certain of the Company’s products infringe on the intellectual property rights of Oakley, Inc. in that registration statement. The Company has not yet formally responded to this action and no discovery has been conducted. However, based on the facts presently known, management believes it has meritorious defenses to this action and intends to vigorously defend the action. Based on the Company’s insurance coverages, its costs related to defending this action could be as high as $250,000.

12. Related Party Transactions

Vendor Purchases

The Company purchases point-of-purchase displays and other materials from a business controlled or owned by a stockholder. The total amounts purchased for the three months ended March 31, 2004 and 2005 were approximately $478,000 and $510,000, respectively. For the three months ended March 31, 2004 and 2005 the Company capitalized approximately $226,000 and $145,000, respectively of these purchases.

Customer Sales

No Fear, Inc., a stockholder, owns retail stores that purchase products from the Company. Aggregated sales to these stores during the three months ended March 31, 2004 and 2005 were approximately $168,000, and $99,000, respectively. Accounts receivable due from these stores amounted to $243,000 and $109,000 at December 31, 2004 and March 31, 2005, respectively.

Stockholders of the Company own retail stores and distribution companies that purchase products from the Company. Aggregated sales to these stores during the three months ended March 31, 2004 and 2005 were approximately $191,000 and $274,000, respectively. Accounts receivable due from these entities amounted to approximately $423,000 and $322,000 at December 31, 2004 and March 31, 2005, respectively.

Contract Services

In August 2004, the Company began operating No Fear’s web site on its behalf. In December 2004, the Company signed an agreement with No Fear to develop and maintain its web site. Products sold on the site include No Fear and Spy Optic branded products. Under the agreement, the Company will be responsible for products purchased from No Fear to fulfill orders including shipping and insurance costs, and all web site development, hosting, and maintenance costs. The Company must also pay No Fear a royalty of 5% on net sales. For the three months ended March 31, 2004 and 2005, the Company purchased approximately $0 and $9,000 respectively, of products from No Fear to fulfill web site orders. At March 31, 2004 and 2005, the operating loss on this agreement was approximately $0 and $23,000 respectively, excluding other accounting and administrative costs incurred by the Company in managing the web site.

On May 11, 2005, the Company and No Fear, Inc. mutually agreed to terminate this agreement effective June 30, 2005.

13. Geographic Information

The Company operated principally in two geographic areas, the United States and Italy, during the three months ended March 31, 2004 and 2005. Net sales are attributed to countries based on shipping point, and therefore the U.S. column includes U.S. sales to foreign customers. There were no significant transfers between geographic areas during the period.

	Three months ended March 31, 2004
	U.S.			Foreign			Consolidated
	(in thousands)

Net sales	$	5,518		$	885		$	6,403
Operating income (loss)	106			(448		)	(342		)
Net income (loss)	(69		)	(279		)	(348		)
Identifiable assets	15,744			3,395			19,139

	Three months ended March 31, 2005
	U.S.			Foreign			Consolidated
	(in thousands)

Net sales	$	7,112		$	1,361		$	8,473

Operating loss	(330		)	(192		)	(522		)

Net loss	(169		)	(326		)	(495		)
Identifiable assets	35,115			5,725			40,840

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion includes the operations of Orange 21 Inc. and its subsidiaries for each of the periods discussed.

We design, develop and market premium products for the action sports and youth lifestyle markets. Our principal products, sunglasses and goggles, are marketed under our brand, Spy Optic. These products target the action sports market, including surfing, skateboarding and snowboarding, and the youth lifestyle market within fashion, music and entertainment. We have built our Spy brand by developing innovative, proprietary products that utilize high-quality materials, handcrafted manufacturing processes and engineered optical lens technology to convey performance, style, quality and value. We sell our products in approximately 4,600 retail locations in the United States and internationally through approximately 2,500 retail locations serviced by us and our international distributors. We have developed strong relationships with key multi-store action sport and youth lifestyle retailers in the United States, such as Cycle Gear, Inc., No Fear, Inc., Pacific Sunwear of California, Inc., Tilly’s Clothing, Shoes & Accessories and Zumiez, Inc., and a strategically selective collection of specialized surf, skate, snow, BMX, mountain bike and motocross stores.

We focus our marketing and sales efforts on the action sports and youth lifestyle markets, and specifically, individuals born between approximately 1977 and 1994, or Generation Y. We separate our eyewear products into two groups: sunglasses, which include fashion, performance sport and women-specific sunglasses, and goggles, which include snow and motocross goggles. In addition, we sell branded apparel and accessories. In managing our business, our management is particularly focused on ensuring that our product designs are keyed to current trends in the fashion industry, incorporate the most advanced technologies to enhance performance and provide value to our target market.

We began as a grassroots brand in Southern California and entered the action sports and youth lifestyle markets with innovative and performance-driven products and an authentic connection to the action sports and youth lifestyle markets. We have a wholly owned subsidiary incorporated in Italy, Spy Optic, S.r.l., and a wholly owned subsidiary incorporated in California, Spy Optic, Inc., which we consolidate in our financial statements. We rely exclusively on an independent third-party consultant for the design of our products. In addition, we maintain a semi-exclusive relationship with our primary manufacturer. We were incorporated as Sports Colors, Inc. in California in August 1992. From August 1992 to April 1994, we had no operations. In April 1994, we changed our name to Spy Optic, Inc. In November 2004, we reincorporated in Delaware and changed our name to Orange 21 Inc.

Critical Accounting Policies and Certain Risks and Uncertainties

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, net sales and expenses and related disclosures. On an ongoing basis, we evaluate our estimates, including those related to inventories, sales returns, income taxes, accounts receivable allowances and warranty. We base our estimates on historical experience, performance metrics and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results will differ from these estimates under different assumptions or conditions.

We apply the following critical accounting policies in the preparation of our consolidated financial statements:

Revenue Recognition

Our net sales are derived principally from the sale of sunglass and goggle products. Net sales are recognized at the time of shipment, when title and the risks and rewards of ownership of the goods have been assumed by the customer, or upon receipt by the customer, depending on the terms of the purchase order. Net sales consist of the sales price for the items sold, plus shipping costs upon shipment of customer orders, net of estimated refunds.

Reserve for Refunds and Returns

We reserve for estimated future refunds and returns at the time of shipment based upon historical data. We adjust reserves as we consider necessary. We make judgments as to our ability to collect outstanding receivables and provide

allowances for anticipated bad debts and refunds. Provisions are made based upon a review of significant outstanding invoices and overall quality and age of those invoices not specifically reviewed. In determining the provision for invoices not specifically reviewed, we analyze collection experience, customer credit-worthiness and current economic trends. If the data used to calculate these allowances does not reflect our future ability to collect outstanding receivables, an adjustment in the reserve for bad debts and refunds may be required.

Inventories

Inventories consist primarily of finished products, including sunglasses, goggles, apparel and accessories, product components such as replacement lens, purchasing and quality control costs, and packaging and shipping materials. Inventory items are carried on the books at the lower of cost or market using the first in first out method of inventory. Periodic physical counts of inventory items are conducted to help verify the balance of inventory. A reserve is maintained for obsolete inventory.

Research and Development

We expense research and development costs as incurred. We capitalize product molds and tooling and depreciate these costs over the estimated useful life of the asset.

Income Taxes

We account for income taxes pursuant to the asset and liability method, whereby deferred tax assets and liabilities are computed at each balance sheet date for temporary differences between the consolidated financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted laws and rates applicable to the periods in which the temporary differences are expected to affect taxable income. We consider future taxable income and ongoing, prudent and feasible tax planning strategies in assessing the value of its deferred tax assets. If we determine that it is more likely than not that these assets will not be realized, we will reduce the value of these assets to their expected realizable value, thereby decreasing net income. Evaluating the value of these assets is necessarily based on our management’s judgment. If we subsequently determined that the deferred tax assets, which had been written down, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made.

Foreign Currency

The functional currency of our wholly owned subsidiary, Spy Optic, S.r.l., and our Canadian division is the local currency. Accordingly, we are exposed to transaction gains and losses that could result from changes in foreign currency. Assets and liabilities denominated in foreign currencies are translated at the rate of exchange on the balance sheet date. Revenues and expenses are translated using the average exchange rate for the period. Gains and losses from translation of foreign subsidiary financial statements are included in accumulated other comprehensive income (loss). Gains and losses resulting from foreign currency transactions and unrealized gains or losses on currency contracts are included in foreign currency transaction gain or loss on the consolidated statements of income.

Vulnerability Due to Supplier Concentrations

We rely on a single source for the supply of several product components, including the uncoated lens blanks from which substantially all of its sunglass lenses are cut. In the event of the loss of its source for lens blanks, we have identified an alternate source that may be available, and may also manufacture some portion of its lenses directly. The effect of the loss of any of these sources (including any possible disruption in business) will depend primarily upon the length of time necessary to find a suitable alternative source and could have a material adverse impact on our business. There can be no assurance that, if necessary, an additional source of supply for lens blanks or other critical materials could be located or developed in a timely manner. If we were to lose the source for its lens blanks or other critical materials, it could have a materially adverse effect on our business.

Commitments and Contingencies

We have entered into operating leases, primarily for facilities, and have commitments under endorsement contracts with selected athletes and others who endorse the our products.

Results of Operations

Three Months Ended March 31, 2005 and 2004

Net Sales

Net sales increased 33% to $8.5 million for the three months ended March 31, 2005 from $6.4 million for the three months ended March 31, 2004. The increase in net sales was the result of the introduction of several new styles and expanded domestic and international distribution. Based on attributing sales using customer location instead of point of shipping, net sales increased in the United States by $1.4 million, or 27%. Net sales increased in the rest of the world by approximately $695,000, or 52%, based upon an increase in sales of our products in Canada of $233,000 and $462,000 in other countries. Approximately 6% of the international sales growth was attributable to a weaker U.S dollar. Net sales in the United States represented 76% and 79% of total net sales for the three months ended March 31, 2005 and 2004, respectively. Net sales in the rest of the world represented 24% and 21% of total net sales for the three months ended March 31, 2005 and 2004, respectively. Sunglass unit shipments increased 19% with a 10% increase in the average sales price. Goggle unit shipments increased 28% with no increase in the average sales price. The sales mix on a dollar basis for the three months ended March 31, 2005 was 69% for sunglasses, 24% for goggles and 7% for apparel and accessories. The sales mix on a dollar basis for the three months ended March 31, 2004 was 67% for sunglasses, 24% for goggles and 9% for apparel and accessories.

Cost of Sales and Gross Profit

Gross profit increased 29% to $4.1 million for the three months ended March 31, 2005 from $3.2 million for the three months ended March 31, 2004. The increase in absolute dollars was due primarily to the increase in sales volume. As a percentage of net sales, gross profit was 48% for the three months ended March 31, 2005, as compared to 49% for the three months ended March 31, 2004. As a percentage of net sales, the decrease in gross profit was due primarily to increased product costs from purchasing products in euros and an increase in close out sales.

Sales and Marketing Expense

Sales and marketing expense increased 27% to $2.9 million for the three months ended March 31, 2005 from $2.3 million for the three months ended March 31, 2004. The increase in sales and marketing expense primarily was due to increased sales and marketing compensation and related payroll taxes of $170,000, increased commission expense of $149,000 due to the period over period sales increase, increased payments to athletes pursuant to endorsement agreements of $34,000, and increased point-of-purchase and sales display expenses of $179,000. As a percentage of net sales, sales and marketing expense was 34% and 35% for the three months ended March 31, 2005 and 2004, respectively.

General and Administrative Expense

General and administrative expense increased 32% to $1.3 million for the three months ended March 31, 2005 from $1.0 million for the three months ended March 31, 2004. The increase in general and administrative expense primarily was due to increases in wages and related payroll taxes of $87,000, increased costs of being a public company including legal and accounting fees of $181,000, franchise taxes of $53,000, board fees of $32,000, and investor relations expenses of $29,000. This was offset by a reduction in bad debt reserves of $105,000 and consulting expenses of $51,000 As a percentage of net sales, general and administrative expense remained unchanged at 15% for each of the three months ended March 31, 2005 and 2004.

Shipping and Warehousing Expense

Shipping and warehousing expense increased 80% to $292,000 for the three months ended March 31, 2005 from $162,000 for the three months ended March 31, 2004. The increase was due primarily to increased compensation and related payroll taxes of $23,000, increased temporary labor of $60,000, and an increase in third-party warehousing expenses of $16,000. As a percentage of net sales, shipping and warehousing expense remained relatively unchanged at 3% for each of the three months ended March 31, 2005 and 2004.

Research and Development Expense

Research and development expense increased 53% to $136,000 for the three months ended March 31, 2005 from $89,000 for the three months ended March 31, 2004. The increase was due primarily to increased increased consulting fees of $37,000. As a percentage of net sales, research and development expense was 2% for the three months ended March 31, 2005, up from 1% for the three months ended March 31, 2004.

Other (Expense) Income

Other expense was $72,000 for the three months ended March 31, 2005 compared to other expense of $54,000 for the three months ended March 31, 2004. The decrease in other expense was due primarily to interest income of $64,000 for the three months ended March 31, 2005 compared to net interest expense of $121,000 due to a pay down on the Company’s lines of credit in 2005 and large balances of cash and investments as a result of the offering, and foreign currency loss of $132,000 for the three months ended March 31, 2005 compared to a foreign currency gain of $83,000 for the three months ended March 31, 2004 due to a mark to market of outstanding forward contracts and revaluation of intercompany payables.

Income Tax Provision

The income tax benefit for the three months ended March 31, 2005 was $99,000 compared to $48,000 for the three months ended March 31, 2004. The Company’s effective tax rate for the three months ended March 31, 2005 was 17% compared to 12% for the three months ended March 31, 2004.

Net Loss

The Company’s net loss increased 42% to $495,000 for the three months ended March 31, 2005 from $348,000 for the three months ended March 31, 2004. The increase in the net loss was due primarily to an increase in loss from operations of $180,000 due primarily to lower gross margins and increased operating expenses, primarily sales and marketing and general and administrative.

Liquidity and Capital Resources

The Company historically has financed its operations primarily through sales of common stock and borrowings under its credit facilities and from private lenders. The Company’s principal sources of liquidity are its cash and lines of credit, as well as cash flow it generates from operations. At both December 31, 2004 and March 31, 2005, the Company had unused lines of credit of $8 million.

Cash provided by or used in operating activities consists primarily of net income adjusted primarily for certain non-cash items including depreciation, amortization, deferred income taxes, provision for bad debts, stock compensation expense and the effect of changes in working capital and other activities. Cash used in operating activities for the three months ended March 31, 2005 was $647,000 and consisted of a net loss of $495,000, adjustments for non-cash items of approximately $362,000, and $514,000 used by working capital and other activities. Working capital and other activities consisted primarily of a decrease in accounts receivable of $1.8 million due primarily to cash collections, an increase in inventory of $1.3 million due primarily to purchases related to our new product lines, a net increase in accounts payable and accrued liabilities of $264,000, offset by an increase in prepaid expenses of $768,000 due to prepayments related to point-of purchase displays and production deposits, and a decrease in the income tax payable due primarily to payments related to our U.S. tax liabilities of $541,000.

Cash provided by operating activities for the three months ended March 31, 2004 was $948,000 and consisted of a net loss of $348,000, adjustments for non-cash items of $515,000, and $781,000 provided by working capital and other activities. Working capital and other activities consisted primarily of a decrease in accounts receivable of $1.6 million due cash collections, a decrease in inventory of $431,000, offset by an increase in prepaid expenses of $242,000 and an increase in accounts payable and accrued liabilities of $852,000 due to increased sales and operating expenses.

Cash used in investing activities for the three months ended March 31, 2005 was $11.6 million and was attributable primarily to short-term investments made primarily from the proceeds of the Company’s offering of $10.9 million, and capital expenditures of $665,000. Capital expenditures were for the purchase of retail point-of-purchase displays, box vans, and other corporate assets. Cash used in investing activities for the three months ended March 31, 2004 was $448,000, due primarily to capital expenditures of $444,000. Capital expenditures were for the purchase of retail point-of-purchase displays and other corporate assets.

Cash provided by financing activities for the three months ended March 31, 2005 was $4.1 million and was due primarily to the sale of common stock to cover over - -allotments as a result of the Company’s offering. Cash used by financing activities for the three months ended March 31, 2004 was $593,000 due primarily to net payments on our bank lines of credit of $450,000 payments on private lender debt of $31,000.

At March 31, 2005 working capital was $31.5 million compared to $28.4 million at December 31, 2004, a 5% increase. Working capital may vary from time to time as a result of seasonality, and changes in accounts receivable and inventory levels. Accounts receivable balances, less allowance for doubtful accounts and sales returns were $6.5 million at March 31, 2005, compared to $8.2 million at December 31, 2004. Accounts receivable days outstanding at March 31, 2005 was 78 compared to 81 at December 31, 2004. Inventories increased to $13.1 million at March 31, 2005 compared to $11.8 million at December 31, 2004. This reflects greater inventory levels to support 2005 product launches and sales growth. Quarterly inventory turns were 1.44, up slightly from 1.41 at December 31, 2004.

Credit Facilities

The Company’s line of credit with Comerica Bank allows for borrowings up to $8 million and matures in June 2005. At December 31, 2004 and March 31, 2005, amounts outstanding under lines of credit amounted were zero.

The Company also has a term loan with Comerica with a balance of approximately $260,000 at March 31, 2005, which matures in March 2007. Amounts outstanding under this loan are due on a monthly basis for the term of the loan.

All of our loan facilities and term loans with Comerica described above are secured by all of our assets, excluding our intellectual property. We also have agreed to various financial and non-financial covenants. At December 31, 2004 and March 31, 2005 we were in compliance with all covenants.

The Company also has a foreign exchange facility in the amount of $750,000, which provides up to $7.5 million in purchases of foreign exchange contracts. This foreign exchange facility is due to mature in June 2005. As of March 31, 2005, our total outstanding currency contracts under this facility in to U.S. dollars was $5.4 million. This represents approximately 4.1 million Euro foreign currency contracts at March 31, 2005.

Deferred Taxes

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on the level of historical operating results and projections for the taxable income for the future, management has determined that it is more likely than not that the deferred tax assets, net of the valuation allowance, will be realized. Accordingly, the Company has recorded no valuation allowance for its U.S. operations at

December 31, 2004 and March 31, 2005. The Company has recorded a valuation allowance of $378,000 for its wholly owned subsidiary, Spy S.r.l. at December 31, 2004 and March 31, 2005.

Backlog

Historically, purchases of sunglass and motocross eyewear products have not involved significant pre-booking activity. Purchases of our snow goggle products are generally pre-booked and shipped primarily from August to October. At March 31, 2004 and 2005 we had a backlog, including backorders (merchandise remaining unshipped beyond its scheduled shipping date), of approximately $665,000 and $1.3 million, respectively.

Seasonality

Our net sales fluctuate from quarter to quarter as a result of changes in demand for our products. Historically, we have experienced greater net sales in the second half of the fiscal year as a result of the seasonality of our customers and the markets in which we sell our products. We generally sell more of our sunglass products in the first half of the fiscal year and a majority of our goggle products in the last half of the fiscal year. We anticipate that this seasonal impact on our net sales is likely to continue. As a result, our net sales and operating results have fluctuated significantly from period-to-period in the past and are likely to do so in the future.

Inflation

The Company does not believe inflation has a material impact on the Company’s operations in the past, although there can be no assurance that this will be the case in the future.

Forward-Looking Statements

This document contains certain statements of a forward-looking nature. Such statements are made pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, including but not limited to growth and strategies, future operating and financial results, financial expectations and current business indicators are based upon current information and expectations and are subject to change based on factors beyond the control of the Company. Forward-looking statements typically are identified by the use of terms such as “may,” “will,” “should,” “might,” “believe,” “expect,” “anticipate,” “estimate” and similar words, although some forward-looking statements are expressed differently. The accuracy of such statements may be impacted by a number of business risks and uncertainties that could cause actual results to differ materially from those projected or anticipated, including but not limited to: risks related to the Company’s ability to manage rapid growth; risks related to the limited visibility of future sunglass orders; the ability to identify qualified manufacturing partners; the ability to coordinate product development and production processes with those partners; the ability of those manufacturing partners and the Company’s internal production operations to increase production volumes on raw materials and finished goods in a timely fashion in response to increasing demand and enable the Company to achieve timely delivery of finished goods to its retail customers; the ability to provide adequate fixturing to existing and future retail customers to meet anticipated needs and schedules; the Company’s ability to expand distribution channels and its own retail operations in a timely manner; unanticipated changes in general market conditions or other factors, which may result in cancellations of advance orders or a reduction in the rate of reorders placed by retailers; a weakening of economic conditions could continue to reduce or further reduce demand for products sold by the Company and could adversely affect profitability; further terrorist acts, or the threat thereof, could continue to adversely affect consumer confidence and spending, could interrupt production and distribution of product and raw materials and could, as a result, adversely affect the Company’s operations and financial performance; the ability of the Company to integrate acquisitions and licensing arrangements without adversely affecting operations; the ability to continue to develop and produce innovative new products and introduce them in a timely manner; the acceptance in the marketplace of the Company’s new products and changes in consumer preferences; reductions in sales of products, either as the result of economic or other conditions or reduced consumer acceptance of a product, could result in a buildup of inventory; the ability to source raw materials and finished products at favorable prices to the Company; foreign currency exchange rate fluctuations; earthquakes or other natural disasters concentrated in California where a significant portion of the Company’s current net sales are generated and where the Company’s headquarters are based; the Company’s ability to identify and execute successfully cost control initiatives; and other risks outlined in the Company’s SEC filings, including but not limited to the Annual Report on Form 10-K for the year ended December 31, 2004 and other filings made periodically by the Company. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to update this forward-looking information. Nonetheless, the Company reserves the right to make such updates from time to time by press release, periodic report or other method of public disclosure without the need for specific reference to this

quarterly report. No such update shall be deemed to indicate that other statements not addressed by such update remain correct or create an obligation to provide any other updates.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Interest Rate Risk

Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates. At March 31, 2005, we had $260,000 outstanding under our loan facilities with Comerica. We had unused lines of credit with Comerica of $8 million. The amounts outstanding under these loan facilities at any time may fluctuate and we may from time to time be subject to refinancing risk. We do not believe that a change of 100 basis points in interest rate would have a material effect on our results of operations or financial condition.

Foreign Currency Risk

We operate our business and derive a substantial portion of our net sales outside of the United States. For the three month period ended March 31, 2004 and 2005, we derived 24% and 21% of our net sales in the rest of the world. We also purchase a majority of our products in transactions denominated in Euros. As a result, we are exposed to movements in foreign currency exchange rates between the local currencies of the foreign markets in which we operate and the U.S. dollar. Our foreign currency exposure is generally related to Europe. A strengthening of the Euro relative to the U.S. dollar or to other currencies in which we receive revenues could impact negatively the demand for our products, could increase our manufacturing costs and could reduce our results of operations. In addition, we manufacture a substantial amount of our sunglass and goggle products in Italy. Because these purchases are paid in Euros, we face currency risk. A strengthening Euro could negatively affect the cost of our products and reduce our gross profit margins.

To hedge our purchase risk, we utilize forward foreign exchange contracts with durations, on the average, of three to six months. As of March 31, 2005, we had purchased a total of 4.1 million Euro foreign currency contracts at an average Euro rate of 1.32 Euro to U.S. dollar.

Recently Issued Accounting Pronouncements

FACTORS THAT MAY AFFECT RESULTS

Risks Related to Our Business

If we are unable to continue to develop innovative and stylish products, demand for our products may decrease.

The action sports and youth lifestyle markets are subject to constantly changing consumer preferences based on fashion and performance trends. Our success depends largely on the continued strength of our brands and our ability to continue to introduce innovative and stylish products that are accepted by consumers in our target markets. We must anticipate the rapidly changing preferences of consumers and provide products that appeal to their preferences in a timely manner while preserving the relevancy and authenticity of our brands. Achieving market acceptance for new products may also require substantial marketing and product development efforts and expenditures to create consumer demand. Decisions regarding product designs must be made several months in advance of the time when consumer acceptance can be measured. If we do not continue to develop innovative and stylish products that provide greater performance and design attributes than the products of our competitors and that are accepted by our targeted consumers, we may lose customer loyalty, which could result in a decline in our net sales and market share.

We may not be able to compete effectively, which will cause our net sales and market share to decline.

The action sports and youth lifestyle markets in which we compete are intensely competitive. We compete with smaller sunglass and goggle brands in various niches of the action sports market and a limited number of larger competitors, such as Arnette, Oakley and Smith Optics. We also compete with broader youth lifestyle brands that offer eyewear products, such as Hurley International and Quiksilver, and in the broader fashion sunglass sector of the eyewear market, which is fragmented and highly competitive. We compete with a number of brands in these sectors of the market, including Armani, Christian Dior, Dolce & Gabbana, Gucci, Prada and Versace. In both markets, we compete primarily on the basis of fashion trends, design, performance, value, quality, brand recognition, marketing and distribution channels.

The purchasing decisions of consumers are highly subjective and can be influenced by many factors, such as marketing programs, product design and brand image. Several of our competitors enjoy substantial competitive advantages, including greater brand recognition, a longer operating history, more comprehensive lines of products and greater financial resources for competitive activities, such as sales and marketing, research and development and strategic acquisitions. Our competitors may enter into business combinations or alliances that strengthen their competitive positions or prevent us from taking advantage of such combinations or alliances. They also may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or consumer preferences.

If our marketing efforts are not effective, our brands may not achieve the broad recognition necessary to our success.

We believe that broader recognition and favorable perception of our brands, and in particular, our Spy brand, by persons ranging in age from 10 to 27 is essential to our future success. Accordingly, we intend to continue an aggressive brand strategy through a variety of marketing techniques, including athlete sponsorship, sponsorship of surfing, snowboarding, skateboarding, wakeboarding, BMX, downhill mountain biking and motocross events, vehicle marketing, internet and print media, action sports industry relationships, sponsorship of concerts and music festivals and celebrity endorsements, to foster an authentic action sports and youth lifestyle company culture. If we are unsuccessful, these expenses may never be offset, and we may be unable to increase net sales. Successful positioning of our brands will depend largely on:

• the success of our advertising and promotional efforts;

• preservation of the relevancy and authenticity of our brands in our target demographic; and

• our ability to continue to provide innovative, stylish and high-quality products to our customers.

To increase brand recognition, we must continue to spend significant amounts of time and resources on advertising and promotions. These expenditures may not result in a sufficient increase in net sales to cover such

advertising and promotional expenses. In addition, even if brand recognition increases, our customer base may decline or fail to increase and our net sales may not continue at present levels and may decline.

If we are unable to leverage our business strategy successfully to develop new products, our business may suffer.

We are evaluating potential entries into or expansion of new product offerings, such as handmade fashion sunglasses and prescription eyewear frames. In expanding our product offerings, we intend to leverage our sales and marketing platform and customer base to develop these opportunities. While we have been successful promoting our sunglasses and goggles in our target markets, we cannot predict whether we will be successful in gaining market acceptance for any new products that we may develop. In addition, expansion of our business strategy into new product offerings will require us to incur significant sales and marketing expenses. These requirements could strain our management and financial and operational resources. Additional challenges that may affect our ability to expand our product offerings include our ability to:

• increase awareness and popularity of our existing Spy brand;

• establish awareness of any new brands we may introduce or acquire, including our Dale Earnhardt, Jr. brand E Eyewear and our Handcrafted Collection;

• increase customer demand for our existing products and establish customer demand for any new product offering, including E Eyewear;

• attract, acquire and retain customers at a reasonable cost;

• achieve and maintain a critical mass of customers and orders across all of our product offerings;

• maintain or improve our gross margins; and

• compete effectively in highly competitive markets.

We may not be able to address successfully any or all of these challenges in a manner that will enable us to expand our business in a cost-effective or timely manner. If new products we may develop are not received favorably by consumers, our reputation and the value of our brands could be damaged. The lack of market acceptance of new products we may develop or our inability to generate satisfactory net sales from any new products to offset their cost could harm our business.

Our business could be impacted negatively if our sales are concentrated in a small number of popular products.

If sales become concentrated in a limited number of our products, we could be exposed to risk if consumer demand for such products were to decline. For the three months ended March 31, 2004 and 2005, 69% and 67%, respectively, of our net sales were derived from sales of our sunglass products and 24% net sales were derived from sales of our goggle products. In addition, for the three months ended March 31, 2004 and 2005 19% and 16%, respectively, of our net sales related to our sunglass products were derived from two models of our product line. As a result of these concentrations in net sales, our operating results could be harmed if sales of any of these products were to decline substantially and we were not able to increase sales of other products to replace such lost sales.

Our business could be harmed if we fail to maintain proper inventory levels.

We place orders with our manufacturers for some of our products prior to the time we receive orders for these products from our customers. We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery. We also maintain an inventory of selected products that we anticipate will be in high demand. We may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs, and the sale of excess inventory at discounted prices could significantly impair our brand image and harm our operating results and financial condition. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply

the quality products that we require at the time we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships and diminish brand loyalty, thereby harming our business. For example, in fiscal 2003, we experienced a delay of two months in the delivery of goggle shipments, which we believe may have reduced our net sales in the third quarter of fiscal 2003 by less than 5%.

If we are unable to recruit and retain key personnel necessary to operate our business, our ability to develop and market our products successfully may be harmed.

We are heavily dependent on our current executive officers and management. The loss of any key employee or the inability to attract or retain qualified personnel, including product design and sales and marketing personnel, could delay the development and introduction of, and harm our ability to sell, our products and damage our brands. We believe that our future success is highly dependent on the contributions of Barry Buchholtz, our Chief Executive Officer. We have entered into an employment agreement with Mr. Buchholtz; however, we cannot be certain that he will not be recruited by our competitors or otherwise terminate his relationship with us. The loss of the services of Mr. Buchholtz would be very difficult to replace. Our future success may also depend on our ability to attract and retain additional qualified management, design and sales and marketing personnel. We do not carry key man insurance.

If we are unable to retain the services of our primary product designer, our ability to design and develop new products likely will be harmed.

We are heavily dependent on our primary product designer, Jerome Mage, for the design and development of our eyewear products. Mr. Mage provides his services to us as an independent consultant through his business, Mage Design. We cannot be certain that Mr. Mage will not be recruited by our competitors or otherwise terminate his relationship with us. If Mr. Mage terminates his relationship with us, we will need to obtain the services of another qualified product designer to design our eyewear products, and even if we are able to locate a qualified product designer, we may not be able to agree on commercially reasonable terms acceptable to us, if at all. If we were to enter into an agreement with a qualified product designer, we could experience a delay in the design and development of new sunglass and goggle product lines, and we may not experience the same level of consumer acceptance with any such product offerings. Any such delay in the introduction of new product lines or the failure by customers to accept new product lines could reduce our net sales.

If we are unable to maintain and expand our endorsements by professional athletes, our ability to market and sell our products may be harmed.

A key element of our marketing strategy has been to obtain endorsements from prominent action sports athletes to sell our products and preserve the authenticity of our brands. We generally enter into endorsement contracts with our athletes for terms of one to three years. There can be no assurance that we will be able to maintain our existing relationships with these individuals in the future or that we will be able to attract new athletes or public personalities to endorse our products in order to grow our brands or product categories. Further, we may not select athletes that are sufficiently popular with our target demographics or successful in their respective action sports. Even if we do select successful athletes, we may not be successful in negotiating commercially reasonable terms with those individuals. If we are unable in the future to secure athletes or arrange athlete endorsements of our products on terms we deem to be reasonable, we may be required to modify our marketing platform and to rely more heavily on other forms of marketing and promotion which may not prove to be as effective as endorsements. In addition, negative publicity concerning any of our sponsored athletes could harm our brands and adversely impact our business.

Any interruption or termination of our relationships with our manufacturers could harm our business.

Our principal manufacturers are located in Italy. We do not have long-term agreements with any of our manufacturers. Our agreement with our primary manufacturer, LEM S.r.l., requires us to purchase a minimum amount of products from LEM monthly and annually and allows either party to terminate the agreement for any reason upon 180 days’ notice. We cannot be certain that we will not experience difficulties with this manufacturer or our other manufacturers, such as reductions in the availability of production capacity, errors in complying with product specifications, insufficient quality control, failures to meet production deadlines or increases in manufacturing costs and failures to comply with our requirements for the proper utilization of our intellectual property. If our relationship with any of our manufacturers is interrupted or terminated for any reason, including the failure of any manufacturer to

be able to perform its obligations under our agreement or the termination of our agreement by any of our manufacturers, we would need to locate alternative manufacturing sources. The establishment of new manufacturing relationships involves numerous uncertainties, and we cannot be certain that we would be able to obtain alternative manufacturing sources in a manner that would enable us to meet our customer orders on a timely basis or on satisfactory commercial terms. If we are required to change any of our major manufacturers, we would likely experience increased costs, substantial disruptions in the manufacture and shipment of our products and a loss of net sales.

We purchase substantially all of our products from two manufacturers, LEM S.r.l. and Intersol S.r.l. For the three months ended March 31, 2004 and 2005, we purchased approximately 76% and 79%, respectively, of these products from LEM and approximately 13% and 15%, respectively, of these products from Intersol. We expect in the future that the portion of our products manufactured by LEM will increase and the portion of our products manufactured by Intersol will decrease. Accordingly, any ability to diffuse potential manufacturer-related risks noted above, and to attenuate the potentially debilitating effect on our business and results of operations, is thereby lessened - thus augmenting the risks.

Our manufacturers must be able to continue to procure raw materials and we must continue to receive timely deliveries from our manufacturers to sell our products profitably.

The capacity of our manufacturers to manufacture our products is dependent upon the availability of raw materials used in the fabrication of eyeglasses. Our manufacturers have experienced in the past, and may experience in the future, shortages of raw materials, which have resulted in delays in deliveries of our products by our manufacturers of up to several months. For example, in fiscal 2003, we experienced a delay of two months in the delivery of goggle shipments due to manufacturing problems. We believe the delay may have reduced our net sales in the third quarter of fiscal 2003 by less than 5%. Any shortage of raw materials or inability of a manufacturer to manufacture or ship our products in a timely manner, or at all, could impair our ability to ship orders of our products in a timely manner and could cause us to miss the delivery requirements of our customers. As a result, we could experience cancellation of orders, refusal to accept deliveries or a reduction in purchase prices, any of which could harm our net sales, results of operations and reputation.

Any failure to maintain ongoing sales through our independent sales representatives could harm our business.

We sell our products through our direct sales team and a network of 41 independent sales representatives. We rely on these independent sales representatives to provide customer contacts and market our products directly to our customer base. Our independent sales representatives are not obligated to continue selling our products, and they may terminate their arrangements with us at any time with limited notice. Our ability to maintain or increase our net sales will depend in large part on our success in developing and maintaining relationships with our independent sales representatives. It is possible that we may not be able to maintain or expand these relationships successfully or secure agreements with additional sales representatives on commercially reasonable terms, or at all. Any failure to develop and maintain our relationships with our independent sales representatives and any failure of our independent sales representatives to effectively market our products could harm our net sales.

We face business, political, operational, financial and economic risks because a significant portion of our operations and sales are to customers outside of the United States.

Our European operations are located in Italy, and our primary manufacturers are located in Italy. For the three months ended March 31, 2004 and 2005, we derived 76% and 79% of our net sales in the United States based on attributing sales using customer location (as opposed to shipping point) and 24% and 21% of our net sales in the rest of the world, primarily in Australia, Canada, France, Japan and Spain. We are subject to risks inherent in international business, many of which are beyond our control, including:

• difficulties in obtaining domestic and foreign export, import and other governmental approvals, permits and licenses and compliance with foreign laws, including employment laws;

• difficulties in staffing and managing foreign operations, including cultural differences in the conduct of business, labor and other workforce requirements;

• transportation delays and difficulties of managing international distribution channels;

• longer payment cycles for, and greater difficulty collecting, accounts receivable;

• trade restrictions, higher tariffs or the imposition of additional regulations relating to import or export of our products;

• unexpected changes in regulatory requirements, royalties and withholding taxes that restrict the repatriation of earnings and effects on our effective income tax rate due to profits generated or lost in foreign countries;

• political and economic instability, including wars, terrorism, political unrest, boycotts, curtailment of trade and other business restrictions; and

• difficulties in obtaining the protections of the intellectual property laws of other countries.

Any of these factors could reduce our net sales, decrease our gross margins or increase our expenses.

Fluctuations in foreign currency exchange rates could harm our results of operations.

We sell a majority of our products in transactions denominated in U.S. dollars; however, we purchase substantially all of our products from our independent manufacturers in transactions denominated in Euros. As a result, if the U.S. dollar were to weaken against the Euro, our cost of sales could increase substantially. We also are exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our consolidated financial statements due to the translation of the operating results and financial position of our Italian subsidiary, Spy Optic, S.r.l., and due to net sales in Canada. For the three months ended March 31, 2004 and 2005, we had an unrealized foreign currency gain of approximately $83,000 and an unrealized loss of approximately $132,000, representing 1% and 2% of our net sales, respectively. As of March 31, 2005, we had purchased a total of 4.1 million Euro foreign currency contracts at an average Euro rate of 1.32 Euro to U.S. dollar.

We may experience conflicts of interest with our significant stockholder, No Fear, Inc., which could harm our other stockholders.

Upon completion of our initial public offering, No Fear, Inc. beneficially owned approximately 14% of our outstanding common stock. As a result of No Fear’s ownership interest, No Fear has the ability to influence who is elected to our board of directors each year and, through those directors, to influence our management, operations and potential significant corporate actions. In addition, as a purchaser of our products, No Fear accounted for approximately $168,000 and $99,000 of our net sales for the three months ended March 31, 2004 and 2005, respectively. No Fear may have interests that conflict with, or are different from, the interests of our other stockholders. These conflicts of interest could include potential competitive business activities, corporate opportunities, indemnity arrangements, registration rights, sales or distributions by No Fear of our common stock and the exercise by No Fear of its ability to influence our management and affairs. Further, this concentration of ownership may discourage, delay or prevent a change of control of our company, which could deprive our other stockholders of an opportunity to receive a premium for their stock as part of a sale of our company, could harm the market price of our common stock and could impede the growth of our company. Our certificate of incorporation does not contain any provisions designed to facilitate resolution of actual or potential conflicts of interest or to ensure that potential business opportunities that may become available to both No Fear and us will be reserved for or made available to us. If these conflicts of interest are not resolved in a manner favorable to our stockholders, our stockholders’ interests may be substantially harmed.

In addition, Mark Simo, the Chairman of our board of directors, serves as the Chief Executive Officer and Chairman of the board of directors of No Fear and owns approximately 31% of No Fear’s outstanding common stock. As a result of his position in No Fear, Mr. Simo may face conflicts of interest in connection with transactions between us and No Fear.

If we fail to secure or protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our net sales or increase our costs.

We rely on patent, trademark, copyright, trade secret and trade dress laws to protect our proprietary rights with respect to product designs, product research and trademarks. Our efforts to protect our intellectual property may not be effective and may be challenged by third parties. Despite our efforts, third parties may have violated and may in the future violate our intellectual property rights. In addition, other parties may independently develop similar or competing technologies. If we fail to protect our proprietary rights adequately, our competitors could imitate our products using processes or technologies developed by us and thereby potentially harm our competitive position and our financial condition. We are also susceptible to injury from parallel trade (i.e., gray markets) and counterfeiting of our products, which could harm our reputation for producing high-quality products from premium materials. Infringement claims and lawsuits likely would be expensive to resolve and would require substantial management time and resources. Any adverse determination in litigation could subject us to the loss of our rights to a particular patent, trademark, copyright or trade secret, could require us to obtain licenses from third parties, could prevent us from manufacturing, selling or using certain aspects of our products or could subject us to substantial liability, any of which would harm our results of operations.

Since we sell our products internationally and are dependent on foreign manufacturing in Italy and China, we also are dependent on the laws of foreign countries to protect our intellectual property. These laws may not protect intellectual property rights to the same extent or in the same manner as the laws of the United States. Although we will continue to devote substantial resources to the establishment and protection of our intellectual property on a worldwide basis, we cannot be certain that these efforts will be successful or that the costs associated with protecting our rights abroad will not be extensive. As of the date of this Annual Report, we have been unable to register Spy as a trademark for our products in a few selected markets in which we do business. In addition, although we have filed applications for federal registration, we have no trademark registrations for Spy for our accessory products currently being sold. We may face significant expenses and liability in connection with the protection of our intellectual property rights both inside and outside of the United States and, if we are unable to successfully protect our intellectual property rights or resolve any conflicts, our results of operations may be harmed.

We may be subject to claims by third parties for alleged infringement of their proprietary rights, which are costly to defend, could require us to pay damages and could limit our ability to use certain technologies in the future.

From time to time, we may receive notices of claims of infringement, misappropriation or misuse of other parties’ proprietary rights. Some of these claims may lead to litigation. Any intellectual property lawsuit, whether or not determined in our favor or settled, could be costly, could harm our reputation and could divert our management from normal business operations. Adverse determinations in litigation could subject us to significant liability and could result in the loss of our proprietary rights. A successful lawsuit against us could also force us to cease sales or to develop redesigned products or brands. In addition, we could be required to seek a license from the holder of the intellectual property to use the infringed technology, and it is possible that we may not be able to obtain a license on reasonable terms, or at all. If we are unable to redesign our products or obtain a license, we may have to discontinue a particular product offering. If we fail to develop a non-infringing technology on a timely basis or to license the infringed technology on acceptable terms, our business, financial condition and results of operations could be harmed.

On March 7, 2005, Oakley, Inc, one of our major competitors, filed a lawsuit alleging patent trade dress and trademark infringement, unfair competition, and false designation of origin. The lawsuit specifically identifies three of our product styles which accounted for less than 4% of our total net sales for 2004. While we believe the lawsuit is without merit and that the ultimate outcome of this proceeding will not have a material adverse effect on our consolidated balance sheet and statements of income and cash flows, litigation is subject to inherent uncertainties.

If we fail to manage any growth that we might experience, our business could be harmed and we may have to incur significant expenditures to address this growth.

We have experienced significant growth, which has placed, and may continue to place, a significant strain on our management and operations. If we continue to experience growth in our operations, our operational and financial systems, procedures and controls may need to be expanded and we may need to train and manage an increasing number of employees, any of which will distract our management team from our business plan and involve increased

expenses. Our future success will depend substantially on the ability of our management team to manage any growth effectively. These challenges may include:

• maintaining our cost structure at an appropriate level based on the net sales we generate;

• implementing and improving our operational and financial systems, procedures and controls;

• managing operations in multiple locations and multiple time zones; and

• ensuring the distribution of our products in a timely manner.

We incur significant expenses as a result of being a public company.

We incur significant legal, accounting, insurance and other expenses as a result of being a public company. The Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the SEC and Nasdaq, have required changes in corporate governance practices of public companies. These new rules and regulations have, and will continue, to increase our legal and financial compliance costs and make some activities more time-consuming and costly. These new rules and regulations have also made, and will continue to make, it more difficult and more expensive for us to obtain director and officer liability insurance.

We may not address successfully problems encountered in connection with any future acquisitions, which could result in operating difficulties and other harmful consequences.

We have obtained an option exercisable through December 2005 to acquire our primary manufacturer, although we have no present intention of exercising such option. We expect to continue to consider other opportunities to acquire or make investments in other technologies, products and businesses that could enhance our capabilities, complement our current products or expand the breadth of our markets or customer base, although we have no specific agreements with respect to potential acquisitions or investments. We have limited experience in acquiring other businesses and technologies. Potential and completed acquisitions and strategic investments involve numerous risks, including:

• problems assimilating the purchased technologies, products or business operations;

• problems maintaining uniform standards, procedures, controls and policies;

• unanticipated costs associated with the acquisition;

• diversion of management’s attention from our core business;

• harm to our existing business relationships with manufacturers and customers;

• risks associated with entering new markets in which we have no or limited prior experience; and

• potential loss of key employees of acquired businesses.

If we fail to properly evaluate and execute acquisitions and strategic investments, our management team may be distracted from our day-to-day operations, our business may be disrupted and our operating results may suffer. In addition, if we finance acquisitions by issuing equity or convertible debt securities, our stockholders would be diluted.

Our eyewear products may subject us to product liability claims, which are expensive to defend and may require us to pay damages.

Due to the nature of our products and the activities in which our products may be used, we may be subject to product liability claims, including claims for serious personal injury. Although we are not involved presently in any product liability claim, successful assertion against us of one or a series of large claims could harm our business.

Risks Related to the Market for Our Common Stock

Our stock price may be volatile, and you may not be able to resell our shares at a profit or at all.

The trading price of our common stock fluctuates due to the factors discussed in this section and elsewhere in this Annual Report. The trading market for our common stock also is influenced by the research and reports that industry or securities analysts publish about us or our industry. If one or more of the analysts who cover us were to publish an unfavorable research report or to downgrade our stock, our stock price likely would decline. If one or more of these analysts were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Fluctuations in our operating results on a quarterly and annual basis could cause the market price of our common stock to decline.

Our operating results fluctuate from quarter to quarter as a result of changes in demand for our products, our effectiveness in managing our suppliers and costs, the timing of the introduction of new products and weather patterns. Historically, we have experienced greater net sales in the second half of the fiscal year as a result of the seasonality of our customers and the markets in which we sell our products, and our first and fourth quarters have traditionally been our weakest operating quarters due to seasonality. We generally sell more of our sunglass products in the first half of the fiscal year and a majority of our goggle products in the last half of the fiscal year. We anticipate that this seasonal impact on our net sales is likely to continue. As a result, our net sales and operating results have fluctuated significantly from period to period in the past and are likely to do so in the future. These fluctuations could cause the market price of our common stock to decline. You should not rely on period-to-period comparisons of our operating results as an indication of our future performance. In future periods, our net sales and results of operations may be below the expectations of analysts and investors, which could cause the market price of our common stock to decline.

Our expense levels in the future will be based, in large part, on our expectations regarding net sales. Many of our expenses are fixed in the short term or are incurred in advance of anticipated sales. We may not be able to decrease our expenses in a timely manner to offset any shortfall of sales.

Future sales of our common stock in the public market could cause our stock price to fall.

Sales of our common stock in the public market, or the perception that such sales might occur, could cause the market price of our common stock to decline. As of April 25, 2005, we have 8,012,483 shares of common stock outstanding and 807,065 shares subject to unexercised options to purchase shares of common stock that are fully vested. Of these outstanding shares, 4,000,000 are eligible for resale and 4,012,483 shares will be available for resale on June 15, 2004 (i.e., following expiration of the lock-up agreements the underwriters entered into with the holders of our common stock in connection with our initial public offering), subject to certain volume limitations. In addition, in connection with our initial public offering, we agreed to issue Roth Capital Partners, LLC, a warrant to purchase up to approximately 147,000 shares of common stock.

Any or all of the shares subject to the lock-up agreements may be released prior to expiration of the 180-day lock-up period at the discretion of Roth Capital Partners, LLC. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our common stock could decline.

Delaware law and our corporate charter and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.

Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

• the establishment of a classified board of directors requiring that not all directors be elected at one time;

• the size of our board of directors can be expanded by resolution of our board of directors;

• any vacancy on our board can be filled by a resolution of our board of directors;

• advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;

• the ability of the board of directors to alter our bylaws without obtaining stockholder approval;

• the ability of the board of directors to issue and designate the rights of, without stockholder approval, up to 5,000,000 shares of preferred stock, which rights could be senior to those of common stock; and

• the elimination of the right of stockholders to call a special meeting of stockholders and to take action by written consent.

In addition, because we reincorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, or Delaware law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. The provisions in our charter, bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future, resulting in the market price being lower than it would without these provisions.

We are party to securities litigation that distracts our management, is expensive to conduct and seeks a damage award against us.

We, our directors and certain of our officers have recently been named as defendants in two stockholder class action lawsuits filed in the United States District Court for the Southern District of California. The complaints purport to seek unspecified damages on behalf of an alleged class of persons who purchased our common stock pursuant to our registration statement we filed in connection with our public offering of stock on December 14, 2005. The complaints allege that we and our officers and directors violated federal securities laws by failing to disclose material information about the status of our European operations and whether certain of our products infringe on the intellectual property rights of Oakley, Inc. in that registration statement. We have not yet formally responded to this action and no discovery has been conducted. However, based on the facts presently known, our management believes we have meritorious defenses to this action and intends to vigorously defend the action. This litigation presents a distraction to our management, and is expensive to conduct. Based of our insurance coverages, our costs related to defending this action could be as high as $250,000. This could negatively affect our operating results.

Item 4. Controls and Procedures

Based on their evaluation as of the end of the period covered by this report, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), our CEO and CFO have concluded that, as of the end of such period, our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”) were effective in timely making known to them material information relating to the Company required to be disclosed in the Company’s reports filed or submitted under the Exchange Act.

During the first fiscal quarter ended March 31, 2005, there was no change in our internal controls over financial reporting identified in connection with the evaluation described above that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

We are beginning the evaluation of our internal controls over financial reporting in order to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires us to evaluate annually the effectiveness of our internal controls over financial reporting as of the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. However, in March 2005, the Securities Exchange Commission postponed the Section 404 requirement for one year for those companies not qualifying as accelerated filers as of June 30, 2005. Inasmuch as we believe we will not be an accelerated filer at that time, we will not have to comply with the Section 404 requirement until our annual report on Form 10-K for the fiscal year ending December 31, 2006.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

See footnote 11 to the financial statements.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

See footnote 10 to the financial statements.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit Number		Description of Document
3.2	*	Restated Certificate of Incorporation of the Company

3.4	*	Amended and Restated Bylaws of the Company

4.1	*	Form of Common Stock Certificate

10.1	+*	Form of Indemnification Agreement between the Company and its officers and directors

10.2	+*	2004 Stock Incentive Plan of the Company

10.3	*	Corporate Services Agreement by and between the Company and No Fear, Inc. dated as of October 1, 2004

10.4	*	Loan and Security Agreement by and between Comerica Bank-California and Spy Optic, Inc. dated as of October 5, 2001

10.5	*	First Amendment to Loan and Security Agreement by and between Comerica Bank-California and Spy Optic, Inc. dated as of July 17, 2002

10.6	*	Second Amendment to Loan and Security Agreement by and between Comerica Bank-California and Spy Optic, Inc. dated as of March 21, 2003

10.7	*	Third Amendment to Loan and Security Agreement by and between Comerica Bank-California and Spy Optic, Inc. dated as of August 14, 2003

10.8	*	Fourth Amendment to Loan and Security Agreement by and between Comerica Bank-California and Spy Optic, Inc. dated as of November 26, 2003

10.9	*	Fifth Amendment to Loan and Security Agreement by and between Comerica Bank-California dated as of December 16, 2003

10.10	*	Sixth Amendment to Loan and Security Agreement by and between Comerica Bank dated as of August 5, 2004

10.11	*	Sublease Agreement by and between Harris Corporation and Spy Optic, Inc. dated as of September 18, 2002

10.12	*	Preliminary Commercial Lease Contract by and among Giudici Stefano, Giudici Sandro and Spy Optic, S.r.l. dated as of March 4, 2003

10.13	*	Limited Exclusive Supply Agreement by and between Spy Optic, Inc. and LEM S.R.L. dated as of November 19, 2004

10.14	+*	Employment Agreement by and between Spy Optic, Inc. and Barry Buchholtz dated as of January 1, 2002

10.15	*	Website Services Agreement by and between the Company and No Fear, Inc. dated December 17, 2004

10.16	*	Premium Dealer Agreement by and between Spy Optic, Inc. and No Fear, Inc. dated as of September 9, 2004

14.1	**	Code of Ethics for Senior Officers

14.2	**	Code of Business Conduct

Exhibit Number		Description of Document
21.1	**	Subsidiaries of the Company.

31.1		Rule 13a-14(a) certification of Chief Executive Officer

31.2		Rule 13a-14(a) certification of Chief Financial Officer

32.1		Statement of Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.§1350)

* Incorporated by reference to exhibits filed with the Company’s Registration Statement on Form S-1 (File No. 333-119024) declared effective by the U.S. Securities and Exchange Commission on December 13, 2004.

** Incorporated by reference to exhibits filed with the Company's Form 10-K dated December 31, 2004.

+ Management contract or compensatory plan or arrangement

(b) Reports on Form 8-K

(1)		On February 18, 2005, the registrant furnished a current report on Form 8-K to report matters under Item 2 and Item 7 of the report in relation to a press release issued by the registrant on February 17, 2005.
(2)		On March 3, 2005, the registrant furnished a current report on Form 8-K to report matters under Item 4 of the report in relation to a letter Nation Smith Hermes Diamond APC to the SEC dated March 3, 2005.
(3)		On March 23, 2005, the registrant furnished a current report on Form 8-K to report matters under Item 8 of the report in relation to a press releases issued by the registrant on March 7, 2005.
(4)		On April 5, 2005, the registrant furnished a current report on Form 8-K to report matters under Item 2 and Item 7 of the report in relation to a press releases issued by the registrant on March 30, 2005.
(5)		On April 20, 2005, the registrant furnished a current report on Form 8-K to report matters under Item 7 of the report in relation to a press releases issued by the registrant on April 14, 2005.

Items 3, 4, and 5 are not applicable and have been omitted.

PART I	FINANCIAL INFORMATION	2
	Item 1. Financial Statements	2
	Consolidated Balance Sheets as of December 31, 2004 and March 31, 2005 (Unaudited)	2
	Consolidated Statements of Operations (Unaudited) for the three month periods ended March 31, 2004 and 2005	3
	Consolidated Statements of Cash Flows (Unaudited) for the three month periods ended March 31, 2004 and 2005	4
	Notes to Unaudited Consolidated Financial Statements	5

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
	Item 3. Quantitative and Qualitative Disclosures About Market Risk	16
	Item 4. Controls and Procedures	25

PART II	OTHER INFORMATION	26
	Item 1. Legal Proceedings	26
	Item 2. Changes in Securities and Use of Proceeds	26
	Item 3. Defaults Upon Senior Securities	27
	Item 4. Submission of Matters to a Vote of Security Holders	27
	Item 5. Other Information	27
	Item 6(a). Exhibits	26
	(b). Reports on Form 8-K	27

Signatures		28

	Orange 21 Inc.

Date: May 16, 2005
	By	/s/ Barry Buchholtz
		Barry Buchholtz
		Chief Executive Officer

Date: May 16, 2005
	By	/s/ Michael Brower
		Michael Brower
		Chief Financial Officer