10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2009

OR

¨ 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)	(I.R.S. Employer Identification No.)
2070 Las Palmas Drive, Carlsbad, CA 92011	(760) 804-8420
(Address of principal executive offices)	(Registrant’s telephone number, including area code)

Securities registered pursuant 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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ¨    No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.    Yes ¨    No x

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.  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ¨    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨	Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨    No x

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant computed by reference to the closing price as reported on the NASDAQ Capital Market on June 30, 2009 was $4,707,000. As of March 19, 2010, there were 11,903,943 shares of Common Stock, par value $0.0001 per share, issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Items 10, 11, 12, 13 and 14 of Part III incorporate by reference information from the registrant’s proxy statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the registrant’s 2010 Annual Meeting of Stockholders.

ORANGE 21 INC. AND SUBSIDIARIES

2009 FORM 10-K

INDEX

PART I		1
	Item 1. Business	1
	Item 1A. Risk Factors	13
	Item 1B. Unresolved Staff Comments	25
	Item 2. Properties	25
	Item 3. Legal Proceedings	25
	Item 4. Reserved	25
PART II		26
	Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	26
	Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
	Item 8. Financial Statements and Supplementary Data	39
	Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure	71
	Item 9A(T). Controls and Procedures	71
	Item 9B. Other Information	72
PART III		73
	Item 10. Directors, Executive Officers and Corporate Governance	73
	Item 11. Executive Compensation	73
	Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	73
	Item 13. Certain Relationships and Related Transactions, Director Independence	73
	Item 14. Principal Accounting Fees and Services	73
PART IV		74
	Item 15. Exhibits, Financial Statement Schedules	74

PART I

Item 1. Business

This Annual Report contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Annual Report.

Although forward-looking statements in this Annual Report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include those described in Item 1A of Part I of this Annual Report under the caption “Risk Factors,” as well as those discussed elsewhere in this Annual Report. Readers are urged not to place undue reliance on forward-looking statements, which speak only as of the date of this Annual Report. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Annual Report. Readers are urged to carefully review and consider the various disclosures made in this Annual Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

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. The information contained in, or that can be accessed through, our website is not a part of this Annual Report. References in this Annual Report to “we,” “our,” “us” and “Orange 21” refer to Orange 21 Inc. and our consolidated subsidiaries, O21NA, O21 Europe and LEM, except where it is made clear that the term means only the parent company.

Overview

We are a multi-branded designer, developer, manufacturer and distributor of premium sunglasses and goggles. We began as a grassroots brand in Southern California and entered the action sports and lifestyle markets with innovative and performance-driven products and an authentic connection to the action sports and lifestyle markets under the Spy Optic^™ brand. We recently entered into a licensing agreement with O’Neill Trademark BV (“O’Neill”) to develop and sell O’Neill^™ branded eyewear in addition to our existing brands, Spy^™ and SpyOptic^™. We have two wholly owned subsidiaries incorporated in Italy, Orange 21 Europe S.r.l. (formerly known as Spy Optic S.r.l., “O21 Europe”) and LEM S.r.l. (“LEM”) (sunglass and goggle manufacturer), and a wholly owned subsidiary incorporated in California, Orange 21 North America (formerly known as Spy Optic, Inc. (“O21NA”), all of which we consolidate in our financial statements. Spy Optic S.r.l. changed its name to Orange 21 Europe effective October 13, 2009. Spy Optic, Inc. changed its name to Orange 21 North America Inc. effective January 11, 2010.

Action Sports Lifestyle Brands

We design, develop and market premium products for the action sports, motorsports, snowsports and lifestyle markets. Our principal products, sunglasses and goggles, are marketed primarily under the brands, Spy^™, SpyOptic^™ and O’Neill^™. These products target the action sport and power sports markets, including surfing, skateboarding, snowboarding, ski and motocross, and the lifestyle market within fashion, music and entertainment. We have built our brands by developing innovative, proprietary products that utilize high-quality materials and optical lens technology to convey performance, style, quality and value. We sell our products in approximately 3,000 retail locations in the United States and Canada and internationally through approximately 3,000 retail locations serviced by our international distributors and us. We have developed strong relationships

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with key multi-store action sport and lifestyle retailers as well as sunglass specialty retailers in the United States, such as Zumiez, Inc., Sunglass Hut, Tilly’s Clothing, Shoes & Accessories, No Fear, Solstice, Totes/Sunglass World, Sun Diego, Industrial Skateboards and a strategically selective collection of specialized individually owned and operated surf, skate, snow and motocross stores.

For the Spy and O’Neill brands, we focus our marketing and sales efforts on the action sports, motorsports, snowsports and lifestyle markets, and specifically, persons ranging in age from 17 to 35. We separate our eyewear products into two groups: sunglasses, which includes fashion, performance sport and women-specific sunglasses, and goggles, which includes snowsport and motocross goggles. In addition, we sell branded sunglass and goggle accessories. In managing our business, we are 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.

Other Lifestyle Brand

In February 2010, we further diversified our brand portfolio by partnering with Jimmy Buffett and his Margaritaville^™ brand for eyewear. Mr. Buffett has developed the Margaritaville into a commercially successful brand platform built around the positioning of island escapism. The Margaritaville brand has developed a strong presence across many categories, including apparel, foods, distilled spirits, beer and party appliances. Brand Margaritaville attracts a diverse consumer base united by their desire to escape to the island lifestyle with Margaritaville products.

Target Markets

Action Sports Lifestyle Brands

We focus our marketing and sales efforts on the action sports, motorsports, snowsports and lifestyle markets, and specifically, persons ranging in age from 17 to 35. Individuals born between approximately 1982 and 2002, more commonly referred to as Generation Y, represent a large sector of this target demographic. Generation Y is a powerful demographic supported by solid growth and spending power. Comprising more than 80 million people within the United States, Generation Y represents the second largest demographic next to the Baby Boomer generation and according to Brand Mercenaries, they spend approximately $200 billion per year and have a major influence on their parent’s spending. We believe this combination of Generation Y’s youth and purchasing power has made it a powerful driver of trends in fashion, music and sports.

We have initially targeted the action sports, motorsports, snowsports and lifestyle markets due to their popularity with Generation Y and the need for premium quality, high performance eyewear in these markets. We believe the nexus between Generation Y and action sports generates tremendous crossover appeal between sport and fashion in our target demographic, members of Generation Y who are seeking premium quality eyewear products. The need for high performance eyewear products within action sports and the influence of the athletes in such action sports has fueled our growth and led to strong appeal for our products and brand recognition. We have leveraged this success into expanding our product lines into fashion forward designs for the lifestyle market.

As the action sports markets have grown and aged, we have broadened our core audience. While these sports were in their infancy 20 + years ago and unknown to many parents, today they are accepted sports that are entering the mainstream. While we market primarily to the younger end of the demographic, many of our customers from a decade ago have stayed with the Spy brand and begun to raise the average age of our customer base.

O’Neill is a well-established brand with a strong global reputation, whose retail demand in many regions is complimentary to that of the Spy brand. Additionally, the O’Neill brand offers a new set of distribution opportunities within our current market sectors, as well as offering new global distribution opportunities.

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Other Lifestyle Brand

Jimmy Buffett and his brand Margaritaville^™ has partnered with us to produce a signature collection of eyewear. Launching in summer 2010, Margaritaville premium eyewear collection will compliment the existing Margaritaville products; essentials and accessories for the perfect tropical escape. Brand Margaritaville targets consumers aged 18 to 55 years with equal participation from men and women.

Business Strategy

Our long-term goal is to capitalize on the strengths of our consumer brands by providing consumers with stylish, high-quality, performance-driven products. We seek to differentiate our brands by offering diverse product lines that emphasize authenticity, functionality, quality and comfort. In pursuit of this goal, we are pursuing the following operating and growth strategies that provide the framework for our future growth, while maintaining the quality and integrity of our brand.

Operating Strategy

• Drive Product Demand Through Premium Quality and Innovative Design.    We believe our reputation for premium quality, innovation and technical leadership distinguishes our products from those of our competitors and provides us with significant competitive advantages. Our sunglasses are forged from materials such as grilamid, propionate and acetate, which we believe are superior to the materials used by many of our competitors. These materials provide product characteristics such as flexible sport frames, more comfortable fashion frames and, in the case of acetate, allow us to hand cut and polish our fashion frames. Our use of hand painting techniques and specialized trims, including metal logos, hinges and temple plates, create unique premium sunglasses and goggles. We intend to continue developing innovative styles and products in order to preserve and strengthen our leadership position as having a progressive action sports, motorsports, snowsports and lifestyle brand.

• Sustain Brand Authenticity.    To sustain the authenticity of our action sports brands, our grassroots marketing programs feature advertising in action sports and lifestyle media at a global level, participation in and sponsorship of events and sponsorship of action sports athletes. Our advertising campaign, found in print media such as Surfer, Transworld Snowboarding and Alliance Wakeboard magazines, fuses athletes, lifestyle, innovative product photography and our unique style. Our approach to event marketing utilizes our Spy^® branded vehicles to showcase our products and athletes at events such as the Eastern Surfing Association, X Games, Wakestock, the U.S. Open of Surfing and the Whistler Ski and Snowboard Festival.

• Actively Manage Retail Relationships.    We manage the retail sales process by monitoring customer sales and inventory levels by product category and style to ensure optimal brand representation and product offerings. Our sales programs, including in-store clinics, point-of-purchase displays and marketing materials, assist our authorized retailers in promoting the authenticity of our brands and products and maximize the implementation of our consumer marketing initiatives. We will continue to develop strategic partnerships with brand enhancing specialty and national retailers that ensure brand authenticity and maximum point of sale opportunities. As a result, we have excellent relationships with our retailers, which enable us to influence the assortments and positioning of our brands at retail.

Growth Strategy

• Expand Domestic Distribution and Brand Recognition Outside of California.    We believe that opportunities exist to increase our sales outside of California by building tight partnerships with our key retailers through brand management, product positioning and managing account expectations for turn and profitability.

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• Expand International Distribution.    We believe significant opportunities exist to increase our sales outside of the United States. To increase the distribution of our products on a global basis, historically we have utilized different distribution models based on the needs for each individual territory. The two current distribution models are Direct and Traditional Distributor.

Direct: This model is currently utilized in five countries (France, Italy, Germany, Austria and United Kingdom). This model emulates the distribution model currently utilized in the United States. We hire a sales force and sell products directly to our dealer network within these countries. This model provides the best opportunity to accelerate growth within these countries, but also requires the most upfront investment to establish the dealer network, sales force and internal infrastructure.

Traditional Distribution: This model is currently utilized in 35 countries. This model allows us to sell products within certain countries without making a substantial investment in that country. Products are sold to an Authorized Distributor in the country who in turn provides all sales, service, marketing and accounting functions for the dealer base within that country. The effectiveness of this model is directly related to the effectiveness of the distribution partners in the relevant markets. We are currently evaluating all partners and making appropriate necessary changes to maximize returns.

We are continuously evaluating alternative distribution models with a view towards increasing our international sales.

• Introduce New Products Under Our Existing Brands, Spy and O’Neill.    We intend to increase our sales by developing and introducing new products under our existing brands that embody our standards of design, performance, value and quality. We have expanded our women’s product line in both the U.S. and international markets. Additionally, we have expanded our handmade products and launched several product lines within the optical prescription eyewear market through our international sales channels. We plan to continue to introduce new eyewear product lines such as fashion and sport-lifestyle frames and product lines with premium lenses and special limited edition collections.

• Continue to Build or Acquire New Brands.    We intend to focus on developing or acquiring new brands that we believe complement our action sports and lifestyle brand. We believe that brand acquisition opportunities currently exist in the action sports and lifestyle markets that would allow us to expand both our product offerings and our target demographics.

Products

We design, develop and market premium eyewear products, apparel and accessories. Our current product matrix consists of seven product categories, including fashion sunglasses, women-specific sunglasses, performance sport sunglasses, snowsport goggles, motocross goggles, accessories and prescription glasses.

Fashion Sunglasses

We currently offer 27 models of fashion sunglass products. The majority of our fashion sunglass frames are constructed of propionate or acetate, which enable us to produce smooth, dense products that are adjustable to the contours of each individual’s face and are very comfortable to wear. We are one of the few brands in the action sports and lifestyle markets to offer high-quality fashion sunglass frames constructed from propionate or acetate. These frames are engineered utilizing a wide variety of unique colorations and color fades that are created and/or polished for a high-gloss finish. The majority of our fashion sunglass frames, including all color fades, are hand painted in Italy and China. We also incorporate adjustable wire-core temples into seven of our

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fashion sunglass products so that our sunglass frames will provide a more custom fit for each individual. In addition, we offer metal sunglass frames and eyewear forged from pliable yet strong monel alloy, a metal compound made from nickel, silver and aluminum. Retail prices for these models range from $70 to $155.

Women-Specific Sunglasses

We currently offer eleven models of women-specific sunglass products. These models are constructed of propionate or acetate, which are engineered utilizing a wide variety of unique colorations and color fades that are polished for a high-gloss finish. Other materials utilized in this product line include grilamid and monel alloy. Retail prices for these models range from $100 to $160.

Performance Sport Sunglasses

We currently offer three Spy^® branded performance sport sunglass products, which are designed to meet the demands of action sports athletes while offering innovative styling. The frames are constructed from injection-molded grilamid, an exceptionally lightweight material that is shatter-resistant and remains pliable in all weather conditions. These models incorporate our patented Scoop airflow technology, contain our ARC lenses and are engineered to incorporate interchangeable lenses. Most models also are available with our Trident polarized lenses and Hytrel rubber on the bridge and temple tips of the frames to prevent slippage. Retail prices for these models range from $90 to $150.

Snowsport Goggles

We currently offer eight models of snowsport goggle products. All of our snowsport goggle models are constructed of injected polyurethane, anti-fog lens construction and Isotron foam, and offer 100% ultraviolet, or UV, protection incorporate our patented Scoop airflow technology. Three of the models utilize our ARC spherical, dual-lens system, one uses our multibase Mosaic^® technology, and the other models utilize cylindrical, dual-pane lens technology. Retail prices for these models range from $40 to $180.

Motocross Goggles

We currently offer five models of motocross goggles. Similar to our line of snowsport goggles, our motocross goggles are constructed of injected polyurethane and incorporate our patented Scoop airflow technology, Isotron foam and polycarbonate hard-coated scratch-resistant lenses. For perspiration absorption, we use either our moisture-wicking Dri-Force fleece, which is bonded to our Isotron foam, or our two-stage Sweat Absorption System. All of the models of motocross goggles utilize our high-quality, anti-fog coating and are compatible with tear-off lens systems. Retail prices for these models range from $30 to $90.

Accessories

We offer a full range of motocross accessories as well as sport sunglass and snowsport goggle lens replacement kits, which enable consumers to interchange the color of lenses in our performance eyewear products to adjust to various light conditions. Retail prices for our accessories range from $18 to $125.

Prescription glasses

We have 12 unisex prescription eyewear frames, made in Italy and China of hand-milled acetate, available only in European countries and retailing for between 170 Euros and 200 Euros.

Sales and Distribution

Our distribution strategy is based on our belief that the integrity and success of our brand is dependent on strategic growth and careful selection of the retail accounts where our products are merchandised and sold. We

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sell our products in approximately 3,000 retail locations in the United States and internationally through approximately 3,000 retail locations serviced by us and our international distributors. Our success at building a strong distribution strategy that focuses on the action sports and lifestyle markets has been critical to developing new channel business and fostering stronger businesses with our current national account partners. The largest growth opportunity for our brands is expanding our presence outside of California and increasing sales into sporting goods, sunglass specialty and optical retailers around the globe. As a result, we intend to focus substantial resources towards growing sales of our products to these types of retail accounts.

Domestic Sales and Distribution

We sell our products to retailers who merchandise our products in a manner consistent with the image of our brands and the quality of our products. We have developed long-term relationships with key multi-store action sport and lifestyle retailers in the United States, such as Zumiez, Inc., Tilly’s Clothing, Shoes & Accessories, Cycle Gear, Inc., Ron Jon Surf Shops and a large collection of action sport retailers that focus on surfing, skateboarding, snowboarding, snow skiing, motocross, wakeboarding and mountain biking. We have entered into dealer arrangements with our retailers; however, these arrangements do not contain minimum purchase commitments and can be terminated by either party at any time. As of December 31, 2009, our domestic sales force consisted of approximately 42 independent, non-exclusive field sales representatives, 16 sub-sales representatives, one vice president of sales, five regional sales directors or managers and 11 internal sales and customer service representatives.

We require our retailers and distributors to maintain specific standards in representing our brands at the point of sale, including minimum inventory levels, point-of-purchase branding, authorized dealer identification and an agreement that ensures store inventory is consistent with our current product collection. Our retailers also must agree not to resell or divert products through unauthorized distribution channels. To preserve and enhance our brand, retailers not adhering to strict guidelines are coached to ensure compliance to such guidelines. Retailers that are not able to comply with such guidelines are eliminated from our authorized dealer network.

We understand that our retail partners represent the connection between our brands and the consumer; therefore, we have focused on building the strongest relationships with all of the top accounts and their senior management, buyers, merchandisers and retail sales staff. Our retail marketing and sales support teams ensure that our sales representatives and retailers have the tools, knowledge and support to sell our products. We provide dealer catalogs, clinic tools, displays, point-of-purchase materials, dealer mailings, sales representative training and an in-house sales support staff to ensure that we focus on all aspects of selling our products and building relationships with our retailers. We also utilize mobile sales support vehicles operated by key sales and marketing representatives. These vehicles effectively promote our brand at regional action sports events and provide a variety of retailer support services, including merchandising and onsite training.

International Sales and Distribution

Our products are currently sold in over 40 countries outside of the United States. Net sales to foreign countries accounted for 30% and 29% of our total net sales for the years ended December 31, 2009 and 2008, respectively. All of our sales, marketing and distribution activities outside of the United States and Canada are currently serviced directly by our wholly owned European subsidiary, O21 Europe, located in Varese, Italy. Our international sales are generated by our direct sales force (France, Italy, Spain, Germany, Austria and United Kingdom) and our international distributors. Our direct sales force consists of 22 independent sales reps and two sales agencies. Our international distributors utilize an independent or hired sales force consisting of over 100 non-exclusive sales representatives in Europe, Middle East and Africa (“EMEA”), Asia Pacific and South American regions. These distributors allow us to ensure that each region is provided with the optimal marketing, sales support and product mix that are complementary to the needs of retailers within their respective territories.

In addition to our traditional distribution model, we utilize another method of international distribution that does not rely exclusively upon our international distributors and their sales representatives. This method of

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international distribution consists of targeting sales territories where product demand is expected to support the establishment of direct operations in such territory, which we refer to as our Dealer Direct program. This program utilizes regional independent or agency sales representatives that provide all on-site retail services, while we provide all marketing, accounting and fulfillment operations. Fulfillment services can be provided by our United States or Italy based distribution centers, depending on the location of the Dealer Direct territory. We have implemented the Dealer Direct program in Canada, Italy, France, Germany, Austria and United Kingdom. We may continue to expand this program in other countries in the future. We are continuously evaluating alternative distribution models with the goal of increasing our international sales.

Promotion and Advertising

All marketing and branding is managed by our in-house staff, which enables us to deliver a targeted, consistent and recognized advertising message. Our commitment to marketing at the grassroots level in the action sports market and the lifestyle market within fashion, music and entertainment is the foundation of the promotion and advertising of our brand and products. We focus our marketing efforts on Generation Y, which we believe is one of the most influential and growing demographics in contemporary culture. We seek to increase our brand’s support and influence within the action sports and lifestyle markets through our athlete sponsorship program, a variety of consumer print advertising campaigns and grassroots marketing initiatives, such as sponsorship of action sports events and promotional vehicle tours.

We employ managers for the surf, snowboard, motocross, ski and wakeboard sectors of the action sports market, each of whom possesses expertise within his or her specific sport. Many of our managers were professional athletes and remain immersed within their specific sports. Our managers are responsible for selecting sponsored athletes, grassroots marketing and event initiatives, maintaining industry relationships and directing print advertising within their segment. We are extremely selective with athlete sponsorship and only sign athletes who we believe are able to influence youth culture on a regional or global level. Some of our athletes include: surfers Dean Morrison and Clay Marzo; snowboarders Eero Niemela, Louie Vito and Louri Podlatchikov; motocross riders Jeremy McGrath and Kevin Windham; wakeboarder Danny Harf and NASCAR driver Dale Earnhardt, Jr.

We sponsor regional and national action sports events and employ a vehicle-marketing program to drive the growth of our brand at trade shows and action sports, music and lifestyle events. Our vehicle marketing program primarily consists of regional sales and marketing vehicles, which we utilize to create a dynamic and unique event experience. We also have given away four Spy^® branded wakeboarding boats in recent years in conjunction with Correct Craft/Air Nautique and several action sports magazines and/or retail store Sports Chalet.

Our advertising campaign fuses athletes, lifestyle, innovative product photography and our unique style. We utilize the exposure generated by our athletes as an editorial endorsement of product performance and style. Major trade magazines, including Transworld Business and Snow Industries of America Daily News, publish special product reports, including reports featuring our products, in conjunction with international and domestic action sports and power sports trade shows. We take advantage of this by strategically timing product releases to coincide with these trade shows and eyewear dealers’ purchasing schedules. We also attend most of the major action sport trade shows in North America, Europe and the Asia/Pacific region to promote our brand and products.

Product Design and Development

• Our products are designed for individuals who embrace the action sports and lifestyle markets. We believe our most valuable input comes from our managers, employees, sponsored athletes and sales representatives who are actively involved in action sports. This connection with the action sports and lifestyle markets continues to be the driving force for the design and performance features of our products and is key to our reputation for innovative and authentic product designs.

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• In order to respond effectively to changing consumer preferences, we attempt to stay abreast of emerging lifestyle and fashion trends in the action sports and lifestyle markets. Our design team constantly monitors regional and global fashion in order to identify trends that may be incorporated into future product designs.

• Every eyewear design starts with a hand-drawn sketch, which is then converted into a computer-rendered technical drawing. The computer-rendered technical drawing is then fabricated into a hand-finished prototype. This prototype is extensively analyzed and measured through laboratory and field-testing to ensure that it reflects the design integrity of the original sketch and that the fit meets our exacting standards. In addition, we often incorporate key changes and improvements for our eyewear through input from our sponsored athletes, sales representatives, managers and employees. Once the prototype is thoroughly tested and optimized, the design is translated into a hand-polished, steel injection-mold or a “tool” for handmade product.

• We differentiate our products from those of our competitors by incorporating innovative designs, advanced optical technology, and premium components and materials. In certain instances, we believe that such innovations have allowed us to grow consumer acceptance of our products with only nominal increases in manufacturing costs. We believe that the substantial experience of our design team will greatly enhance our ability to maintain our position as having one of the leading brands in the action sports and lifestyle markets and to expand the scope of our product lines.

Research and development expenses during the years ended December 31, 2009 and 2008 were approximately $1,145,000 and $1,309,000, respectively.

Product Technologies

Scoop Airflow Technology

Our patented airflow system is referred to as Scoop airflow technology. The Scoop ventilation system forces air through strategically placed vents on goggle and sunglass frames, which reduces pressure and eliminates fogging. Our Scoop technology is protected by four U.S. patents. Currently, we license our Scoop technology to one other sunglass company on a non-exclusive basis. During the years ended December 31, 2009 and 2008, we received approximately $4,000 and $29,000 in royalty revenue from this sunglass company.

Sunglass Lens Technology

Our Accurate Radius Curvature, or ARC, prismatic lenses are utilized in most of our sunglass frames to provide optically correct, distortion-free vision and a total absence of prismatic aberration and astigmatism. Our ARC lens becomes thinner as it moves away from the optical center of the lens, thereby complementing the natural curvature of the human eye to provide clarity at all angles of vision, eliminate distortion and selectively filter out light waves that cause eye fatigue and discomfort. The lens properties, combined with high-quality, vacuum-applied surface coatings, manipulate the light spectrum to ensure maximum visual performance with no distortion. We also offer a number of surface coatings to achieve different lens colors by absorbing and reflecting different wavelengths in the light spectrum. In addition, we integrate filtering agents into our lens manufacturing process to provide eye protection in every type of environment. All of our lenses provide complete UV protection, including UVA, UVB, and UVC energy, and provide powerful protection against the harmful effects of all types of solar radiation.

Some of our products incorporate high-quality injected polarized lenses. Our Trident polarized lenses are designed to diffuse glare through the use of a highly advanced polarizing filter placed between two injected lens layers, allowing incredible clarity even in the harshest conditions and effectively eliminating almost all blinding glare.

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Our Mosaic lens technology combines retro aesthetics with advanced engineered optics. Mosaic features a dynamic lens curvature that closely conforms to the contours of the face with a “multi” base curvature. The entire lens surface has been engineered for superior optical performance.

Snowsport Goggle Technology

• ARC Spherical Goggle Lenses.    Our ARC spherical goggle lenses employ the same technology as our sunglass lenses. Our goggle lenses consist of an integrated dual lens system that enables the inner lens to conform to body temperature and the outer lens to conform to environmental temperature to eliminate fogging of the lenses. The outer lens is a high-density, scratch-resistant injected ARC polycarbonate lens. The thermal spacer between the two lenses consists of an engineered acrylic-based bonding agent and closed-cell foam gasket. The inner lens is made of spherically thermoformed, anti-fog impregnated propionate.

• Isotron Foam.    The interior lining of our snowsport goggles where they make contact with an individual’s face, which we refer to as Isotron foam, is engineered from high-quality, ergonomic thermoformed foam to provide each user with a comfortable, custom fit and a superior seal around his or her face. On several models our Isotron foam is designed to work in conjunction with our Dri-Force fleece to wick moisture away from an individual’s face.

• Mosaic Lens Technology.    During 2008 we introduced this lens technology to goggles with the Apollo snowsports goggle. The Apollo goggle features a Mosaic multi-base snow goggle lens, which has three distinct lens curvatures. The mosaic lens technology permits a vast improvement in peripheral goggle visibility with a minimal frame shape while creating a sleek, yet wide window on the slopes. The mosaic lens has one curvature on the vertical axis like a spherical lens, yet two distinct curvatures on the horizontal axis, one is a large diameter curvature from eye to eye and the other is a tighter radius curvature at the outside of the cheekbones.

Motocross Goggle Technology

• Engineered Visual Optics.    We use polycarbonate hard-coated, scratch-resistant extruded lens material on all of our motocross goggles. All lenses are cut precisely for an exact fit between the lens and the frames. We also impregnate a high-quality anti-fog coating into the internal surface of the lenses on our motocross goggles which cannot be wiped off. The hard coating on the external surface of our lenses is designed to prevent scratching.

• Tear-Offs.    We utilize engineered thin, antistatic, low-haze tear-off lens sheets to be used with our motocross goggles to enable riders to retain a clear field of vision. This ultra-thin material is designed to enable a rider to stack these lens sheets onto the goggle lens and tear them off while riding in order to maintain a clear field of vision without having to wipe off the goggle lens.

• Sweat Absorption System.    We have developed a two-stage moisture-wicking system that absorbs significantly more perspiration than our standard fleece-lined Isotron foam, which we refer to as Sweat Absorption System, or SAS. Our SAS consists of a removable pad which can be replaced at any time to prevent perspiration from entering a user’s eyes. We have obtained a U.S. patent for our SAS two-stage moisture wicking system.

• Isotron Foam.    Our motocross goggles, like our snowboard goggles, utilize our Isotron foam to create a comfortable, ergonomic fit and superior seal around an individual’s face. Our Alloy SAS model utilizes our Dri-Force fleece, which is bonded to single density Isotron foam, and is designed to be used with our two-stage Sweat Absorption System. All of our motocross goggles also utilize high-density filter foam which is designed to prevent dust and dirt from entering the rider’s field of vision and to enhance air circulation to minimize fogging of the lens.

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• Selectron Removable Foam System.    The professional models of our Magneto motocross goggle feature patent pending Selectron foam, a completely removable and replaceable face-foam system. The idea behind Selectron is to allow riders to pick the foam that best meets their fit needs. In addition, it enables riders to replace old, sweat-saturated foam with a fresh part.

Manufacturing

We manufacture a majority of our sunglass products through our wholly owned Italian subsidiary, LEM. Currently, approximately 60% and 40% of LEM’s manufacturing capacity is allocated to intercompany and third party sales, respectively.

Our sunglass manufacturing process begins with fabrication of the eyewear frames. The final mold for each model of our eyewear products is injected with intensely heated materials, such as grilamid or propionate. The components of each frame are then placed in a wood chip or ceramic chip tumbling machine for up to 48 hours to ensure that every frame piece is completely smooth without any imperfections. After the tumbling process, the frames are washed in high-speed ultra-sonic vibration machines to ensure that each piece is completely clean and dust-free prior to the extensive inspections, polish and painting process.

Our highly specialized painting process includes up to five layers of paint; substantially all of which are applied by hand. Each of these layers includes an elaborate, multi-day painting, drying and curing process. We also hand set all of our polished metal logos and accents. Our lenses are cut and inserted into frames with exacting standards. The machinery used to cut each lens ensures that our products will perform to the highest optical standards.

Once the assembly process is completed, we test all of our products for optical clarity based on United States, European and Australian standards. The American National Standards Institute and the American Society for Testing and Materials have established specific testing criteria for eyewear. These tests analyze product safety and provide quantitative measure of optical quality, UV protection, light transmission and impact resistance. In addition, we perform a broad range of eyewear durability testing and mechanical integrity testing that includes extremes of UV, heat, condensation and humidity. Our testing process also utilizes a laser-based lens testing technique to ensure that our lenses meet a variety of optical distortion standards. After lens testing, each product is inspected for paint quality, fit, finish and overall appearance.

Our goggle frames are manufactured by third party factories. Our goggle manufacturing process begins with the fabrication of the goggle frame. The final mold for each goggle model is injected with intensely heated polyurethane. The frame components are then carefully washed using specialized cleaning processes that ensure secure paint adherence. After cleaning, each frame is subjected to our extensive painting process, which can include up to four layers of paint and often includes a specialized method of printing custom paint designs. Several key components of our products are assembled using overmolding or a sonic welding process to ensure a secure bond between materials, and all of our metal logos and details are hand painted and set into the frame. All of our goggles utilize what we believe to be the highest quality materials and components from the most reputable suppliers in the industry. Our lenses are carefully assembled using specialized machinery designed to ensure strict anti-fogging lens performance.

Once the assembly process is completed, we test our goggles to ensure they meet and exceed all international directives for goggle safety and performance. These directives analyze product safety by testing for optical clarity, impact resistance, anti-fog protection, light transmission, UV protection and quality of frame materials. In addition to independent laboratory testing, we perform extensive testing at each of our manufacturers, including analyzing our goggles for product strength, wear and accelerated weather testing. Prior to shipment, each goggle is inspected for paint quality, fit, finish and overall appearance.

Each of our apparel and accessory manufacturers is carefully selected based upon quality standards, manufacturing methods and ability to produce custom designed products. All apparel and accessories are

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manufactured to exacting standards and specifications using high-quality materials. Treatments and fits are carefully inspected upon receipt, and products that do not fall within our specification sheets are rejected. To ensure quality, we require our manufacturers to source specific materials.

Customers

Our products are currently sold in the United States, Canada and in 40 other countries around the world. Our customer base reflects our heritage and influence across the action sports and lifestyle markets and a distribution strategy which focuses on action sport and lifestyle retailers. Our net sales are spread over a large customer base. No single customer or group of related customers accounted for more than 10% of our net sales during each of the years ended December 31, 2009 and 2008.

Government Regulation

Our products are subject to governmental health safety regulations in most countries where they are sold, including the United States and the European Union, as well as import duties and tariffs on products being imported into countries outside of the United States. In addition, we are subject to various state and federal regulations generally applicable to similar businesses. We regularly inspect our production techniques and standards to ensure compliance with applicable requirements.

Intellectual Property

We use a combination of patent, trademark, copyright, trade secret and trade dress laws, as well as confidentiality agreements, to aggressively protect our intellectual property, including product designs, product research and development and recognized trademarks. We have six U.S. utility patents with respect to our products as follows: one regarding our sports goggle (expires in 2022); four regarding our Scoop airflow technology (expire between 2012 and 2015); and one regarding our screen for eye protection goggles (expires 2025). We have 31 U.S. design patents with respect to our products as follows: 27 regarding our sunglasses (expire between 2010 and 2023); one regarding one of our goggles (expires in 2013); two regarding certain of our sunglass cases (expire in 2011); and one regarding our eyewear retail display case (expires in 2010). We are continuing to file patent applications on our inventions that are significant to our business and pursue significant trademarks where applicable.

Our registered trademarks include: Spy, SpyOptic, EyeSpy, Windows For Your Head, Scoop, Delta Photochromic, Dri-Force, ARC, a “trident” design, Plus System, Gemini, Mosaic, Prodigus Metal Alloy, Zed, Haymaker, Selectron, Double Decker, Hielo, Logan, HSX, MC2, Decker, Viente, a “triangle with cross” design, a “cross with bar” design, and three “cross” designs; and our unregistered or pending marks include, but are not limited to: Spy (various), and Dirty Mo. We actively combat counterfeiting through monitoring of the global marketplace. We utilize our employees, sales representatives, distributors and retailers to police against infringing products by encouraging them to notify us of any suspect products, confiscating counterfeit products and assisting law enforcement agencies. Our sales representatives are also educated on our patents and trade dress and assist in preventing potentially infringing products from obtaining retail shelf space.

Environmental Matters

We use numerous chemicals and generate other hazardous by-products in our manufacturing operations. As a result, we are subject to a broad range of foreign environmental laws and regulations. These environmental laws govern, among other things, air emissions, wastewater discharges and the acquisition, handling, use, storage and release of wastes and hazardous substances. Such laws and regulations can be complex and change often. Remediation of chemicals or other hazardous by-products could require substantial resources which could reduce our cash available for operations, consume valuable management time, reduce our profits or impair our financial condition.

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Contaminants have been detected at some of our present facilities in Italy. Remediation efforts for such contaminants included the purchase and installation of new paint booths and related equipment, which are nearly complete. Costs related to the remediation efforts during the years ended December 31, 2009 and 2008 included approximately 499,000 Euros and 57,000 Euros, respectively, for machinery and equipment capitalized on the balance sheet under property, plant and equipment, of which 358,000 Euros was purchased through a capital lease during 2009. In addition, we incurred approximately 5,000 Euros for environmental analysis costs, maintenance, spare parts and installation during each of the years ended December 31, 2009 and 2008. We do not expect to incur any further material amounts related to such remediation efforts and expect to be completed by April 30, 2010.

Competition

Action Sports and Lifestyle Brands (Spy, Spy Optic and O’Neill)

We compete with sunglass and goggle brands in various niches of the action sports market including Dragon Optical, Fox, Anon Optics, Von Zipper, Electric Visual, Arnette, Oakley, Scott and Smith Optics. We also compete with broader lifestyle brands that offer eyewear products, such as Quiksilver. In both markets, we compete primarily on the basis of design, performance, price, value, quality, brand name, marketing and distribution.

We also compete in the broader fashion sunglass sector of the eyewear market, which is fragmented and highly competitive. The major competitive factors in this sector of the market include fashion trends, brand recognition, distribution channels and the number and range of products offered. We compete with a number of brands in this sector of the market, including Armani, Christian Dior, Dolce & Gabbana, Gucci, Prada, and Versace.

Other Lifestyle Brands (Margaritaville)

We believe Margaritaville will compete with other lifestyle brands.

We believe that our principal competitive advantages are quality, design, performance, brand name and value. We believe that many of our competitors enjoy significantly greater financial resources than we have, which enables them to promote their products more heavily than we can. Also, many of our competitors have greater brand recognition, a longer operating history and more comprehensive product lines than us.

Segments

We focus our business on two geographic segments: North America (including the U.S. and Canada) and foreign, and operate in two business segments: distribution and manufacturing. See Note 16 “Operating Segments and Geographic Information,” to our Consolidated Financial Statements for a further description of these segments.

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 and third quarters of the fiscal year as a result of the seasonality of our products and the markets in which we sell our products, and our first and fourth fiscal 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 will 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.

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Employees

As of December 31, 2009, O21NA and O21 Europe employed 83 full-time employees and two part-time employees, including 75 employees in the United States and 10 employees in the rest of the world. This aggregate number of employees consists of 33 in sales and marketing, 21 in general and administration, three in research and development and 28 in manufacturing support and fulfillment operations. We have never had a work stoppage. As of December 31, 2009, LEM also had 105 full-time employees. We consider our employee relations to be good.

Item 1A. Risk Factors

Risks Related to Our Business

You should consider each of the following factors as well as the other information in this Annual Report in evaluating our business and our prospects. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business and financial results could be harmed. In that case, the trading price of our common stock could decline. You should also refer to the other information set forth in this Annual Report, including our financial statements and the related notes.

Economic conditions and the resulting decline in consumer spending could continue to adversely affect our business and financial performance.

Our performance depends on general economic conditions and their impact on consumer confidence and discretionary consumer spending, which have deteriorated significantly over the past several months and may remain depressed for the foreseeable future. Our business and financial performance, including our sales and the collection of our accounts receivable, may continue to be adversely affected by the current weakness and any future weakness in economic activity and consumer spending in the United States or in other regions of the world in which we do business. Further, economic factors such as a reduction in the availability of credit, increased or continuing unemployment levels, higher fuel and energy costs, rising interest rates, adverse conditions in the housing markets, financial market volatility, recession, reduced consumer confidence, savings rates, acts of terrorism, major epidemics (including H1N1 and other influenzas) and other factors affecting consumer spending behavior could adversely affect demand for our products. If consumer spending fails to increase, we will not be able to improve our sales. In addition, reduced consumer spending may cause us to lower prices or suffer increases in product returns, which would have a negative impact on gross profit.

Current economic conditions could adversely impact our liquidity and our ability to obtain financing, including counterparty risk.

On February 26, 2007, O21NA entered into a Loan and Security Agreement (the “Loan Agreement”) with BFI Business Finance (“BFI”) with a maximum borrowing capacity of $5.0 million, which was extended to $8.0 million. In addition, effective March 23, 2010, we entered into a $3.0 million Promissory Note with Costa Brava Partnership III, L.P. (“Costa Brava”). The Chairman of our Board of Directors, Seth Hamot, is the President and sole member of Roark, Rearden & Hamot, LLC, which is the sole general partner of Costa Brava. The Promissory Note is subordinated to our Loan Agreement with BFI. The proceeds from the Note are expected to be used (i) to prepay the current balance on our revolving line of credit balance with BFI in its entirety and (ii) if any proceeds remain after such prepayment, for working capital purposes. However, we may continue to re-borrow from BFI under the Loan Agreement after such prepayment is made.

We rely on this credit line with BFI and other credit arrangements to fund working capital needs. The recent unprecedented disruptions in the credit and financial markets and resulting decline in general economic and business conditions may adversely impact our access to capital through our credit line and other sources.

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Under the terms of our Loan Agreement, BFI may reduce our borrowing availability in certain circumstances, including, without limitation, if in its reasonable business judgment our creditworthiness, sales or the liquidation value of our inventory have declined materially. Further, the Loan Agreement provides that BFI may declare us in default if we experience a material adverse change in our business or financial condition or if BFI determines that our ability to perform under the Loan Agreement is materially impaired.

In addition, we have a 0.6 million Euros line of credit in Italy with San Paolo IMI for LEM, which was reduced from 1.3 million Euros during 2009. We rely on this line of credit to fund working capital needs at LEM. Under the terms of this line of credit, San Paolo may further reduce the line of credit at its discretion.

The current economic environment could cause lenders to fail to extend credit to us, which would have an immediate and substantial adverse impact on our business, financial condition or results of operations. Also, if we require additional financing as a result of the foregoing or other factors, the capital markets turmoil could negatively impact our ability to obtain such financing. Our access to additional financing will depend on a variety of factors (many of which we have little or no control over) such as market conditions, the general availability of credit, the overall availability of credit to our industry, our credit ratings and credit capacity, as well as the possibility that lenders could develop a negative perception of our long-term or short-term financial prospects.

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 a substantial portion of our products from our manufacturers in transactions denominated in Euros. As a result, the weakening of the U.S. Dollar during 2008 and 2009 caused our cost of sales to increase substantially. If the U.S. Dollar further weakens against the Euro in the future, our cost of sales could further increase. We are also 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 subsidiaries O21 Europe and LEM, and due to net sales in Canada. Between January 1, 2008 and March 22, 2010, the Euro exchange rate has ranged from U.S. $1.23 to U.S. $1.60. Between January 1, 2008 and March 22, 2010, the Canadian Dollar exchange rate has ranged from U.S. $0.77 to U.S. $1.03. For the years ended December 31, 2009 and 2008, we had a net foreign currency gain and a net foreign currency loss of $0.3 million and $0.1 million, respectively, which represented approximately one percent and zero percent of our net sales, respectively.

The effect of foreign exchange rates on our financial results can be significant. Therefore we have engaged in the past, and may in the future engage in, certain hedging activities to mitigate over time the impact of the translation of foreign currencies on our financial results. Our hedging activities have in the past reduced, but have not eliminated, the effects of foreign currency fluctuations. Factors that could impact the effectiveness of our hedging activities include the volatility of currency markets and the availability of hedging instruments. The degree to which our financial results are affected has depended in part upon the effectiveness of our hedging activities. As of December 31, 2009, we were not engaged in any foreign currency hedging activities.

We have a history of significant losses. If we do not achieve or sustain profitability, our financial condition and stock price could suffer.

We have a history of losses and we may continue to incur losses for the foreseeable future. As of December 31, 2009, our accumulated deficit was $35.9 million and, during the year ended December 31, 2009, we incurred a net loss of $3.4 million. We have not achieved profitability for a full fiscal year since our initial public offering. If we are unable to maintain or grow our revenues, or if we are unable to reduce operating expenses sufficiently, we may not be able to achieve full fiscal year profitability in the near future or at all. Even if we do achieve full fiscal year profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If we are unable to achieve full fiscal year profitability within a short period of time, or at all, or if we are unable to sustain profitability at satisfactory levels, our financial condition and stock price could be adversely affected.

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Our future capital needs are uncertain, and we may need to raise additional funds in the future which may not be available on acceptable terms or at all.

Our capital requirements will depend on many factors, including:

• acceptance of, and demand for our products;

• the costs of developing and selling new products;

• the extent to which we invest in new equipment and product development;

• the number and timing of acquisitions and other strategic transactions;

• the costs associated with the growth of our business, if any; and

• our ability to realize additional savings through streamlining our operations.

Although we believe we have sufficient funds to operate our business over the next twelve months, our existing sources of cash and cash flows may not be sufficient to fund our activities. As a result, we may need to raise additional funds, and such funds may not be available on favorable terms, or at all, particularly given current economic conditions and the recent turmoil in the capital markets. Furthermore, if we issue equity or convertible debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences, and privileges senior to those of our existing stockholders. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization. If we cannot raise funds on acceptable terms, we may need to scale back our expenditures and we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities, or respond to competitive pressures.

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

The action sports and 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 brand. 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 lifestyle markets in which we compete are intensely competitive. We compete with sunglass and goggle brands in various niches of the action sports market including Anon Optics, Arnette, Dragon Optical, Electric Visual, Fox, Oakley, Scott, Smith Optics and Von Zipper. We also compete with broader lifestyle brands that offer eyewear products, such as 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 brands such as Armani, Christian Dior, Dolce & Gabbana, Gucci, Prada and Versace. We expect that our Margaritaville eyewear will compete with other lifestyle brands. In all markets, we compete primarily on the basis of fashion trends, design, performance, value, quality, brand recognition, marketing and distribution channels.

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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 Spy and O’Neill brands by persons ranging in age from 17 to 35 and of our Margaritaville brand by persons ranging from 18 to 55 is essential to our future success. Accordingly, we intend to continue an aggressive brand strategy through a variety of marketing techniques designed to foster an authentic action sports and lifestyle company culture, including athlete sponsorship, sponsorship of surfing, snowboarding, skateboarding, wakeboarding, and motocross events, vehicle marketing, internet and print media, action sports industry relationships, sponsorship of concerts and music festivals and celebrity endorsements. If we are unsuccessful, these expenses may never be offset, and we may be unable to maintain or increase net sales. Successful positioning of our brand depends largely on:

• the success of our advertising and promotional efforts;

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

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

• managing the recognition and perception of our various brands.

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 or may decline.

If we fail to develop new products that are received favorably by our target customer audience, our business may suffer.

We are continuously evaluating potential entries into or expansion of new product offerings. In expanding our product offerings, we intend to leverage our sales and marketing platform and customer base to develop these opportunities. While we have generally 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 and research and development 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 brands;

• establish awareness of any new brands we may introduce or acquire;

• increase customer demand for our existing products and establish customer demand for any new product offering;

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• 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 develop are not received favorably by consumers, our reputation and the value of our brand could be damaged. The lack of market acceptance of new products we develop or our inability to generate satisfactory net sales from any new products to offset their cost could harm our business.

Substantially all of our assets are pledged to secure obligations under our outstanding indebtedness.

O21NA granted a security interest in substantially all of its assets to BFI as security for its obligations under the Loan Agreement. O21NA also established a bank account in BFI’s name into which collections on accounts receivable and other collateral are deposited (the “Collateral Account”). Pursuant to the deposit control account agreement between O21NA and BFI with respect to the Collateral Account, BFI is entitled to sweep all amounts deposited into the Collateral Account and apply the funds to outstanding obligations under the Loan Agreement; provided that BFI is required to distribute to O21NA any amounts remaining after payment of all amounts due under the Loan Agreement. Additionally, Orange 21 Inc. guaranteed O21NA’s obligations under the Loan Agreement and granted BFI a blanket security interest in substantially all of its assets as security for its obligations under its guaranty.

If O21NA defaults on any of its obligations under the Loan Agreement, BFI will be entitled to exercise its remedies under the Loan Agreement and applicable law, which could harm our results of operations and reputation. Additionally, our Promissory Note with Costa Brava is subordinated to our Loan Agreement with BFI. Pursuant to the terms of a Debt Subordination Agreement, by and between Costa Brava and BFI, Costa Brava has the option to purchase the outstanding amount under the BFI Loan Agreement. Specifically, the remedies available to BFI include, without limitation, increasing the applicable interest rate on all amounts outstanding under the Loan Agreement, declaring all amounts under the Loan Agreement immediately due and payable, assuming control of the Collateral Account or any other assets pledged by O21NA or Orange 21 Inc. and directing our customers to make payments directly to BFI. Our results of operations and reputation may be harmed by BFI’s exercise of its remedies.

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 brands’ 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.

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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, including our subsidiary LEM, to manufacture our products is dependent in substantial part, upon the availability of raw materials used in the fabrication of sunglasses and goggles. 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. Our manufacturers, including LEM, have experienced in the past, and may experience in the future, shortages of raw materials and other production delays, which have resulted in, and may in the future result in, delays in deliveries of our products of up to several months. In addition, LEM provides manufacturing services to other companies under supply agreements. The inability of LEM and our other suppliers to manufacture and ship products in a timely manner could result in breaches of the agreements with our customers, which could harm our results of operations, reputation and demand for our products.

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 brand. We believe that our future success is significantly dependent on the contributions of A. Stone Douglass, who became our Chief Executive Officer in October 2008 and our acting Chief Financial Officer in February 2010, as well as Stefano Lodigiani, our General Manager of LEM and Director of Operations, Italy and our Vice President of Sales, Erik Darby. The loss of the services of Mr. Douglass, Mr. Lodigiani or Mr. Darby would be 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 currently have key man insurance on Mr. Douglass or Mr. Darby. We do carry key man life insurance on Mr. Lodigiani for $1.0 million. If our management team is unable to execute on our business strategy, our business may be harmed, which could adversely impact our branding strategy, product development strategy and 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 brand and adversely impact our business.

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

We purchase a substantial amount of our sunglass products from LEM and substantially all of our goggle products are manufactured by OGK in China. We expect to continue to manufacture substantially all of our

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goggles through OGK in 2010. We do not have long-term agreements with any of our manufacturers other than LEM. We cannot be certain that we will not experience difficulties with our 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. Many of our manufacturers have extended credit to us and there can be no assurances that they will continue to do so on commercially reasonable terms or at all. If our relationship with any of our manufacturers is interrupted or terminated for any reason, including the failure of any manufacturer to perform its obligations to us, we would need to locate alternative manufacturing sources. The establishment of new manufacturing relationships involves numerous uncertainties, and we may not 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 and delays in the manufacture and shipment of our products and a loss of net sales.

Any failure to maintain ongoing sales through our independent sales representatives or maintain our international distributor relationships could harm our business.

We sell our products to retail locations in the United States and internationally through retail locations serviced by us through our direct sales team and a network of independent sales representatives in the United States, and through our international distributors. We rely on these independent sales representatives and distributors 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. We do not have long-term agreements with all of our international distributors. 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 and our international distributors. It is possible that we may not be able to maintain or expand these relationships successfully or secure agreements with additional sales representatives or distributors on commercially reasonable terms, or at all. Any failure to develop and maintain our relationships with our independent sales representatives or our international distributors, and any failure of our independent sales representatives or international distributors 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 sales and administration operations as well as some of our manufacturers are located in Italy. 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 and regulatory 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;

• ability to finance our foreign operations;

• fluctuations in currency exchange rates;

• ability to finance our foreign operations;

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• 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 effect 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.

If we fail to secure or protect our intellectual property rights, or upon expiration of 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 U.S. 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 significant. 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

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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.

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.

If we 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.

Our eyewear products and business may subject us to product liability claims or other litigation, which are expensive to defend, distracting to our management 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 or other litigation, including claims for serious personal injury, breach of contract, shareholder litigation or other litigation. Successful assertion against us of one or a series of large claims could harm our business by causing us to incur legal fees, distracting our management or causing us to pay damage awards.

We could incur substantial costs to comply with foreign environmental laws, and violations of such laws may increase our costs or require us to change certain business practices.

We use numerous chemicals and generate other hazardous by-products in our manufacturing operations. As a result, we are subject to a broad range of foreign environmental laws and regulations. These environmental laws govern, among other things, air emissions, wastewater discharges and the acquisition, handling, use, storage and release of wastes and hazardous substances. Such laws and regulations can be complex and change often. Remediation of chemicals or other hazardous by-products could require substantial resources which could reduce our cash available for operations, consume valuable management time, reduce our profits or impair our financial condition.

For example, contaminants have been detected at some of our present facilities in Italy. Remediation efforts for such contaminants included the purchase and installation of new paint booths and related equipment, which are nearly complete. Costs related to the remediation efforts during the years ended December 31, 2009 and 2008 included approximately 499,000 Euros and 57,000 Euros, respectively, for machinery and equipment capitalized on the balance sheet under property, plant and equipment, of which 358,000 Euros was purchased through a capital lease during 2009. In addition, we incurred approximately 5,000 Euros for environmental analysis costs, maintenance, spare parts and installation during each of the years ended December 31, 2009 and 2008. We do not expect to incur any further material amounts related to such remediation efforts and expect to be completed by April 30, 2010. However, it is possible that we could incur additional costs in the future related to U.S. and foreign environmental laws.

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In the event we are unable to remedy any deficiency we identify in our system of internal controls over financial reporting, or if our internal controls are not effective, our business and our stock price could suffer.

Under Section 404 of the Sarbanes-Oxley Act, or Section 404, management is required to assess the adequacy of our internal controls, remediate any deficiency that may be identified for which there are no compensating controls in place, validate that controls are functioning as documented and implement a continuous reporting and improvement process for internal controls. As part of this continuous process, we may discover deficiencies that require us to improve our procedures, processes and systems in order to ensure that our internal controls are adequate and effective and that we are in compliance with the requirements of Section 404. If any deficiency we may find from time to time is not adequately addressed, or if we are unable to complete all of our testing and any remediation in time for compliance with the requirements of Section 404 and the SEC rules thereunder, we would be unable to conclude that our internal controls over financial reporting are effective, which could adversely affect investor confidence in our internal controls over financial reporting.

We may not successfully integrate any future acquisitions, which could result in operating difficulties and other harmful consequences.

We expect to consider opportunities to acquire or make investments in other technologies, products and businesses from time to time 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 or managing various different brands;

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

• unanticipated costs associated with the acquisition;

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

• inability to generate sufficient revenues to offset acquisition startup costs;

• 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.

Acquisitions also frequently result in the recording of goodwill and other intangible assets which are subject to potential impairments that could harm our financial results. 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.

We will be unable to compete effectively if we fail to anticipate product opportunities based upon emerging technologies and standards and fail to develop products and solutions that incorporate these technologies and standards in a timely manner.

To date, we have introduced various sunglass and goggle products developed around various technologies and standards and we may spend significant time and money on research and development to design and develop

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products around any new emerging technologies or industry standards. If an emerging technology or industry standard that we have identified fails to achieve broad market acceptance in our target markets, we may be unable to generate significant revenue from our research and development efforts. Moreover, even if we are able to develop products using adopted standards, our products may not be accepted in our target markets. As a result, our business would be materially harmed.

We have limited experience in designing and developing products that support new technologies or industry standards. If our competitors move away from the use technologies or industry standards that we support with our products and adopt alternative technologies and standards, we may be unable to design and develop new products that conform to these new technologies and standards. The expertise required is unique to each technology and industry standard, and we would have to either hire individuals with the required expertise or acquire such expertise through a licensing arrangement or by other means. The demand for individuals with the necessary expertise to develop a product relating to a particular technology or industry standard is generally high, and we may not be able to hire such individuals. The cost to acquire such expertise through licensing or other means may be high and such arrangements may not be possible in a timely manner, if at all.

Risks Related to the Market for Our Common Stock

Our common stock now trades on the over-the-counter market, which may impact the liquidity of our common stock and our ability to raise additional capital.

Until March 25, 2010, our common stock was quoted on the NASDAQ Capital Market. On September 16, 2009, we received a notice from NASDAQ indicating that, for the preceding 30 consecutive business days, the bid price of our common stock had closed below the $1.00 minimum bid price required for continued listing on the NASDAQ Capital Market under Marketplace Rule 5550(a)(2). Pursuant to Marketplace Rule 5810(c)(3)(A), we had 180 calendar days from the date of the notice, or until March 15, 2010, to regain compliance with the minimum bid price rule. On March 16, 2010, we received a letter from NASDAQ indicating that we had not regained compliance with the Rule and are not eligible for an additional 180 day compliance period. Accordingly, our securities were delisted from the NASDAQ Capital Market on March 25, 2010. We expect our common stock to be traded on the over-the-counter market.

The trading market for our common stock is limited and an active trading market may not develop. Selling our common stock may be difficult because the limited trading market for our shares on the over-the-counter market could result in lower prices and larger spreads in the bid and ask prices of our shares, as well as lower trading volume. In addition, our ability to raise additional capital may be significantly limited as a result of our delisting from the NASDAQ Capital Market. We could face other significant material adverse consequences, including the following:

• a limited availability of market quotations for our common stock;

• a reduced amount of news and analyst coverage of us;

• a decreased ability to issue additional securities or obtain additional financing in the future;

• reduced liquidity for our stockholders;

• increased volatility of our stock price;

• potential loss of confidence by collaboration partners and employees; and

• loss of institutional investor interest and fewer business development opportunities.

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In addition, our stock may be defined as a “penny stock” under Rule 3a51-1 under the Exchange Act. “Penny stocks” are subject to Rule 15g-9, which imposes additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell our common stock and affect the ability of holders to sell their shares of our common stock in the secondary market. To the extent our common stock is subject to the penny stock regulations, the market liquidity for the shares will be adversely affected.

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 report. For example, between January 1, 2008 and February 25, 2010, our stock has traded as high as $5.00 and as low as $0.41. In addition, the trading market for our common stock may be influenced by the public float that exists in our stock from time to time. For example, although as of February 25, 2010 we have approximately 11.9 million shares outstanding, approximately 8.7 million, or approximately 73%, of those shares are held by 10 stockholders. If any of those investors were to decide to sell a substantial portion of their respective shares, it would place substantial downward pressure on our stock price. We also have 1,484,125 shares of our common stock reserved for the exercise of outstanding stock options, of which 553,416 were fully vested and exercisable as of December 31, 2009. Additionally, in connection with our initial public offering, we issued warrants to purchase up to 147,000 shares of common stock to Roth Capital Partners, LLC, and an affiliate, which are fully vested as of December 31, 2009. All 11,903,943 of our outstanding shares of common stock at February 25, 2010 may be sold in the open market, subject to certain limitations.

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 and third quarters of the fiscal year as a result of the seasonality of our products and the markets in which we sell our products, and our first and fourth fiscal 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 will 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 and based on acquisitions we may complete. 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.

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Because of their significant stock ownership, some of our existing stockholders are able to exert control over us and our significant corporate decisions.

Four of our stockholders and affiliates control over 60% of our outstanding capital stock. Directors Seth Hamot and John Pound have direct or indirect control over approximately 48% of our capital stock, and our current executive officers, directors and their affiliates own or control, in the aggregate, approximately 52% of our outstanding common stock. These stockholders are able to exercise influence over matters requiring stockholder approval, such as the election of directors and the approval of significant corporate transactions, including transactions involving an actual or potential change of control of the company or other transactions that non-controlling stockholders may not deem to be in their best interests. This concentration of ownership may harm the market price of our common stock by, among other things:

• delaying, deferring, or preventing a change in control of our company;

• impeding a merger, consolidation, takeover, or other business combination involving our company;

• causing us to enter into transactions or agreements that are not in the best interests of all stockholders; or

• discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company.

Item 1B. Unresolved Staff Comments

None

Item 2. Properties

Our corporate headquarters totals 30,556 square feet and is located in Carlsbad, California. Our current monthly rent for this facility is approximately $38,000 per month, which we lease on a month to month basis. We also lease one building in Varese, Italy totaling approximately 9,000 square feet with monthly lease payments of approximately $5,000. These facilities are used for international sales and distribution and the lease expires in June 2010; however, we have an option to terminate this lease upon six months’ notice. Additionally, our subsidiary LEM leases three buildings in Italy totaling approximately 29,000 square feet with monthly lease payments of approximately $26,000. These facilities are used for office space, warehousing and manufacturing and the leases expire between March 2010 and March 2011.

We believe our facilities are adequate for our current needs and that suitable additional or substitute space will be available to accommodate foreseeable expansion of our operations or to move our operations in the event one or more of our leases can no longer be renewed on commercially reasonable terms.

Item 3. Legal Proceedings

From time to time we may be party to lawsuits in the ordinary course of business. We are not currently a party to any material legal proceedings.

Item 4. Reserved

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Principal Market and Holders

Our common stock, par value $0.0001, was traded on the NASDAQ Capital Market under the symbol “ORNG” until March 25, 2010 when we were delisted as a result of noncompliance with NASDAQ Listing Rules. Our common stock is now traded in the over-the-counter market. At March 19, 2010, there were 73 stockholders of record of our common stock. Many of the holders are brokers and other institutions on behalf of stockholders; therefore, we are unable to estimate the total number of beneficial owners represented by these stockholders of record.

Dividends

We have never declared or paid any cash dividend on our common stock, nor do we currently intend to pay any cash dividend on our common stock in the foreseeable future. We expect to retain our earnings, if any, for the growth and development of our business. In addition, the terms of our credit facility limit our ability to pay cash dividends on our common stock. A description of our credit facility can be found in this Annual Report under Item 7 under the caption “Liquidity and Capital Resources” and Item 8 under the caption “Financial Statements and Supplementary Data”.

Common Stock Prices

As of March 19, 2010, the closing sales price for our common stock was $0.77. The following table sets forth, for the periods indicated, the range of high and low sales prices for our common stock on the NASDAQ Capital Market:

	Stock Prices
	High		Low
2009
Fourth Quarter	$	0.81	$	0.68
Third Quarter		1.28		0.65
Second Quarter		0.96		0.71
First Quarter		0.99		0.60
2008
Fourth Quarter	$	3.40	$	0.68
Third Quarter		3.70		2.84
Second Quarter		4.46		3.36
First Quarter		5.00		3.76

Securities Authorized for Issuance under Compensation Plans

Set forth in the table below is certain information regarding the number of shares of our common stock that were subject to outstanding stock options or other compensation plan grants and awards as of December 31, 2009.

Plan Category	Number of Securites to be Issued Upon Exercise of Outstanding Options, Warrants and Rights	Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights		Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
	( a )	( b )		( c )
Equity compensation plans approved by security holders (1)	1,632,375	$	2.27	521,100
Total	1,632,375	$	2.27	521,100

(1) Includes vesting of restricted stock

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Annual Report contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Annual Report. Additionally, statements concerning future matters such as the development of new products, our ability to increase manufacturing capacity and sales levels, manage expense levels and other statements regarding matters that are not historical are forward-looking statements.

Although forward-looking statements in this Annual Report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, but are not limited to the following: matters generally affected by the domestic and global economy, such as changes in consumer discretionary spending, changes in the value of the U.S. dollar, Canadian dollar and the Euro, and changes in commodity prices; the ability to source raw materials and finished products at favorable prices; risks related to our history of losses; risks related to our ability to access capital market transactions; risks related to our ability to manage growth; risks related to the limited visibility of future orders; the ability to identify and work with qualified manufacturing partners and consultants; the ability to expand distribution channels and 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; the ability to continue to develop, produce and introduce innovative new products in a timely manner; the ability to identify and execute successfully cost control initiatives; uncertainties associated with our ability to maintain a sufficient supply of products and to successfully manufacture our products; the performance of new products and continued acceptance of current products; the execution of strategic initiatives and alliances; uncertainties associated with intellectual property protection for our products; and other factors described in Item 1A of Part I of this Annual Report under the caption “Risk Factors,” as well as those discussed elsewhere in this Annual Report. Readers are urged not to place undue reliance on forward-looking statements, which speak only as of the date of this Annual Report. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Annual Report. Readers are urged to carefully review and consider the various disclosures made in this Annual Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes and other financial information appearing elsewhere in this Annual Report.

Overview

We are a multi-branded designer, developer, manufacturer and distributor of premium sunglasses and goggles. We began as a grassroots brand in Southern California and entered the action sports and lifestyle markets with innovative and performance-driven products and an authentic connection to the action sports and lifestyle markets under the Spy Optic^™ brand. We recently entered into a licensing agreement with O’Neill Trademark BV (“O’Neill”) to develop and sell O’Neill^™ branded eyewear in addition to our existing brands, Spy^™ and SpyOptic^™. We have two wholly owned subsidiaries incorporated in Italy, Orange 21 Europe S.r.l. (formerly known as Spy Optic S.r.l., “O21 Europe”) and LEM S.r.l. (“LEM”) (sunglass and goggle manufacturer), and a wholly owned subsidiary incorporated in California, Orange 21 North America (formerly known as Spy Optic, Inc. (“O21NA”), all of which we consolidate in our financial statements. Spy Optic S.r.l. changed its name to Orange 21 Europe effective October 13, 2009. Spy Optic, Inc. changed its name to Orange 21 North America Inc. effective January 11, 2010.

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Action Sports Lifestyle Brands

We design, develop and market premium products for the action sports, motorsports, snowsports and lifestyle markets. Our principal products, sunglasses and goggles, are marketed primarily under the brands, Spy^™, SpyOptic^™ and O’Neill^™. These products target the action sport and power sports markets, including surfing, skateboarding, snowboarding, ski and motocross, and the lifestyle market within fashion, music and entertainment. We have built our brands by developing innovative, proprietary products that utilize high-quality materials and optical lens technology to convey performance, style, quality and value. We sell our products in approximately 3,000 retail locations in the United States and Canada and internationally through approximately 3,000 retail locations serviced by our international distributors and us. We have developed strong relationships with key multi-store action sport and lifestyle retailers as well as sunglass specialty retailers in the United States, such as Zumiez, Inc., Sunglass Hut, Tilly’s Clothing, Shoes & Accessories, No Fear, Solstice, Totes/Sunglass World, Sun Diego, Industrial Skateboards and a strategically selective collection of specialized individually owned and operated surf, skate, snow and motocross stores. We began marketing and selling the O’Neill^™ brand following our entry into a license agreement with O’Neill Trademark BV in 2009.

For the Spy and O’Neill brands, we focus our marketing and sales efforts on the action sports, motorsports, snowsports and lifestyle markets, and specifically, persons ranging in age from 17 to 35. We separate our eyewear products into two groups: sunglasses, which includes fashion, performance sport and women-specific sunglasses, and goggles, which includes snowsport and motocross goggles. In addition, we sell branded sunglass and goggle accessories. In managing our business, we are 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.

Other Lifestyle Brand

In February of 2010, we further diversified our brand portfolio by partnering with Jimmy Buffett and his Margaritaville^™ brand for eyewear. Mr. Buffett has developed the Margaritaville brand into a commercially successful brand platform built around the island culture lifestyle and music. The Margaritaville brand has had a successful track record with its sales of attire, foods, spirits and party/tailgate essentials. The Margaritaville brand attracts a diverse customer base that enjoys bringing Margaritaville with them wherever they go.

Results of Operations

Years Ended December 31, 2009 and 2008

Net Sales

Consolidated net sales decreased 27.6% to $34.2 million for the year ended December 31, 2009 from $47.3 million for the year ended December 31, 2008. We believe that the overall decrease is largely due to a decline in the economy and consumer discretionary spending. Sales have decreased across all lines including snow and motocross goggles and sunglasses and amongst all customer classes. Sunglass sales represented approximately 71% and 67% of net sales during the years ended December 31, 2009 and 2008, respectively. Goggle sales represented approximately 28% and 31% of net sales during the years ended December 31, 2009 and 2008, respectively. Apparel and accessories represented approximately 1% and 2% of net sales during the years ended December 31, 2009 and 2008, respectively. We increased sunglass prices mid 2008 and decreased prices for certain goggles during 2009. We also limited the production of apparel and accessories during late 2008 and early 2009 and began to sell only select items primarily on a prebook basis. Domestic net sales represented 70% and 71% of total net sales for the years ended December 31, 2009 and 2008, respectively. Foreign net sales represented 30% and 29% of total net sales for the years ended December 31, 2009 and 2008, respectively.

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Cost of Sales and Gross Profit

Our consolidated gross profit decreased 35% to $13.8 million for the year ended December 31, 2009 from $21.3 million for the year ended December 31, 2008. Gross profit as a percentage of net sales decreased to 40% for the year ended December 31, 2009 from 45% for the year ended December 31, 2008 largely due to: (1) a $0.1 million net decrease in inventory reserves for slow moving and obsolete inventory during the year ended December 31, 2009 compared to a $1.0 million net decrease in inventory reserves during the year ended December 31, 2008 as a result of the sale and disposal of previously reserved inventory. The net decreases for each year included additions of $0.9 million and $0.3 million during the years ended December 31, 2009 and 2008, respectively, (2) a $0.6 million decrease in capitalized inventory overhead costs during the year ended December 31, 2009 compared to a $0.1 million decrease during the year ended December 31, 2008 both as a result of the reduction of inventory levels and purchasing due to management’s efforts to decrease inventory levels at O21NA and O21 Europe, (3) $0.4 million for impairment charges on molds and tooling no longer in use and (4) unabsorbed fixed costs at LEM due to the decrease in sales as a result of the reduced discretionary spending and decreased plant hours during 2009 due to the reduction in employee-related costs discussed below. In addition, the gross profit margin was positively impacted by the decrease of $0.6 million in sales return reserve during the year ended December 31, 2009 compared to increase of $0.1 million during the year ended December 31, 2008. The decrease in 2009 was mainly due to the decrease in average returns percentage and the overall decrease in net sales.

Employee-related decreases were achieved in 2009 over 2008 as a result of temporary plant and office shutdowns both in the U.S. and in Italy, reduction in workforce through no replacement of certain terminated employees and as a result of a temporary 10% reduction in compensation for our U.S. employees and 20% to 30% reduction of salary expense in Italy resulting from a ten-week government-subsidized leave program at LEM, whereby certain employees’ work schedules were reduced. As part of this program at LEM, the Italian government subsidized a portion of employees’ salaries to minimize the effect on the employees and us. Both the reduction in the U.S. and the program at LEM began on March 13, 2009 and continued in the U.S. through the date of this report. These efforts in the U.S. and at LEM were and are currently aimed at reducing expenses during the current global economic downturn.

Sales and Marketing Expense

Sales and marketing expense decreased 38% to $7.3 million for the year ended December 31, 2009 from $11.8 million for the year ended December 31, 2008. The decrease is primarily due to reduced sales commissions of $1.5 million as a result of declining sales and the restructuring of sales compensation plans, as well as reductions of other sales and marketing expenditures, including point-of-purchase displays and materials of $0.8 million, employee-related expenses of $0.3 million, advertising of $0.4 million, athletes of $0.3 million, consulting of $0.2 million, depreciation of $0.1 million due to disposal of vehicles, travel, tradeshows and events and various other expenses. Marketing expense reductions are primarily due to an overall effort by management to improve efficiencies and cut costs to be more in line with the decline in sales due to the current economic conditions.

General and Administrative Expense

General and administrative expense decreased 23% to $7.6 million for the year ended December 31, 2009 from $9.9 million for the year ended December 31, 2008. The decrease was largely due to the $0.9 million decrease in bad debt reserve at O21NA due to the reversal of $0.4 million reserve during 2009, which was previously reserved for in 2008 for related parties, No Fear and MX No Fear, as a result of the Settlement Agreement with the No Fear Parties as discussed in Note 13 “Related Party Transactions” to the Notes to Consolidated Financial Statements in Item 8. We also experienced decreases in consulting and outside services of $0.3 million, legal fees of $0.2 million, and employee-related expenses for reasons discussed above, LEM building termination settlement costs and various other decreases as a result of other reductions made in an effort

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to maximize efficiencies and reduce overall costs. Delaware franchise tax fees also declined as a result of the additional stock issued in connection with our rights offering during 2009 (see Note 19 “Rights Offering” to the Consolidated Financial Statements in Item 8). Decreases were partly offset by $0.3 million in additional compensation expense incurred as a result of the Settlement Agreement with Mark Simo, our former Chief Executive Officer (“CEO”), for compensation related to services rendered as our former CEO. See further discussion about the Settlement Agreement with the No Fear Parties in Note 13 “Related Party Transactions” to the Consolidated Financial Statements in Item 8.

Shipping and Warehousing Expense

Shipping and warehousing expense decreased 42% to $1.0 million for the year ended December 31, 2009 from $1.8 million for the year ended December 31, 2008 primarily due to decreases in employee-related expenses, a decrease in packaging supplies at O21NA due to decreased sales, a decrease in employee-related costs at LEM due to reduction in headcount and decreases in third party warehousing costs as O21 Europe closed its outsourced warehouse in the Netherlands. The closure is expected to improve efficiencies at O21 Europe in future periods.

Research and Development Expense

Research and development expense decreased 13% to $1.1 million for the year ended December 31, 2009 from $1.3 million for the year ended December 31, 2008 primarily due to decreases in employee-related expenses and design and development consulting costs.

Non-Cash Goodwill Impairment Charges

With the current economic conditions, significant deterioration in the retail business climate and the large decline in the market value of our common stock during the fourth quarter of fiscal year 2008, we determined an interim evaluation of goodwill impairment was warranted at December 31, 2008. As a result of this interim evaluation, we have determined that the goodwill associated with our January 2006 acquisition of our manufacturer, LEM, was fully impaired. We recorded a pre-tax non-cash goodwill impairment charge of $8.4 million in our December 31, 2008 financial statements.

Other Net Expense

Other net expense decreased 98% to $16,000 for the year ended December 31, 2009 from $0.7 million for the year ended December 31, 2008. The decrease is primarily due to a net foreign currency gain of $0.3 million for the year ended December 31, 2009 compared to a net foreign currency loss of ($0.1 million) for the year ended December 31, 2008 and a reduction in interest expense of $0.3 million due to reduced borrowing levels and lower interest rates.

Income Tax Provision

The income tax provision for the years ended December 31, 2009 and 2008 was $0.1 million and $2.7 million, respectively. The effective tax rate for the years ended December 31, 2009 and 2008 was (3%) and (21%), respectively. The change in the valuation allowance for the years ended December 31, 2009 and 2008 was an increase of $0.2 million and $3.5 million, respectively. In assessing the realization of deferred tax assets, we consider whether it is more likely than not that some portion or all of our 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. We consider 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 the uncertainty of the economic conditions, we

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have recorded a full valuation allowance of $10.0 million for our worldwide operations at December 31, 2009. Based on the projections for the taxable income for the future, we determined that it was more likely than not that the deferred tax assets, net of the valuation allowance of $9.8 million, would be realized worldwide at December 31, 2008. We have recorded a $7.6 million and $6.7 million valuation allowance for O21NA at December 31, 2009 and 2008, respectively. We have recorded a $1.3 million and $1.5 million valuation allowance for O21 Europe at December 31, 2009 and 2008, respectively. We have recorded a $1.1 million and $1.6 million valuation allowance for LEM at December 31, 2009 and 2008, respectively.

Net Loss

A net loss of $3.4 million was incurred for the year ended December 31, 2009 compared to a net loss of $15.2 million for the year ended December 31, 2008.

Liquidity and Capital Resources

We generally finance our working capital needs and capital expenditures with operating cash flows and bank revolving lines of credit supplied by banks in the United States and in Italy. We have also entered into capital leases for certain long-term asset purchases and other long-term debt to supplement our lines of credit. As of December 31, 2009, we had a total of $6.0 million in debt under lines of credit, capital leases and notes payable. We recorded approximately $310,000 in interest expense during the year ended December 31, 2009. Cash on hand at December 31, 2009 was $654,000.

Cash flow activities

Cash provided by operating activities consists primarily of net loss adjusted for certain non-cash items, including depreciation, amortization, deferred income taxes, provision for bad debts, share-based compensation expense and the effect of changes in working capital and other activities. Cash provided by operating activities for the year ended December 31, 2009 was $2.6 million, which consisted of a net loss of $3.4 million, adjustments for non-cash items of approximately $2.6 million and approximately $1.9 million provided by working capital and other activities. Working capital and other activities includes a $1.2 million decrease in accounts receivable due to timing of cash receipts and a decrease in sales, a $4.0 million decrease in net inventories due to management’s efforts to decrease inventory levels through improved planning and purchasing and due to the increase in inventory obsolescence reserve, partly offset by a $3.7 million decrease in accounts payable and accrued liabilities due to timing of invoices received and payments and management’s efforts to decrease overall spending.

Cash provided by operating activities for the year ended December 31, 2008 was approximately $2.2 million, which consisted of a net loss of approximately $15.2 million, adjustments for non-cash items of approximately $14.4 million, including an $8.4 million goodwill impairment charge, and approximately $3.0 million provided by working capital and other activities. Working capital and other activities includes a $2.6 million decrease in accounts receivable due to timing of cash receipts and a decrease in sales late in 2008 due to economic conditions and a $1.0 million increase in accounts payable and accrued liabilities due to timing of invoices received and payments, partly offset by a $0.8 million increase in inventory due mainly to lower than expected sales for the third and fourth quarters 2008 and increased work in progress for future sunglass and goggle lines.

Cash used in investing activities during the year ended December 31, 2009 was $0.8 million and was primarily attributable to the purchase of fixed assets, including molds at O21NA, computer and software and point-of-purchase displays purchased at O21 Europe and molds, tooling and plant equipment at LEM.

Cash used in investing activities during the year ended December 31, 2008 was $1.5 million and was primarily attributable to the purchase of fixed assets, including molds and tooling for new eyewear product lines, computer and software and point-of- purchase displays purchased at our subsidiary Orange 21 Europe.

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Cash used in financing activities for the year ended December 31, 2009 was $0.2 million and was attributable to $2.0 million in net payments on our lines of credit and $1.3 million for notes payable and capital lease principal payments partly offset by $2.5 million in net proceeds received from the sales of common stock in conjunction with our Rights Offering, described below and $0.7 million in proceeds received at LEM from the issuance of notes payable.

Cash used in financing activities for the year ended December 31, 2008 was $0.7 million and was attributable to $0.8 million for notes payable and capital lease principal payments, partly offset by $0.1 million in net borrowings on our lines of credit.

Rights Offering

On January 22, 2009, we launched a rights offering to raise a maximum of $7.6 million pursuant to which holders of our common stock, options and warrants, were entitled to purchase additional shares of our common stock at a price of $0.80 per share (the “Rights Offering”). In the Rights Offering, stockholders, option holders and warrant holders as of 5:00 p.m., New York City time January 21, 2009, were issued, at no charge, one subscription right for each share of common stock then outstanding or subject to outstanding options or warrants (whether or not currently exercisable). Each right entitled the holder to purchase one share of our common stock for $0.80 per share. The subscription rights issued pursuant to the Rights Offering expired at 5:00 p.m., New York City time, on March 6, 2009. Approximately 3.6 million shares of our common stock were purchased in the Rights Offering for an aggregate of approximately $2.9 million, including approximately $0.5 million in proceeds from the purchase of unsubscribed shares allocated to other investors. Costs related to the Rights Offerings during the year ended December 31, 2009 were approximately $396,000. The proceeds from the Rights Offering were used for general corporate purposes, including research and development, capital expenditures, payment of trade payables, working capital and general and administrative expenses.

Credit Facilities

On February 26, 2007, O21NA entered into a Loan and Security Agreement (“Loan Agreement”) with BFI Business Finance (“BFI”) with a maximum borrowing capacity of $5.0 million, which was subsequently modified to extend the maximum borrowing capacity to $8.0 million and to effect certain other changes. Actual borrowing availability under the Loan Agreement is based on eligible trade receivable and inventory levels of O21NA Loans extended pursuant to the Loan Agreement will bear interest at a rate per annum equal to the prime rate as reported in the Western Edition of the Wall Street Journal from time to time plus 2.5%, with a minimum monthly interest charge of $2,000. We granted BFI a security interest in substantially all of O21NA’s assets as security for its obligations under the Loan Agreement. Additionally, the obligations under the Loan Agreement are guaranteed by Orange 21 Inc. The Loan Agreement renews annually in February for one additional year unless otherwise terminated by either us or by BFI. The Loan Agreement renewed in February 2010 until February 2011.

The Loan Agreement imposes certain covenants on O21NA, including, but not limited to, covenants requiring it to provide certain periodic reports to BFI, inform BFI of certain changes in the business, refrain from incurring additional debt in excess of $100,000 and refrain from paying dividends. O21NA also established a bank account in BFI’s name into which collections on accounts receivable and other collateral are deposited (the “Collateral Account”). Pursuant to the deposit control account agreement between O21NA and BFI with respect to the Collateral Account, BFI is entitled to sweep all amounts deposited into the Collateral Account and apply the funds to outstanding obligations under the Loan Agreement; provided that BFI is required to distribute to O21NA any amounts remaining after payment of all amounts due under the Loan Agreement. To secure its obligations under the guaranty, Orange 21 Inc. granted BFI a blanket security interest in substantially all of its assets. We were in compliance with the covenants under the Loan Agreement at December 31, 2009. At December 31, 2009, there were outstanding borrowings of $3.0 million under the Loan Agreement, bearing an interest rate of 5.8%, and availability under this line of $0.9 million. We had $0.7 million availability under this line at March 19, 2010.

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We have a 1.3 million Euros line of credit in Italy with San Paolo IMI for LEM, which was reduced at December 31, 2009 to 0.6 million Euros. Borrowing availability is based on eligible accounts receivable and export orders received at LEM. At December 31, 2009, there was approximately 0.1 million Euros available under this line of credit. At December 31, 2009 and 2008, outstanding amounts under this line of credit amounted to $0.8 million and $1.9 million, respectively. The interest rate at December 31, 2009 was 2.5%. We had a 0.1 million Euros availability under this line at March 19, 2010.

As a result of the reductions in the Italian line of credit with San Paolo IMI, LEM entered into an unsecured note with San Paolo IMI during June 2009 for 0.4 million Euros. The note is guaranteed by Eurofidi, a government sponsored third party, and bears interest at EURIBOR 3 months interest rate plus a 1.27% spread, payable in quarterly installments due from June 2009 through September 2014. LEM was not in compliance with certain debt covenants required by San Paolo IMI related to this note and therefore the entire balance of the note is classified as current in our December 31, 2009 financial statements. If San Paola IMI were to call this unsecured note as a result of noncompliance with the debt covenants, our operations and cash flow at LEM would be adversely impacted.

Effective March 23, 2010, we entered into a $3.0 million Promissory Note with Costa Brava Partnership III, L.P. The Promissory Note is subordinated to our Loan Agreement with BFI. The proceeds from the Note are expected to be used (i) to prepay the current balance on our revolving line of credit balance with BFI in its entirety and (ii) if any proceeds remain after such prepayment, for working capital purposes. However, we may continue to re-borrow from BFI under the Loan Agreement after such prepayment is made.

Interest under the Promissory Note accrues daily at the following rates: (i) from the date of receipt of funds under the Promissory Note through April 30, 2010, at (A) 6% per annum on the last day of each calendar month and (B) 6% per annum payable on April 30, 2010, and (ii) from May 1, 2010 through the maturity date, at (A) 9% per annum on the last day of each calendar month and (B) 3% per annum payable on the maturity date. In addition, the Promissory Note requires that we pay a facility fee of 1% of the original principal amount on December 31, 2010 and the maturity date. The Promissory Note matures on July 29, 2011. The terms of the Promissory Note include customary representations and warranties, as well as reporting and financial covenants, customary for financings of this type.

Future Capital Requirements

If we are able to achieve anticipated net sales, manage our inventory and manage operating expenses, we believe that our cash on hand and available loan facilities will be sufficient to enable us to meet our operating requirements for at least the next 12 months. Otherwise, changes in operating plans, lower than anticipated net sales, increased expenses or other events, including those described in Item 1A, “Risk Factors,” may require us to seek additional debt or equity financing in the future.

Due to economic conditions, on March 13, 2009, we temporarily reduced our employee-related expenses by approximately 10% in the U.S., which reductions are currently continuing into the first quarter of 2010, and approximately 20%-30% in salary costs at our Italian-based subsidiary, LEM, which reductions lasted approximately ten weeks. The reductions were and are being achieved through a combination of temporarily-reduced salaries and work schedules as well as mandatory vacation leave. In addition, we are in the process of streamlining our Italian manufacturing and sales operations, which we expect could provide additional savings.

Our future capital requirements will depend on many factors, including our ability to maintain or grow net sales, our ability to manage our expenses and our expected capital expenditures among other issues. We may be required to seek additional equity or debt financing in the future, which may result in additional dilution of our stockholders. Additional debt financing would result in increased interest expense and could result in covenants that would restrict our operations. We rely on our credit line with BFI, San Paolo IMI and other credit arrangements to fund working capital needs. The recent unprecedented disruptions in the credit and financial

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markets and resulting decline in general economic and business conditions may adversely impact our access to capital through our credit line and other sources. Under the terms of our Loan Agreement, BFI may reduce our borrowing availability in certain circumstances, including, without limitation, if in its reasonable business judgment our creditworthiness, sales or the liquidation value of our inventory have declined materially. Further, the Loan Agreement provides that BFI may declare us in default if we experience a material adverse change in our business or financial condition or if BFI determines that our ability to perform under the Loan Agreement is materially impaired. The current economic environment could also cause lenders and other counterparties who provide us credit to breach their obligations to us, which could include, without limitation, lenders or other financial services companies failing to fund required borrowings under our credit arrangements. Any of the foregoing could adversely impact our business, financial condition or results of operations.

Also, if we require additional financing as a result of the foregoing or other factors, the capital markets turmoil could negatively impact our ability to obtain such financing. Our access to additional financing will depend on a variety of factors (many of which we have little or no control over) such as market conditions, the general availability of credit, the overall availability of credit to our industry, our credit ratings and credit capacity, as well as the possibility that lenders could develop a negative perception of our long-term or short-term financial prospects. If future financing is not available or is not available on acceptable terms, we may not be able to fund our future needs which could also restrict our operations.

Off-balance sheet arrangements

We did not enter into any off-balance sheet arrangements during the years ended December 31, 2009 or 2008, nor did we have any off-balance sheet arrangements outstanding at December 31, 2009 and 2008.

Income 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 the uncertainty of the economic conditions, we have recorded a full valuation allowance for O21NA, O21 Europe and LEM.

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.

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 and third quarters of the fiscal year as a result of the seasonality of our products and the markets in which we sell our products, and our first and fourth fiscal 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 will 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

We do not believe inflation has had a material impact on our operations in the past, although there can be no assurance that this will be the case in the future.

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Critical Accounting Policies and Estimates

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, share-based compensation, impairment testing 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 and Reserve for Returns

Our revenue is primarily generated through sales of sunglasses, goggles and apparel, net of returns and discounts. Revenue from product sales is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. These criteria are usually met upon delivery to our “common” carrier, which is also when the risk of ownership and title passes to our customers.

Generally, we extend credit to our customers after performing credit evaluations and do not require collateral. Our payment terms generally range from net-30 to net-90, depending on the country or whether we sell directly to retailers or to a distributor. Our distributors are typically set up as prepay accounts; however, credit may be extended to certain distributors, usually upon receipt of a letter of credit. Generally, our sales agreements with our customers, including distributors, do not provide for any rights of return or price protection. However, we do approve returns on a case-by-case basis in our sole discretion. We record an allowance for estimated returns when revenue is recorded based on historical data and make adjustments when we consider it necessary. The allowance for returns is calculated using a three step process that includes: (1) calculating an average of actual returns as a percentage of sales over a rolling twelve month period; (2) estimating the average time period between a sale and the return of the product (12 and 8.8 months at December 31, 2009 for O21NA and O21 Europe, respectively) and (3) estimating the value of the product returned. The reserve is calculated as the average return percentage times gross sales for the average return period less the estimated value of the product returned and adjustments are made as we consider necessary. The average return percentage has ranged from 6.9% to 9.7% and 2.1% to 7.1% during the past two years at O21NA and O21 Europe, respectively, with 6.9% and 7.1% used at December 31, 2009 for O21NA and O21 Europe, respectively. If O21NA were to use 9.7% (the highest average return rate in the past two years) it would have resulted in approximately $502,000 increase to the liability, which would have resulted in a reduction in net sales for the year ended December 31, 2009. Historically, actual returns have been within our expectations. If future returns are higher than our estimates, our earnings would be adversely affected.

Accounts Receivable and Allowance for Doubtful Accounts

Throughout the year, we perform credit evaluations of our customers, and we adjust credit limits based on payment history and the customer’s current creditworthiness. We continuously monitor our collections and maintain a reserve for estimated credits which is calculated on a monthly basis. 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 all 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.

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If the data used to calculate these allowances does not reflect our future ability to collect outstanding receivables, an adjustment in the reserve for refunds may be required. Historically, our losses have been consistent with our estimates, but there can be no assurance that we will continue to experience the same credit loss rates that we have experienced in the past. Unforeseen, material financial difficulties experienced by our customers could have an adverse impact on our profits.

Share-based Compensation Expense

We measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized in the consolidated statement of operations over the period during which the employee is required to provide service in exchange for the award—the requisite service period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The grant-date fair value of employee share options and similar instruments is estimated using option-pricing models adjusted for the unique characteristics of those instruments.

Determining Fair Value of Stock Option Grants

Valuation and Amortization Method.    We use the Black-Scholes option-pricing valuation model (single option approach) to calculate the fair value of stock option grants. For options with graded vesting, the option grant is treated as a single award and compensation cost is recognized on a straight-line basis over the vesting period of the entire award.

Expected Term.    The expected term of options granted represents the period of time that the option is expected to be outstanding. We estimate the expected term of the option grants based on historical exercise patterns that we believe to be representative of future behavior as well as other various factors.

Expected Volatility.    We estimate our volatility using our historical share price performance over the expected life of the options, which management believes is materially indicative of expectations about expected future volatility.

Risk-Free Interest Rate.    We use risk-free interest rates in the Black-Scholes option valuation model that are based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life of the options.

Dividend Rate.    We have not paid dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. Therefore, we use an expected dividend yield of zero.

Forfeitures.    The FASB requires companies to estimate forfeitures at the time of grant and revise those estimates in subsequent reporting periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and records share-based compensation expense only for those awards that are expected to vest.

Inventories

Inventories consist primarily of raw materials and finished products, including sunglasses, goggles, apparel and accessories, product components such as replacement lenses and purchasing and quality control costs. Inventory items are carried on the books at the lower of cost or market using the weighted average cost method for LEM and first in first out method for our distribution business. Periodic physical counts of inventory items are conducted to help verify the balance of inventory.

A reserve is maintained for obsolete or slow moving inventory. Products are reserved at certain percentages based on their probability of selling, which is estimated based on current and estimated future customer demands and market conditions. Historically, there has been variability in the amount of write offs, compared to estimated reserves. These estimates could vary significantly, either favorably or unfavorably, from actual experience if future economic conditions, levels of consumer demand, customer inventory or competitive conditions differ from expectations.

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Goodwill

Goodwill is not amortized, but instead was measured for impairment at least annually on October 1 to allow for the necessary time to complete an external valuation of the reporting units based on the best estimate at that date. We also tested for impairment if events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is below its carrying amount. We evaluate the recoverability of goodwill based on a two-step impairment test. The first step compares the fair value of each reporting unit, with its carrying amount, including goodwill. If the carrying amount exceeds fair value, then the second step of the impairment test is performed to measure the amount of any impairment loss. The fair value of each reporting unit is determined using a combination of the income approach and the market approach. Under the income approach, the fair value of a reporting unit is calculated based on the present value of estimated future cash flows. The present value of estimated future cash flows uses our estimates of profit for the reporting units, driven by assumed market growth rates and assumed market segment share, and estimated costs as well as appropriate discount rates. These estimates are consistent with the plans and estimates that we use to manage the underlying business. Under the market approach, fair value is estimated based on market multiples of earnings for comparable companies and similar transactions.

Our use of a discounted cash flow model to estimate the fair value of reporting units involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the extent of such charge. Assumptions critical to our fair value estimates under the discounted cash flow models include discount rates, royalty rates, and cash flow projections and inherent in cash flow projections are estimates regarding projected revenue growth rates, projected cost reductions and efficiencies and projected long-term growth rates in the determination of terminal values.

We measure the amount of any goodwill impairment based upon the estimated fair value of the underlying assets and liabilities of the reporting unit, including any unrecognized intangible assets, and estimate the implied fair value of goodwill. We identify unrecognized intangible assets, such as trade name and customer relationships, and use discounted cash flow models to estimate the values of the reporting unit’s recognized and unrecognized intangible assets. The estimated values of the reporting unit’s intangible assets and net tangible assets are deducted from the reporting unit’s total value to determine the implied fair value of goodwill. An impairment charge is recognized to the extent the recorded goodwill exceeds the implied fair value of goodwill.

We performed our last annual test of goodwill on October 1, 2008 and determined that the fair values of the reporting units exceeded their carrying values, with a “cushion” of approximately 4% on a combined fair value basis. Since there were no indications of impairment the second step was not performed. With the significant deterioration in the economy as well as a large decline in the market value of our common stock during the fourth quarter of 2008, we determined an interim evaluation of goodwill impairment was warranted. As a result of this interim testing, we determined that the goodwill associated with our January 2006 acquisition of our manufacturer, LEM, was fully impaired. We recorded a pre-tax non-cash goodwill impairment charge of $8.4 million in our December 31, 2008 financial statements. As of December 31, 2008, we had no further goodwill recorded on our balance sheet and therefore no annual test was performed during the year ended December 31, 2009. See also Notes 1 and 18 of the Notes to Consolidated Financial Statements in Item 8.

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 our deferred tax assets. If we determine that it is more likely than not that

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these assets will not be realized, we will reduce the value of these assets to their expected realizable value, thereby decreasing our net income. Evaluating the value of these assets is necessarily based on our management’s judgment. If we subsequently determine 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.

We have established a valuation allowance against our deferred tax assets in each jurisdiction where we cannot conclude that it is more likely than not that those assets will be realized. In the event that actual results differ from our forecasts or we adjust the forecast or assumptions in the future, the change in the valuation allowance could have a significant impact on future income tax expense.

We are subject to income taxes in the United States and foreign jurisdictions. In the ordinary course of our business, there are calculations and transactions, including transfer pricing, where the ultimate tax determination is uncertain. In addition, changes in tax laws and regulations as well as adverse judicial rulings could materially affect the income tax provision.

Foreign Currency and Derivative Instruments

The functional currency of each of our foreign wholly owned subsidiaries, O21 Europe and LEM and our Canadian division is the respective 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).

Recently Issued Accounting Pronouncements

In June 2009, the FASB issued authoritative guidance, which establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with Generally Accepted Accounting Principles. The guidance is effective for interim and annual periods ending after September 15, 2009 and did not have a material impact on our consolidated financial statements.

In August 2009, the FASB issued changes to fair value accounting for liabilities. These changes clarify existing guidance that in circumstances in which a quoted price in an active market for the identical liability is not available, an entity is required to measure fair value using either a valuation technique that uses a quoted price of either a similar liability or a quoted price of an identical or similar liability when traded as an asset, or another valuation technique that is consistent with the principles of fair value measurements, such as an income approach (e.g., present value technique). This guidance also states that both a quoted price in an active market for the identical liability and a quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. These changes became effective for us on October 1, 2009. We determined that the adoption of these changes did not have an impact on our consolidated financial statements.

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Item 8. Financial Statements and Supplementary Data

ORANGE 21 INC. AND SUBSIDIARIES

Index to Consolidated Financial Statements

	Page
Report of Independent Registered Public Accounting Firm	40
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2009 and 2008	41
Consolidated Statements of Operations for the years ended December 31, 2009 and 2008	42
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2009 and 2008	43
Consolidated Statements of Cash Flows for the years ended December 31, 2009 and 2008	44
Notes to Consolidated Financial Statements	45

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

Orange 21 Inc. and Subsidiaries

Carlsbad, California

We have audited the accompanying consolidated balance sheets of Orange 21 Inc. (a Delaware corporation) and its subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. We have also audited the financial statement schedule listed at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Orange 21 Inc. and its subsidiaries as of December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the schedule listed at item 15(a) presents fairly, in all material respects, the information set forth therein.

/s/ Mayer Hoffman McCann P.C.

San Diego, California

March 26, 2010

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ORANGE 21 INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Thousands, except number of shares and per share amounts)

	December 31,
	2009			2008
Assets
Current assets
Cash	$	654		$	471
Accounts receivable, net		5,886			6,991
Inventories, net		7,759			11,698
Prepaid expenses and other current assets		1,036			1,607
Income taxes receivable		56			171
Total current assets		15,391			20,938
Property and equipment, net		4,892			5,417
Intangible assets, net of accumulated amortization of $714 and $601 at December 31, 2009 and 2008, respectively		296			401
Other long-term assets		92			67
Total assets	$	20,671		$	26,823
Liabilities and Stockholders’ Equity
Current liabilities
Lines of credit	$	3,750		$	5,787
Current portion of capital leases		395			483
Current portion of notes payable		723			484
Accounts payable		5,431			8,635
Accrued expenses and other liabilities		3,350			3,868
Income taxes payable		—			214
Total current liabilities		13,649			19,471
Capitalized leases, less current portion		812			754
Notes payable, less current portion		308			357
Deferred income taxes		404			391
Total liabilities		15,173			20,973
Stockholders’ equity
Preferred stock: par value $0.0001; 5,000,000 authorized; none issued		—			—
Common stock: par value $0.0001; 100,000,000 shares authorized; 11,903,943 and 8,176,850 shares issued and outstanding at December 31, 2009 and 2008, respectively		1			1
Additional paid-in-capital		40,515			37,432
Accumulated other comprehensive income		874			902
Accumulated deficit		(35,892	)		(32,485	)
Total stockholders’ equity		5,498			5,850
Total liabilities and stockholders’ equity	$	20,671		$	26,823

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

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ORANGE 21 INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Thousands, except per share amounts)

	Year Ended December 31,
	2009			2008
Net sales	$	34,238		$	47,276
Cost of sales		20,399			25,980
Gross profit		13,839			21,296
Operating expenses:
Sales and marketing		7,330			11,751
General and administrative		7,614			9,910
Shipping and warehousing		1,040			1,795
Research and development		1,145			1,309
Non-cash goodwill impairment charge		—			8,392
Total operating expenses		17,129			33,157
Loss from operations		(3,290	)		(11,861	)
Other income (expense):
Interest expense		(310	)		(614	)
Foreign currency transaction gain (loss)		330			(107	)
Other income (expense)		(36	)		56
Total other expense		(16	)		(665	)
Loss before provision for income taxes		(3,306	)		(12,526	)
Income tax provision		101			2,686
Net loss	$	(3,407	)	$	(15,212	)
Net loss per share of Common Stock
Basic	$	(0.30	)	$	(1.86	)
Diluted	$	(0.30	)	$	(1.86	)
Shares used in computing net loss per share of Common Stock
Basic		11,444			8,170
Diluted		11,444			8,170

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

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ORANGE 21 INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Thousands)

	Common Stock			Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total
	Shares	Amount
Balance at December 31, 2007	8,162	$	1	$	36,845	$	2,526		$	(17,273	)	$	22,099
Vesting of restricted stock awards	15		—		—		—			—			—
Share-based compensation	—		—		587		—			—			587
Comprehensive income (loss):
Foreign currency translation adjustment	—		—		—		(1,352	)		—			(1,352	)
Realized loss on foreign currency cash flow hedges	—		—		—		(11	)		—			(11	)
Unrealized gain on foreign currency exposure of net investment in foreign operations	—		—		—		(261	)		—			(261	)
Net loss	—		—		—		—			(15,212	)		(15,212	)
Comprehensive loss	—		—		—		—			—			(16,836	)
Balance at December 31, 2008	8,177		1		37,432		902			(32,485	)		5,850
Issuance of common stock in connection with subscription rights offering, net of issuance costs	3,591		—		2,476								2,476
Vesting of restricted stock awards	135		—		—		—			—			—
Share-based compensation	—		—		607		—			—			607
Comprehensive income (loss):
Foreign currency translation adjustment	—		—		—		(149	)		—			(149	)
Unrealized gain on foreign currency exposure of net investment in foreign operations	—		—		—		121			—			121
Net loss	—		—		—		—			(3,407	)		(3,407	)
Comprehensive loss	—		—		—		—			—			(3,435	)
Balance at December 31, 2009	11,903	$	1	$	40,515	$	874		$	(35,892	)	$	5,498

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

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ORANGE 21 INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Thousands)

	Year Ended December 31,
	2009			2008
Operating Activities
Net loss	$	(3,407	)	$	(15,212	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		1,779			1,983
Deferred income taxes		3			2,470
Share-based compensation		607			587
Provision for (recovery of) bad debts		(118	)		690
(Gain) loss on sale of property and equipment		38			(15	)
Impairment of property and equipment		336			250
Non-cash goodwill impairment charge		—			8,392
Change in operating assets and liabilities:
Accounts receivable		1,177			2,624
Inventories, net		4,029			(860	)
Prepaid expenses and other current assets		609			255
Other assets		(48	)		42
Accounts payable		(3,222	)		2,236
Accrued expenses and other liabilities		(497	)		(1,227	)
Income tax payable/receivable		(101	)		(28	)
Net cash provided by operating activities		1,185			2,187
Investing Activities
Purchases of property and equipment		(781	)		(1,475	)
Proceeds from sale of property and equipment		17			42
Purchase of intangibles		(2	)		(18	)
Net cash used in investing activities		(766	)		(1,451	)
Financing Activities
Line of credit borrowings, net		(2,024	)		74
Principal payments on notes payable		(489	)		(459	)
Proceeds from issuance of notes payable		663			—
Principal payments on capital leases		(778	)		(357	)
Proceeds from sale of common stock, net of issuance costs of $396		2,476			—
Net cash used in financing activities		(152	)		(742	)
Effect of exchange rate changes on cash		(84	)		(78	)
Net increase (decrease) in cash and cash equivalents		183			(84	)
Cash at beginning of year		471			555
Cash at end of year	$	654		$	471
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	341		$	636
Income taxes	$	141		$	—
Summary of noncash financing and investing activities:
Acquisition of property and equipment through capital leases	$	648		$	575

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

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ORANGE 21 INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Significant Accounting Policies

Basis of Presentation

Description of Business

Orange 21 Inc. (the “Company”) was originally formed as a California corporation in 1992. On November 29, 2004, upon reincorporation in the State of Delaware, the Company changed its name from Spy Optic, Inc. to Orange 21 Inc. and the Board of Directors of the Company approved a 16 to 1 reverse stock split and authorized 5,000,000 shares of preferred stock. All financial data and share data in these consolidated financial statements give retroactive effect to this split.

The Company designs, develops, manufactures and distributes high quality and high performance products for the action sports, motor sports and lifestyle markets. The Company’s current products include sunglasses, snowsport and motocross goggles and branded accessories. Orange 21 Europe, S.r.l., formerly known as Spy Optic, S.r.l. (“O21 Europe”), a wholly owned subsidiary, was incorporated in Italy in July 2001. O21 Europe manages the distribution, sales, customer service and administration for the Company’s business outside of North America. Orange 21 North America Inc., formerly known as Spy Optic, Inc. (“O21NA”), a California corporation, was formed on December 20, 2004 as a wholly owned subsidiary. In January 2006, the Company completed the acquisition of its manufacturer LEM S.r.l. (“LEM”). See Note 18 “Acquisitions” of the Notes to the Consolidated Financial Statements.

Basis of Presentation

The accompanying consolidated financial statements of Orange 21 Inc. and its subsidiaries have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. In the opinion of management, the consolidated financial statements contain all adjustments, consisting of normal recurring items, considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows.

Capital Resources

If the Company is able to achieve anticipated net sales, manage its inventory and manage operating expenses, the Company believes that its cash on hand and available loan facilities will be sufficient to enable the Company to meet their operating requirements for at least the next 12 months. Otherwise, changes in operating plans, lower than anticipated net sales, increased expenses or other events, including those described in Item 1A, “Risk Factors,” may require the Company to seek additional debt or equity financing in the future. Due to current economic conditions, on March 13, 2009, the Company temporarily reduced its employee-related expenses by approximately 10% in the U.S., which reductions are currently continuing into the first quarter 2010, and approximately 20%-30% in salary costs at its Italian-based subsidiary, LEM, which reductions lasted approximately ten weeks. The reductions were and are being achieved through a combination of temporarily-reduced salaries and work schedules as well as mandatory vacation leave. The reductions at LEM were partly offset by reimbursements through the Italian government to minimize the effects on the employees. In addition, the Company is in the process of streamlining its Italian manufacturing and sales operations, which the Company expects could provide additional savings.

The Company’s future capital requirements will depend on many factors, including its ability to maintain or grow net sales, its ability to manage expenses and expected capital expenditures among other issues. The Company may be required to seek additional equity or debt financing in the future, which may result in additional dilution of its stockholders. Additional debt financing would result in increased interest expense and

45

could result in covenants that would restrict its operations. The Company relies on its credit line with BFI Business Finance (“BFI”), San Paolo IMI and other credit arrangements to fund working capital needs. The recent unprecedented disruptions in the credit and financial markets and resulting decline in general economic and business conditions may adversely impact the Company’s access to capital through its credit line and other sources. Under the terms of the Company’s Loan Agreement with BFI (see Note 6 “Financing Arrangements” to the Consolidated Financial Statements), BFI may reduce the Company’s borrowing availability in certain circumstances, including, without limitation, if in its reasonable business judgment the Company’s creditworthiness, sales or the liquidation value of the Company’s inventory have declined materially. Further, the Loan Agreement provides that BFI may declare the Company in default if the Company experiences a material adverse change in its business or financial condition or if BFI determines that the Company’s ability to perform under the Loan Agreement is materially impaired. The current economic environment could also cause lenders and other counterparties who provide the Company credit to breach their obligations to the Company, which could include, without limitation, lenders or other financial services companies failing to fund required borrowings under the Company’s credit arrangements. Any of the foregoing could adversely impact the Company’s business, financial condition or results of operations.

Effective March 23, 2010, the Company entered into a $3.0 million Promissory Note with Costa Brava Partnership III, L.P. (“Costa Brava”) which matures on July 29, 2011. The Promissory Note is subordinated to the Company’s Loan Agreement, as amended, with BFI, pursuant to the terms of a Debt Subordination Agreement, dated March 23, 2010, by and between Costa Brava and BFI. The proceeds from the Note are expected to be used (i) to prepay the current balance on the Company’s revolving line of credit balance with BFI in its entirety and (ii) if any proceeds remain after such prepayment, for working capital purposes. However, the Company may continue to re-borrow from BFI under the Loan and Security Agreement after such prepayment is made. The terms of the Promissory Note include customary representations and warranties, as well as reporting and financial covenants, customary for financings of this type.

If the Company requires additional financing as a result of the foregoing or other factors, the capital markets turmoil could negatively impact the Company’s ability to obtain such financing. The Company’s access to additional financing will depend on a variety of factors (many of which the Company has little or no control over) such as market conditions, the general availability of credit, the overall availability of credit to its industry, its credit ratings and credit capacity, as well as the possibility that lenders could develop a negative perception of its long-term or short-term financial prospects. If future financing is not available or is not available on acceptable terms, the Company may not be able to fund its future needs which could also restrict its operations.

NASDAQ Deficiency

On September 16, 2009, the Company received a notice from NASDAQ indicating that, for the preceding 30 consecutive business days, the bid price of its common stock had closed below the $1.00 minimum bid price required for continued listing on the NASDAQ Capital Market under Marketplace Rule 5550(a)(2). Pursuant to Marketplace Rule 5810(c)(3)(A), the Company had 180 calendar days from the date of the notice, or until March 15, 2010, to regain compliance with the minimum bid price rule. To regain compliance, the closing bid price of the Company’s common stock had to be at or above $1.00 per share for a minimum of 10 consecutive business days, which was not achieved. On March 16, 2010, the Company received a letter from NASDAQ indicating that it had not regained compliance with the Rule and is not eligible for an additional 180 day compliance period given that the Company does not meet the NASDAQ Capital Market initial listing standard set forth in Listing Rule 5505. Accordingly, the Company’s securities were delisted from the NASDAQ Capital Market on March 25, 2010. The Company’s common stock was suspended from trading on the NASDAQ Capital Market was suspended on March 25, 2010 and is now traded in the over-the-counter market.

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Significant estimates

46

used in preparing these consolidated financial statements include those assumed in computing allowance for doubtful accounts receivable, reserve for obsolete inventory, reserve for sales returns, the testing of goodwill and long-lived assets for impairment and the valuation allowance on deferred tax assets. Accordingly, actual results could differ from those estimates.

Accounts Receivable, Reserve for Refunds and Returns and Allowance for Doubtful Accounts

Throughout the year, the Company performs credit evaluations of its customers, and adjusts credit limits based on payment history and the customer’s current creditworthiness. The Company continuously monitors its collections and maintains a reserve for estimated credits. The Company reserves for estimated future refunds and returns at the time of shipment based upon historical data and adjusts reserves as considered necessary. The Company makes judgments as to its ability to collect outstanding receivables and provides allowances for anticipated bad debts and refunds. Provisions are made based upon a review of all significant outstanding invoices and overall quality and age of those invoices not specifically reviewed. In determining the provision for invoices not specifically reviewed, the Company analyzes collection experience, customer credit-worthiness and current economic trends. If the data used to calculate these allowances does not reflect future ability to collect outstanding receivables, an adjustment in the reserve for refunds may be required. Historically, the Company’s losses have been consistent with estimates, but there can be no assurance that it will continue to experience the same credit loss rates that it has experienced in the past. Unforeseen, material financial difficulties experienced by its customers could have an adverse impact on profits.

Inventories

Inventories consist primarily of raw materials and finished products, including sunglasses, goggles, apparel and accessories, product components such as replacement lenses and purchasing and quality control costs. Inventory items are carried on the books at the lower of cost or market using the weighted average cost method for LEM and first in first out method for our distribution business. Periodic physical counts of inventory items are conducted to help verify the balance of inventory. A reserve is maintained for obsolete or slow moving inventory. Products are reserved at certain percentages based on their probability of selling, which is estimated based on current and estimated future customer demands and market conditions.

Long-Lived Assets

Property and equipment are recorded at cost and are depreciated over the estimated useful lives of the assets (two to thirty three years) using the straight-line method. Amortization of leasehold improvements is computed on the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the assets. Expenditures for repairs and maintenance are expensed as incurred. Gains and losses from the sale or retirement of property and equipment are charged to operations in the period realized or incurred.

Intangible assets consist of trademarks, patents and a customer related intangible that are being amortized on a straight-line basis over 5 to 8.3 years. Amortization expense was approximately $110,000 and $103,000 for the years ended December 31, 2009 and 2008, respectively. Amortization expense related to intangible assets at December 31, 2009 in each of the next five years and beyond is expected to be incurred as follows:

	(Thousands)
2010	$	90
2011		85
2012		67
2013		52
2014		2
Thereafter		—
Total	$	296

47

The Company evaluates the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that such carrying values may not be recoverable. The Company estimates the future undiscounted cash flows derived from an asset to assess whether or not a potential impairment exists when events or circumstances indicate the carrying value of a long-lived asset may differ. If the sum of the undiscounted cash flows is less than the carrying value, an impairment loss will be recognized, measured as the amount by which the carrying value exceeds the fair value of the asset. The Company uses its best judgment based on the most current facts and circumstances surrounding its business when applying these impairment rules to determine the timing of the impairment test, the undiscounted cash flows used to assess impairments and the fair value of a potentially impaired asset. Changes in assumptions used could have a significant impact on the Company’s assessment of recoverability. Numerous factors, including changes in the Company’s business, industry segment or the global economy could significantly impact management’s decision to retain, dispose of or idle certain of its long-lived assets. For the years ended December 31, 2009 and 2008, the Company recorded impairment charges of approximately $336,000 and $250,000, respectively. See Note 4, “Property and Equipment”, for information regarding asset impairment charges recognized by the Company. At December 31, 2009 and 2008, no impairment of the intangible assets had occurred and the amortization periods remain appropriate.

Goodwill

Goodwill is not amortized, but instead is measured for impairment at least annually on October 1 to allow for the necessary time to complete an external valuation of the reporting units based on the best estimate at that date. The Company also tests for impairment if events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is below its carrying amount. The Company evaluates the recoverability of goodwill based on a two-step impairment test. The first step compares the fair value of each reporting unit, with its carrying amount, including goodwill. If the carrying amount exceeds fair value, then the second step of the impairment test is performed to measure the amount of any impairment loss. The fair value of each reporting unit is determined using a combination of the income approach and the market approach. Under the income approach, the fair value of a reporting unit is calculated based on the present value of estimated future cash flows. The present value of estimated future cash flows uses estimates of profit for the reporting units, driven by assumed market growth rates and assumed market segment share and estimated costs as well as appropriate discount rates. These estimates are consistent with the plans and estimates that the Company uses to manage the underlying business. Under the market approach, fair value is estimated based on market multiples of earnings for comparable companies and similar transactions.

The Company uses a discounted cash flow model to estimate the fair value of reporting units, which involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the extent of such charge. Estimates and assumptions critical to the Company’s fair value estimates under the discounted cash flow models include discount rates, royalty rates and cash flow projections and inherent in cash flow projections are estimates regarding projected revenue growth rates, projected cost reductions and efficiencies and projected long-term growth rates in the determination of terminal values.

The Company measures the amount of any goodwill impairment based upon the estimated fair value of the underlying assets and liabilities of the reporting unit, including any unrecognized intangible assets and estimates the implied fair value of goodwill. The Company identifies the unrecognized intangible assets, such as trade name and customer relationships, and uses discounted cash flow models to estimate the values of the reporting unit’s recognized and unrecognized intangible assets. The estimated values of the reporting unit’s intangible assets and net tangible assets are deducted from the reporting unit’s total value to determine the implied fair value of goodwill. An impairment charge is recognized to the extent the recorded goodwill exceeds the implied fair value of goodwill.

The Company performed an annual test of goodwill on October 1, 2008 and determined that the fair values of the reporting units exceeded their carrying values, with a “cushion” of approximately 4% on a combined fair value basis. Since there were no indications of impairment the second step was not performed.

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With the significant deterioration in the retail business climate as well as a large decline in the market value of the Company’s common stock during the fourth quarter for the year ended December 31, 2008, the Company determined an interim evaluation of goodwill impairment was warranted. As a result of this interim testing, the Company determined that the goodwill associated with the January 2006 acquisition of its manufacturer, LEM, was fully impaired. The Company recorded a pre-tax non-cash goodwill impairment charge of $8.4 million in its December 31, 2008 financial statements. As of December 31, 2008, the Company had no further goodwill recorded on its balance sheet and therefore no annual test was performed during the year ended December 31, 2009. See also Note 18.

Point-of-Purchase Displays

In the U.S., the cost of point-of-purchase displays is currently being charged to sales and marketing expense as ownership is transferred to the customer upon shipment of the display. In Italy, the cost is capitalized and ownership remains with Orange 21 Europe.

Revenue Recognition

The Company’s revenue is primarily generated through sales of sunglasses, goggles and apparel, net of returns and discounts. Revenue from product sales is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. These criteria are usually met upon delivery to the Company’s carrier, which is also when the risk of ownership and title passes to the Company’s customers.

Generally, the Company extends credit to its customers after performing credit evaluations and does not require collateral. The Company’s payment terms generally range from net-30 to net-90, depending on the country or whether it sells directly to retailers in the country or to a distributor. The Company’s distributors are typically set up as prepay accounts; however credit may be extended to certain distributors, usually upon receipt of a letter of credit. Generally, the Company’s sales agreements with its customers, including distributors, do not provide for any rights of return or price protection. However, the Company does approve returns on a case-by-case basis in its sole discretion. The Company records an allowance for estimated returns when revenues are recorded. The allowance is calculated using historical evidence of actual returns. Historically, actual returns have been within the Company’s expectations. If future returns are higher than the Company’s estimates, the Company’s earnings would be adversely affected.

Advertising

The Company expenses advertising costs as incurred. Total advertising expense was approximately $144,000 and $464,000 for the years ended December 31, 2009 and 2008, respectively.

Product Warranty

The Company warrants its products for one year. The standard warranty requires the Company to replace any product or portion thereof that is deemed a manufacturer’s defect. The Company records warranty expense as incurred and records the expense in cost of sales. Based on historical evidence and future estimates warranty expense is not considered to be material for additional accrual.

Research and Development

The Company expenses research and development costs as incurred.

Shipping and Handling

The Company records shipping and handling costs charged to customers as revenue and other shipping and handling costs to cost of sales as incurred.

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Financial Instruments

Certain financial instruments are carried at cost on the consolidated balance sheets, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash, accounts receivable, accounts payable, accrued expense, other short-term liabilities, capital leases and notes payable. The carrying fair value of the Company’s long-term debt, including the current portion approximates fair value as of December 31, 2009. The estimated fair value has been determined based on rates for the same or similar instruments.

Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. There is an established hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability. There are three levels of inputs that may be used to measure fair value:

Level 1 uses unadjusted quoted prices that are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the assets or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 uses inputs other than level 1 that are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates volatility factors, are corroborated by readily observable data.

Level 3 uses inputs that are unobservable and are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant’s assumptions.

As of December 31, 2009, the financial liabilities measured at fair value consisted of an interest rate swap agreement. The value is based on model-driven valuation whose inputs are observable. The following table summarizes the financial liabilities measured at fair value on a recurring basis as of December 31, 2009 and the level it falls within the fair value hierarchy:

	Fair Value at December 31, 2009
	Level 1		Level 2		Level 3
	(Thousands)
Item measured at fair value on a recurring bases:
Interest rate swap	$	—	$	4	$	—
	$	—	$	4	$	—

Foreign Currency

The functional currencies of the Company’s wholly owned subsidiaries, O21NA, O21 Europe and LEM are their respective local currency. Accordingly, the Company is exposed to transaction gains and losses that could result from changes in foreign currencies. 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).

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Derivatives and Hedging

The Company is exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to forecasted product purchases denominated in foreign currencies and transactions of its foreign subsidiaries. As part of its overall strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, the Company has used foreign exchange contracts in the form of forward contracts.

Net gains on cash flow hedges included in OCI are as follows:

	Year Ended December 31,
	2009		2008
	(Thousands)
Beginning balance	$	—	$	11
Net losses reclassified into earnings		—		(11	)
Accumulated other comprehensive income	$	—	$	—

During the years ended December 31, 2009 and 2008, the Company did not discontinue any cash flow hedges for which it was probable that a forecasted transaction would not occur.

For foreign currency contracts designated as cash flow hedges, hedge effectiveness is measured using the spot rate. Changes in the spot-forward differential are excluded from the test of hedge effectiveness and are recorded currently in earnings in the foreign currency transaction gain. The Company measures effectiveness by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item.

Foreign currency derivatives are used only to meet the Company’s objectives of minimizing variability in the Company’s operating results arising from foreign exchange rate movements which may include derivatives that do not meet the criteria for hedge accounting. The Company does not enter into foreign exchange contracts for speculative purposes.

In 2009, the Company acquired an interest rate option with a notional principal amount of 200,000 Euros to reduce its exposure to changing European interest rates. This option has not been designated as a hedging instrument. It is carried on the balance sheet at fair value. Changes in the fair value are recorded in current earnings and are considered to be immaterial.

Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income or loss by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by including the additional shares of common stock issuable upon exercise of outstanding options and warrants and upon vesting of restricted stock, using the treasury stock method. The following table lists the potentially dilutive equity instruments, each convertible into one share of common stock, used in the calculation of diluted earnings per share for the periods presented:

	Year Ended December 31,
	2009	2008
	(Thousands)
Weighted average common shares outstanding – basic	11,444	8,170
Assumed conversion of dilutive stock options, restricted stock and warrants	—	—
Weighted average common shares outstanding – dilutive	11,444	8,170

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The following potentially dilutive instruments were not included in the diluted per share calculation for periods presented as their inclusion would have been antidilutive:

	Year Ended December 31,
	2009	2008
	(Thousands)
Stock options	1,484	1,279
Restricted stock	1	22
Warrants	147	147
Total	1,632	1,448

Income Taxes

In assessing the realization of deferred tax assets, the Company 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. The Company 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 the uncertainty of the economic conditions, the Company has recorded a full valuation allowance against its deferred tax assets at December 31, 2009 and 2008 in each jurisdiction where it cannot conclude that it is more likely than not that those assets will be realized.

Royalties

The Company has several royalty agreements with third parties, which represent agreements that the Company has with several athletes to use them in endorsing or advertising several of its products. Royalty expense during the years ended December 31, 2009 and 2008 was approximately $121,000 and $170,000, respectively.

Comprehensive Income (Loss)

Comprehensive income (loss) represents the results of operations adjusted to reflect all items recognized under accounting standards as components of comprehensive income (loss). Total comprehensive loss for the years ended December 31, 2009 and 2008 was approximately $3.4 million and $16.8 million, respectively.

The components of accumulated other comprehensive income, net of tax, are as follows:

	December 31,
	2009		2008
	(Thousands)
Equity adjustment from foreign currency translation	$	382	$	530
Unrealized gain on foreign currency exposure of net investment in foreign operations		492		372
Accumulated other comprehensive income	$	874	$	902

Share-Based Compensation

The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized in the consolidated statement of operations over the period during which the employee is required to provide service in exchange for the award—the requisite service period. No compensation cost is recognized for equity instruments for which

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employees do not render the requisite service. The grant-date fair value of employee share options and similar instruments is estimated using the Black-Scholes option-pricing valuation model adjusted for the unique characteristics of those instruments.

Recently Issued Accounting Pronouncements

In June 2009, the FASB issued authoritative guidance, which establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. The guidance is effective for interim and annual periods ending after September 15, 2009 and did not have a material impact on the Company’s consolidated financial statements.

In August 2009, the FASB issued changes to fair value accounting for liabilities. These changes clarify existing guidance that in circumstances in which a quoted price in an active market for the identical liability is not available, an entity is required to measure fair value using either a valuation technique that uses a quoted price of either a similar liability or a quoted price of an identical or similar liability when traded as an asset, or another valuation technique that is consistent with the principles of fair value measurements, such as an income approach (e.g., present value technique). This guidance also states that both a quoted price in an active market for the identical liability and a quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. These changes became effective for the Company on October 1, 2009. The Company determined that the adoption of these changes did not have an impact on the consolidated financial statements.

2. Accounts Receivable

Accounts receivable consisted of the following:

	December 31,
	2009			2008
	(Thousands)
Trade receivables	$	7,844		$	10,068
Less allowance for doubtful accounts		(485	)		(1,052	)
Less allowance for returns		(1,473	)		(2,025	)
Accounts receivable, net	$	5,886		$	6,991

3. Inventories

Inventories consisted of the following:

	December 31,
	2009		2008
	(Thousands)
Raw materials	$	848	$	1,679
Work in process		619		909
Finished goods		6,292		9,110
Inventories, net	$	7,759	$	11,698

The Company’s balances are net of an allowance for obsolescence of approximately $1,187,000 and $1,284,000 at December 31, 2009 and 2008, respectively.

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4. Property and Equipment

Property and equipment consisted of the following:

	December 31,
	2009			2008
	(Thousands)
Displays	$	1,213		$	1,034
Molds and tooling		1,896			2,231
Machinery and equipment		6,344			5,281
Buildings and leasehold improvements		2,474			2,486
Computer equipment and software		2,243			2,232
Furniture and fixtures		644			630
Vehicles		278			287
		15,092			14,181
Less accumulated depreciation and amortization		(10,200	)		(8,764	)
Property and equipment, net	$	4,892		$	5,417

Impairment charges of $336,000 were recorded during the year ended December 31, 2009. Approximately $387,000 relates to molds and tooling no longer in service and is recorded under the caption “Cost of Sales” in the accompanying Consolidated Statement of Operations and $24,000 relates to property and equipment no longer in service and is recorded under the caption “General and administrative”. These charges are partially offset by a $75,000 recovery of a deposit on production assets that was previously impaired and are recorded in “Cost of Sales”. Impairment charges of $250,000 were recorded during the year ended December 31, 2008. Approximately $92,000 relates to molds and tooling no longer in service and is recorded under the caption “Cost of Sales” in the accompanying Consolidated Statement of Operations. The remaining $158,000 relates to property and equipment no longer in service, of which $100,000, $48,000 and $10,000 are recorded under the captions “Cost of sales,” Sales and marketing” and “General and administrative,” respectively, in the accompanying Consolidated Statements of Operations.

Depreciation expense was approximately $1,669,000 and $1,880,000 for the years ended December 31, 2009 and 2008, respectively.

5. Accrued Expenses and Other Liabilities

Accrued expenses and other liabilities consisted of the following:

	December 31,
	2009		2008
	(Thousands)
Compensation and benefits	$	2,277	$	2,570
Production and warehouse		422		161
Sales and marketing		177		348
Commissions		169		302
Other		145		150
Customers with credit balances		80		178
Professional fees		80		159
Total	$	3,350	$	3,868

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6. Financing Arrangements

Credit Facilities

On February 26, 2007, O21NA, the Company’s wholly owned subsidiary, entered into a Loan and Security Agreement (“Loan Agreement”) with BFI with a maximum borrowing capacity of $5.0 million, which was subsequently modified on December 7, 2007 and February 12, 2008 to extend the maximum borrowing capacity to $8.0 million and affect certain other changes. Actual borrowing availability under the Loan Agreement is based on eligible trade receivable and inventory levels of O21NA. Loans extended pursuant to the Loan Agreement will bear interest at a rate per annum equal to the prime rate as reported in the Western Edition of the Wall Street Journal from time to time plus 2.5% with a minimum monthly interest charge of $2,000. The Company granted BFI a security interest in substantially all of O21NA’s assets as security for its obligations under the Loan Agreement. Additionally, the obligations under the Loan Agreement are guaranteed by Orange 21 Inc. The Loan Agreement renews annually in February for one additional year unless otherwise terminated by either the Company or by BFI. The Loan Agreement renewed in February 2010 until February 2011.

The Loan Agreement imposes certain covenants on O21NA, including, but not limited to, covenants requiring the Company to provide certain periodic reports to BFI, inform BFI of certain changes in the business, refrain from incurring additional debt in excess of $100,000 and refrain from paying dividends. O21NA also established a bank account in BFI’s name into which collections on accounts receivable and other collateral are deposited (the “Collateral Account”). Pursuant to the deposit control account agreement between O21NA and BFI with respect to the Collateral Account, BFI is entitled to sweep all amounts deposited into the Collateral Account and apply the funds to outstanding obligations under the Loan Agreement; provided that BFI is required to distribute to O21NA any amounts remaining after payment of all amounts due under the Loan Agreement. To secure its obligations under the guaranty, Orange 21 Inc. granted BFI a blanket security interest in substantially all of its assets. The Company was in compliance with the covenants under the Loan Agreement at December 31, 2009. At December 31, 2009 and December 31, 2008, there were outstanding borrowings of $3.0 million and $3.8 million, respectively, under the Loan Agreement. The interest rate at December 31, 2009 was 5.8%, and availability under this line was $0.9 million.

The Company has a 1.3 million Euros line of credit in Italy with San Paolo IMI for LEM S.r.l., the Company’s wholly owned subsidiary and manufacturer (“LEM”), which was reduced at December 31, 2009 to 0.6 million Euros. Borrowing availability is based on eligible accounts receivable and export orders received at LEM. At December 31, 2009, there was approximately 0.1 million Euros available under this line of credit. At December 31, 2009 and 2008, outstanding amounts under this line of credit amounted to $0.8 million and $1.9 million, respectively. The interest rate at December 31, 2009 was 2.5%.

As a result of the reductions in the Italian line of credit with San Paolo IMI, LEM entered into an unsecured note with San Paolo IMI during June 2009 for 0.4 million Euros. The note is guaranteed by Eurofidi, a government sponsored third party that guarantees debt, and bears interest at EURIBOR 3 months interest rate plus a 1.27% spread, payable in quarterly installments due from June 2009 through September 2014. LEM was not in compliance with certain debt covenants required by San Paolo IMI related to this note and therefore the entire balance of the note is classified as current. If San Paola IMI were to call this unsecured note as a result of noncompliance with the debt covenants, LEM’s operations and cash flow would be adversely impacted.

Effective March 23, 2010, O21NA entered into a $3.0 million Promissory Note with Costa Brava. The Promissory Note is subordinated to O21NA’s Loan Agreement with BFI. The proceeds from the Note are expected to be used (i) to prepay the current balance on O21NA’s revolving line of credit balance with BFI in its entirety and (ii) if any proceeds remain after such prepayment, for working capital purposes. However, O21NA may continue to re-borrow from BFI under the Loan Agreement after such prepayment is made.

Interest under the Promissory Note accrues daily at the following rates: (i) from the date of receipt of funds under the Promissory Note through April 30, 2010, at (A) 6% per annum on the last day of each calendar

55

month and (B) 6% per annum payable on April 30, 2010, and (ii) from May 1, 2010 through the maturity date, at (A) 9% per annum on the last day of each calendar month and (B) 3% per annum payable on the maturity date. In addition, the Promissory Note requires that O21NA pays a facility fee of 1% of the original principal amount on December 31, 2010 and the maturity date. The Promissory Note matures on July 29, 2011. The terms of the Promissory Note include customary representations and warranties, as well as reporting and financial covenants, customary for financings of this type.

7. Notes Payable

Notes payable at December 31, 2009 consist of the following:

	(Thousands)
Unsecured San Paolo IMI long-term debt guaranteed by Eurofidi, EURIBOR 3 months interest rate plus 1.27% spread, payable in quarterly installments due from June 2009 through September 2014. (1)	$	573
Unsecured San Paolo IMI long-term debt, EURIBOR 6 months interest rate plus 1.0% spread, payable in half year installments due from March 2007 to February 2012		305
Unsecured long-term debt, EURIBOR 1-month interest rate plus 1.5% spread, payable in half year installments due from December 2005 to December 2010		55
Unsecured long-term debt, fixed interest rate at 0.5%, payable in half year installments due from December 2005 to December 2010		22
Unsecured Centro Leasing Banco long-term debt, fixed interest rate at 10.43%, payable July 2012		32
Unsecured Centro Leasing Banco long-term debt, fixed interest rate at 10.04%, payable October 2012		28
Secured note payable for software purchases, 7.45% interest rate with monthly payments of $4,200 due through May 2010. Secured by software.		16
		1,031
Less current portion		(723	)
Notes payable, less current portion	$	308

(1) LEM was not in compliance with certain debt covenants required by San Paolo IMI related to this note and therefore the entire balance of the note is classified as current.

Future minimum payments under long-term debt agreements are as follows:

Year ended December 31,	Thousands
2010	$	723
2011		251
2012		57
Total	$	1,031

8. Stockholder’s Equity

Common Stock

During 2009 and 2008 an aggregate of 135,275 and 15,000 shares of common stock, respectively, were issued to individuals upon vesting of restricted stock awards.

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Shares Reserved

The Company had 100,000,000 authorized shares of common stock at December 31, 2009. The table below outlines common shares reserved for future issuance:

	(Thousands)
Total Authorized Shares	100,000
Common shares issued	(11,903	)
Shares reserved for future issuance:
Stock options outstanding	(1,484	)
Restricted stock awards	(1	)
Warrants	(147	)
Remaining Authorized Shares	86,465

9. Fair Value of Financial Instruments

In April 2009, the Company adopted the FASB’s authoritative guidance on interim disclosures about fair value of financial instruments, which requires disclosures about fair value of financial instruments in interim as well as in annual financial statements. The Company’s financial instruments include cash, accounts receivable and payable, short-term borrowings and accrued liabilities. The carrying amount of these instruments approximates fair value because of their short-term nature. The carrying fair value of the Company’s long-term debt, including the current portion approximates fair value as of December 31, 2009. The estimated fair value has been determined based on rates for the same or similar instruments.

10. Share-Based Compensation

In December 2004, the Board of Directors of the Company adopted, and the stockholders of the Company approved, the 2004 Stock Incentive Plan (the “Plan”). The Plan provides for the grant of incentive stock options to employees only, and restricted stock, stock units, nonqualified options or SARS to employees, consultants and outside directors. The Plan is administered by the Compensation Committee who determines the vesting period, exercise price and other details for each award. In April 2007, in connection with a determination by the Board of Directors to reduce the annual cash compensation paid to the non-employee directors of the Company, the Board of Directors approved an amendment and restatement of the Plan that: (1) increases the number of shares of the Company’s Common Stock underlying the non-qualified stock options that are automatically granted to the Company’s non-employee directors upon their appointment to the Board of Directors and on an annual basis thereafter and (2) modifies the vesting schedule for the automatic option grants made to non-employee directors upon their initial appointment to the Board of Directors. The amendment and restatement of the Plan was approved by the Company’s stockholders at the annual meeting held on June 12, 2007.

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Stock Option Activity

	Shares		Weighted- Average Exercise Price		Weighted-Average Remaining Contractual Term (years)	Aggregate Intrinsic Value
						(Thousands)
Options outstanding at December 31, 2007	937,875		$	6.54
Granted	590,000		$	3.00
Expired	(179,375	)	$	6.93
Forfeited	(70,000	)	$	3.56
Options outstanding at December 31, 2008	1,278,500		$	5.02
Granted	1,020,000		$	1.12
Expired	(444,375	)	$	6.33
Forfeited	(370,000	)	$	3.72
Options outstanding at December 31, 2009	1,484,125		$	2.27	8.46	$	—
Options exercisable at December 31, 2009	553,416		$	4.03	7.41	$	—

Intrinsic value is defined as the difference between the relevant current market value of the common stock and the grant price for options with exercise prices less than the market values on such dates. During the years ended December 31, 2009 and 2008, the Company received $0 in cash proceeds from the exercise of stock options.

On May 26, 2009, the Compensation Committee of the Company’s Board of Directors (the “Committee”) determined, in accordance with the terms of the Company’s 2004 Stock Incentive Plan, as amended, to reprice certain outstanding options held by A. Stone Douglass, the Company’s Chief Executive Officer and Chief Financial Officer, and Jerry Collazo, the Company’s former Chief Financial Officer. Specifically, the exercise price for Mr. Douglass’ option to purchase 250,000 shares of the Company’s common stock granted on September 29, 2008 was reduced from $3.28 to $1.50 and the exercise prices of Mr. Collazo’s options to purchase 20,000 and 150,000 shares of the Company’s common stock granted on October 12, 2006 and August 29, 2007, respectively, were reduced from $4.89 and $5.38, respectively, to $1.50 (the foregoing options held by Messrs. Douglass and Collazo are referred to herein as, the “Options”). The reduced price of $1.50 represents a 103% premium over the closing price of the Company’s common stock on May 22, 2009, the last trading day before the Committee’s decision to reprice the Options. Other than the change to the exercise price, the terms of the Options remain in effect and unchanged.

In determining to reprice the Options, the Committee considered the fact that the Options had exercise prices well above the recent trading prices of the Company’s common stock and, therefore, no longer provided sufficient incentives for Messrs. Douglass and Collazo, and determined that repricing the Options was in the best interest of the Company and its stockholders. The incremental expense incurred as a result of the repricing of the Options was approximately $51,000.

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Information regarding stock options outstanding as of December 31, 2009 is as follows:

	Options Outstanding				Options Exercisable
Price Range	Shares	Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (years)	Shares	Weighted- Average Exercise Price
$  0.69 - $0.71	35,000	$	0.69	9.85	5,000	$	0.71
$  0.74	150,000	$	0.74	9.42	—	$	—
$  0.79	15,000	$	0.79	9.58	—	$	—
$  0.90	305,000	$	0.90	9.26	—	$	—
$  0.94	75,000	$	0.94	9.69	—	$	—
$  1.50	530,000	$	1.50	8.38	225,183	$	1.50
$  3.19 - $4.89	158,125	$	3.43	8.27	119,233	$	3.51
$  5.11 - $5.95	66,000	$	5.45	6.87	54,000	$	5.46
$  6.46	60,000	$	6.46	7.45	60,000	$	6.46
$  8.75	90,000	$	8.75	4.95	90,000	$	8.75
Total	1,484,125	$	2.27	8.46	553,416	$	4.03

Restricted Stock Award Activity

The Company periodically issues restricted stock awards to certain directors and key employees subject to certain vesting requirements based on future service. Fair value is calculated using the Black-Scholes option-pricing valuation model (single option approach).

	Shares		Weighted- Average Grant Date Fair Value
Non-vested at December 31, 2007	37,500		$	5.01
Released	(15,000	)		5.01
Non-vested at December 31, 2008	22,500		$	5.01
Awarded	130,067			0.90
Released	(135,275	)		1.06
Forfeited	(16,042	)		5.01
Non-vested at December 31, 2009	1,250		$	5.01

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The Company recognized the following share-based compensation expense during the years ended December 31, 2009 and 2008:

	Year Ended December 31,
	2009			2008
	(Thousands)
Stock options
General and administrative expense	$	405		$	463
Cost of sales		26			6
Selling and marketing		23			1
Shipping and warehouse		1			—
Research and development		3			—
Restricted stock
General and administrative expense		97			76
Cost of sales		36			—
Selling and marketing		14			24
Research and development		2			17
Total		607			587
Income tax benefit		(206	)		(200	)
Stock-based compensation expense, net of taxes		401			387
Effect of stock-based compensation on net loss per share:
Basic		(0.04	)		(0.05	)
Diluted		(0.04	)		(0.05	)

The following table summarizes the approximate unrecognized compensation cost for the share-based compensation awards and the weighted average remaining years over which the cost will be recognized:

	Total Unrecognized Compensation Expense		Weighted Average Remaining Years
	(Thousands)
Stock options	$	809	2.25
Restricted stock awards		51	0.45
Total	$	860

Determining Fair Value of Stock Option Grants

Valuation and Amortization Method.    The Company uses the Black-Scholes option-pricing valuation model (single option approach) to calculate the fair value of stock option grants. For options with graded vesting, the option grant is treated as a single award and compensation cost is recognized on a straight-line basis over the vesting period of the entire award.

Expected Term.    The expected term of options granted represents the period of time that the option is expected to be outstanding. The Company estimates the expected term of the option grants based on historical exercise patterns that it believes to be representative of future behavior as well as other various factors.

Expected Volatility.    The Company estimates its volatility using our historical share price performance over the expected life of the options, which management believes is materially indicative of expectations about expected future volatility.

Risk-Free Interest Rate.    The Company uses risk-free interest rates in the Black-Scholes option valuation model that are based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life of the options.

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Dividend Rate.    The Company has not paid dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Therefore, the Company uses an expected dividend yield of zero.

Forfeitures.    The FASB requires companies to estimate forfeitures at the time of grant and revise those estimates in subsequent reporting periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest.

The following weighted average assumptions were used to estimate the fair value of options granted during the years ended December 31, 2009 and 2008:

	Year ended December 31,
	2009		2008
Expected volatility	80.8	%	61.1	%
Risk-free interest rate	2.2	%	3.0	%
Expectation term (in years)	4.8		4.4
Dividend yield	—		—

11. Income Taxes

Income tax expense attributed to income from operations consists of:

	Year Ended December 31,
	2009		2008
	(Thousands)
Current
Federal	$	—	$	—
State		2		2
Foreign		96		228
Total		98		230
Deferred
Federal		—		1,864
State		—		585
Foreign		3		7
Total		3		2,456
Income tax provision	$	101	$	2,686

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The components that comprise deferred tax assets and liabilities are as follows:

	December 31,
	2009			2008
	(Thousands)
Deferred tax assets:
NOL carryforwards	$	5,796		$	4,812
Allowance for doubtful accounts		61			307
Compensation and vacation accrual		68			191
Reserve for returns and allowances		490			773
Unrealized foreign currency loss		—			50
Inventory reserve		315			223
Foreign deferred tax asset before valuation allowance		2,407			3,056
Non-cash compensation		282			220
Depreciation and amortization		453			84
Benefit of state tax items		32			1
Other		87			85
Gross deferred tax assets		9,991			9,802
Deferred tax liabilities:
Foreign deferred tax liability		(404	)		(391	)
Net deferred tax asset before valuation allowance		9,587			9,411
Valuation allowance		(9,991	)		(9,802	)
Net deferred tax asset (liability)	$	(404	)	$	(391	)

The reconciliation of computed “expected” income taxes to effective income tax expense by applying the federal statutory rate of 34% is as follows:

	Year Ending December 31,
	2009			2008
	(Thousands)
Computed “expected” tax expense	$	(1,243	)	$	(4,214	)
State taxes, net of federal benefit		(213	)		(723	)
Foreign tax expense		99			235
Foreign subsidiary (income) loss		522			3,631
Permanent items		151			161
U.S. valuation allowances		784			3,592
Other, net		1			4
	$	101		$	2,686

The change in the valuation allowance for the years ended December 31, 2009 and 2008 was an increase of $188,000 and $3,477,000, respectively. 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 the uncertainty of the economic conditions, the Company has recorded a full valuation allowance of $9,991,000 for its worldwide operations at December 31, 2009. The Company has recorded a $7,584,000 and $6,746,000 valuation allowance for its U.S. Operations at December 31, 2009 and 2008, respectively. The Company has recorded a $1,267,000 and $1,491,000 valuation

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allowance for its wholly owned subsidiary, Orange 21 Europe at December 31, 2009 and 2008, respectively. The Company has recorded a $1,140,000 and $1,565,000 valuation allowance for its wholly owned subsidiary, LEM at December 31, 2009 and 2008, respectively.

12. Employee Benefit Plans

In 1998, the Company adopted the Spy Optic 401(k) Plan, or the “Plan.” The Plan covers all employees who meet the eligibility requirements of a minimum of 270 hours of service and 18 years of age. The Plan is subject to the provisions of the Employee Retirement Income Security Act of 1974. Under the provisions of the Plan, eligible participants may contribute up to 15% of their annual compensation, not to exceed the maximum legal deferral. The Company is not required to contribute to the Plan and made no contributions to the Plan during the years ended December 31, 2009 and 2008.

13. Related Party Transactions

Customer Sales

At December 31, 2009, Simo Holdings, Inc. (fka No Fear, Inc., “No Fear”) and its affiliates beneficially owned approximately 11% of the Company’s outstanding common stock. In addition, No Fear and its subsidiaries, No Fear Retail Stores, Inc. (“No Fear Retail”) and MX No Fear Europe SAS (“MX No Fear”), own retail stores in the U.S. and Europe that purchase products from the Company. Aggregated sales to these stores during the years ended December 31, 2009 and 2008 were approximately $0.8 million and $1.2 million, respectively. The year ended December 31, 2009 included approximately $398,000 in sales achieved through product credit given to Mark Simo, the Company’s former Chief Executive Officer and director, in conjunction with the Settlement Agreement and Mutual General Release (the “Settlement Agreement”) discussed below. Accounts receivable due from these stores amounted to $187,000 and $429,000 at December 31, 2009 and 2008, respectively.

Aggregated sales to the MX No Fear stores during the years ended December 31, 2009 and 2008 were approximately $0.5 million and $1.0 million, respectively. Accounts receivable due from the MX No Fear stores amounted to $344,000 and $429,000 at December 31, 2009 and 2008, respectively.

No Fear Parties Settlement Agreement

On April 28, 2009, the Company entered into a Settlement Agreement, effective as of April 30, 2009, by and among the Company’s three wholly owned subsidiaries, O21NA, O21 Europe and LEM (collectively, the “Orange 21 Parties”), and Mark Simo, No Fear, No Fear Retail and MX No Fear, (collectively, the “No Fear Parties”). The Settlement Agreement relates to various disputes among the parties regarding outstanding accounts receivable owed to the Company by No Fear Retail and MX No Fear and certain claims by Mr. Simo regarding his compensation for services he rendered as former Chief Executive Officer of the Company.

Pursuant to the Settlement Agreement, No Fear and its subsidiaries agreed to pay all outstanding accounts receivable due to the Company as follows: (1) an aggregate of approximately 307,000 Euros to Orange 21 Europe on the execution of the Settlement Agreement, approximately 46,000 Euros of which was satisfied by the return of certain goggle products and (2) an aggregate of approximately $429,000 to O21NA, approximately $71,000 of which was paid on the execution of the Settlement Agreement with the remainder paid in monthly installments of approximately $71,000 over five months (the “Installment Payments”) with the final payment delivered on October 1, 2009. In exchange, the Company agreed to provide Mr. Simo, or such other No Fear parties as Mr. Simo may designate, with product credits in the aggregate amount of $600,000 for compensation for services rendered as the former Chief Executive Officer of the Company, less applicable payroll tax withholdings, to purchase products from the Company. The product credits accrue as follows: (1) $350,000 on the execution of the Agreement and (2) $50,000 per month for five months thereafter subject to payment of the

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applicable Installment Payment in full. The Company recorded an additional $300,000 expense in the first quarter of 2009 for Mr. Simo’s compensation as discussed above. The remaining $300,000 was expensed in prior periods.

Additionally, pursuant to the Settlement Agreement, No Fear issued to the Company a promissory note in the amount of approximately $357,000 (the “No Fear Note”) to memorialize the Installment Payments. Interest of 10%, compounded annually, would have accrued if No Fear failed to make timely payment of any of the Installment Payments. The No Fear Note was secured by a pledge of 446,808 shares of the Company’s common stock held by No Fear, pursuant to a stock pledge agreement.

Pursuant to the Settlement Agreement, the Orange 21 Parties on the one hand and the No Fear Parties on the other hand each released the other with respect to any and all claims arising from or related to past dealings of any kind between the parties. The Settlement Agreement was signed on April 28, 2009, but its effectiveness was conditioned upon receipt of all funds required to be delivered on execution, which did not occur until April 30, 2009. As of December 31, 2009, the Company received payments of approximately $429,000 from No Fear and approximately 261,000 Euros (approximately $344,000 in U.S. Dollars) from No Fear MX Europe with no further amounts due in accordance with the Settlement Agreement.

Promissory Note with Shareholder, Costa Brava Partnership III, L.P.

Effective March 23, 2010, O21NA entered into a $3.0 million Promissory Note with Costa Brava, which matures on July 29, 2011. The Chairman of the Company’s Board of Directors, Seth Hamot, is the President and sole member of Roark, Rearden & Hamot, LLC, which is the sole general partner of Costa Brava. See also Notes 6 “Financing Arrangements” and 20 “Subsequent Events” to the Consolidated Financial Statements.

14. Commitments and Contingencies

Operating Leases

The Company leases its principal administrative and distribution facilities in Carlsbad, California, under a month to month operating lease with monthly payments of approximately $38,000, and a warehouse facility in Varese, Italy, which is used primarily for international sales and distribution. LEM leases three buildings in Italy that are used for office space, warehousing and manufacturing. The Company also leases certain computer equipment, vehicles and temporary housing in Italy. Rent expense was approximately $679,000 and $771,000 for the years ended December 31, 2009 and 2008, respectively.

Future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year are as follows:

Year Ending December 31,	(Thousands)
2010	$	150
2011		46
2012		41
2013		3
Total	$	240

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Capital Leases

Future minimum lease payments under capital leases at December 31, 2009 are as follows:

Year Ending December 31,	(Thousands)
2010	$	444
2011		381
2012		169
2013		149
2014		124
Thereafter		38
Total minimum lease payments		1,305
Amount representing interest		(98	)
Present value of minimum lease payments		1,207
Less current portion		(395	)
Long-term portion	$	812

The cost of buildings and improvements, molds and machinery and equipment under capital leases at December 31, 2009 was approximately $1,405,000, $65,000 and $1,319,000, respectively. The amount of accumulated depreciation at December 31, 2009 was approximately $361,000, $11,000 and $169,000, respectively. Amortization of assets held under capital leases is included in depreciation expense.

Athlete Contracts

The Company has entered into endorsement contracts with athletes to actively wear and endorse the Company’s products. These contracts are based on minimum annual payments totaling $106,000 in 2010 and may include additional performance-based incentives and/or product-specific sales incentives. At December 31, 2009 we also had approximately $438,000 due to athletes under contract in 2009.

Product Development and Design Services

In January 2009, the Company entered into a non-exclusive agreement with Bartolomasi, Inc. for the design and development of sunglasses, goggles and prescription sunglass frames. Bartolomasi, Inc. has agreed to provide services to the Company as an independent consultant through January 4, 2011 and to be bound by confidentiality obligations. Under the agreement, Bartolomasi, Inc. assigns all ideas, inventions and other intellectual property rights created or developed on the Company’s behalf during the term of the agreement to the Company. The agreement may be terminated by either party with or without cause upon 60 days prior written notice. The agreement has minimum monthly payments totaling $180,000 per annum in both 2009 and 2010.

Litigation

From time to time the Company may be party to lawsuits in the ordinary course of business. The Company is not currently a party to any material legal proceedings.

15. Concentrations

Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable. The Company grants unsecured credit to substantially all of its customers. Management does not believe that it is exposed to any extraordinary credit risk as a result of this policy.

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The Company maintains cash balances at various financial institutions primarily located in San Diego and in Italy. Accounts at the U.S. institutions are secured by the Federal Deposit Insurance Corporation. The Company has not experienced any losses in such accounts. Management believes that the Company is not exposed to any significant credit risk with respect to its cash.

Customer

For the years ended December 31, 2009 and 2008, the Company had no sales to third party customers that accounted for 10% or more of total net sales.

Supplier

The Company purchases substantially all of its goggles from one manufacturer in China, OGK, and expects to continue to do so during 2010. LEM produces a substantial amount of sunglasses for the Company and currently purchases substantially all of its plastic frames from one supplier in Italy. The Company does not have long-term agreements with any of its manufacturers other than LEM. The Company believes that other suppliers could provide plastic frames on comparable terms, however, a change in suppliers could result in a delay in manufacturing and a possible loss of sales, which would adversely affect operating results.

16. Operating Segments and Geographic Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company’s management in deciding how to allocate resources and in assessing performance. The Company designs, produces and distributes sunglasses, snow and motocross goggles, and branded apparel and accessories for the action sports, snowsports and lifestyle markets. The Company owns a manufacturer LEM located in Italy. LEM manufactures products for non-competing brands in addition to a substantial amount of the Company’s sunglass products. Results for LEM reflect operations of this manufacturer after elimination of intercompany transactions. The Company operates in two business segments: distribution and manufacturing.

Information related to the Company’s operating segments is as follows:

	Year Ended December 31,
	2009			2008
	(Thousands)
Net sales:
Distribution	$	29,384		$	41,936
Manufacturing		4,854			5,340
Intersegment		7,863			13,940
Eliminations		(7,863	)		(13,940	)
Total	$	34,238		$	47,276
Operating loss:
Distribution	$	(2,445	)	$	(3,852	)
Manufacturing		(845	)		(8,009	)
Total	$	(3,290	)	$	(11,861	)
Net loss:
Distribution	$	(2,302	)	$	(6,704	)
Manufacturing		(1,105	)		(8,508	)
Total	$	(3,407	)	$	(15,212	)

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	December 31,
	2009		2008
	(Thousands)
Tangible long-lived assets:
Distribution	$	1,104	$	1,915
Manufacturing		3,788		3,502
Total	$	4,892	$	5,417

The Company markets its products domestically and internationally, with its principal international market being Europe. Revenue is attributed to the location from which the product was shipped. Identifiable assets are based on location of domicile.

	Year Ended December 31,
	U.S. and Canada		Europe and Asia Pacific		Consolidated		Intersegment
			(Thousands)				(Thousands)
	2009						2009
Net sales	$	24,132	$	10,106	$	34,238	$	7,863
	2008						2008
Net sales	$	33,510	$	13,766	$	47,276	$	13,940

	December 31,
	2009		2008
	(Thousands)
Tangible long-lived assets:
U.S. and Canada	$	750	$	1,418
Europe and Asia Pacific		4,142		3,999
Total	$	4,892	$	5,417

17. Quarterly Financial Data (unaudited)

	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
	(Thousands, except per share data)
Year ended December 31, 2009:
Net sales	$	7,421		$	9,116		$	8,776		$	8,925
Gross profit		3,631			4,186			2,861			2,161
Loss before provision (benefit) for income taxes		(824	)		(225	)		(1,085	)		(1,172	)
Net income (loss)		(804	)		(254	)		(1,136	)		(1,213	)
Basic net income (loss) per share	$	(0.08	)	$	(0.02	)	$	(0.10	)	$	(0.10	)
Diluted net income (loss) per share	$	(0.08	)	$	(0.02	)	$	(0.10	)	$	(0.10	)
Year ended December 31, 2008:
Net sales	$	11,554		$	13,984		$	12,042		$	9,696
Gross profit		5,444			6,945			5,913			2,994
Loss before provision (benefit) for income taxes		(1,120	)		(235	)		59			(11,230	)
Net income (loss)		(851	)		(273	)		6			(14,094	)
Basic net income (loss) per share	$	(0.10	)	$	(0.03	)	$	(0.14	)	$	(1.72	)
Diluted net income (loss) per share	$	(0.10	)	$	(0.03	)	$	(0.14	)	$	(1.72	)

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18. Acquisitions

On January 16, 2006, the Company completed the acquisition of a manufacturer LEM. The total purchase price for LEM was 3.5 million Euros or $4.2 million in cash, plus a two year earn-out based on LEM’s future sales. Under the terms of the earn-out, the Company was obligated to make quarterly payments based on unit sales, up to a maximum of 1.4 million Euros, through December 31, 2007. The maximum amount of additional consideration was earned and paid out as of December 31, 2007. Accordingly, the entire amount has been included in the purchase price allocation. The acquisition of LEM has allowed the Company to control its primary manufacturer and ensure a continued source of supply for the Company’s products.

The acquisition was accounted for under the purchase method of accounting; and, accordingly, the purchased assets and liabilities assumed were recorded at their estimated fair values at the date of the acquisition based on internal valuations and third party appraisals. The purchase price allocation for this acquisition resulted in an excess of the purchase price over net tangible assets acquired of approximately $8.2 million, of which $0.2 million was allocated to customer relationships, which is being amortized on a straight-line basis over the estimated useful life of 7 years. The remaining $8.0 million was allocated to goodwill. An estimate of the fair value of the intangible asset acquired was made using the income approach and the residual earnings method. Significant assumptions used in the residual earnings method included an income tax rate of 37.25%, a target EBIT margin of 13% and a long-term growth rate of 3.0%.

Goodwill at December 31, 2008 and 2007 was $0 and $9.7 million, respectively. The change in goodwill from date of acquisition to December 31, 2007 represents a difference in foreign exchange spot rates used in translation of LEM’s books during consolidation. With the significant deterioration in the retail business climate as well as a large decline in the market value of the Company’s common stock during the fourth quarter for the year ended December 31, 2008, the Company performed an interim evaluation of goodwill impairment. As a result of this interim evaluation, the Company determined that the goodwill associated with the January 2006 acquisition of LEM was fully impaired and recorded a pre-tax non-cash goodwill impairment charge of $8.4 million in its December 31, 2008 financial statements. See Note 1 for further information.

19. Rights Offering

On January 22, 2009, the Company launched a rights offering to raise a maximum of $7.6 million pursuant to which holders of the Company’s common stock, options and warrants, were entitled to purchase additional shares of the Company’s common stock at a price of $0.80 per share (the “Rights Offering”). The proceeds from the Rights Offering are being used for general corporate purposes, which may include research and development, capital expenditures, payment of trade payables, working capital and general and administrative expenses. The Company may also use a portion of the net proceeds to acquire or invest in complementary businesses, products and technologies, although the Company has no current plans, commitments or agreements with respect to any such transactions.

In the Rights Offering, stockholders, option holders and warrant holders as of 5:00 p.m., New York City time January 21, 2009, were issued, at no charge, one subscription right for each share of common stock then outstanding or subject to outstanding options or warrants (whether or not currently exercisable). Each right entitled the holder to purchase one share of the Company’s common stock for $0.80 per share.

The Rights Offering was conducted via an existing effective shelf registration statement on Form S-3. An aggregate of 9,544,814 subscription rights were distributed in the Rights Offering entitling the Company’s stockholders, option holders and warrant holders to purchase up to 9,544,814 shares of the Company’s common stock at a price of $0.80 per share. The subscription rights were not transferable and were evidenced by subscription rights certificates. Fractional shares were not issued in the Rights Offering. The subscription rights issued pursuant to the Rights Offering expired at 5:00 p.m., New York City time, on March 6, 2009. The Company also reserved the right to allocate unsubscribed shares to other investors at $0.80 per share.

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Approximately 3.6 million shares of the Company’s common stock were purchased in the Rights Offering for an aggregate of approximately $2.9 million, including approximately $0.5 million in proceeds from the purchase of unsubscribed shares. Costs related to the Rights Offerings during the year ended December 31, 2009 were approximately $0.4 million.

20. Subsequent event

Spy Optic, Inc. Name Change

On January 11, 2010 the Company’s subsidiary Spy Optic, Inc. changed its name to Orange 21 North America Inc.

On February 11, 2010, Jerry Collazo resigned as the Company’s Chief Financial Officer to pursue other opportunities. On February 12, 2010, the Company’s board of directors (the “Board”) appointed A. Stone Douglass, the Company’s Chairman and Chief Executive Officer, as the Company’s acting Chief Financial Officer. The Board does not have any immediate plans to replace Mr. Collazo.

Additionally, effective February 12, 2010, the Board elected Seth Hamot, an existing director of the Company, as Chairman of the Board to replace Mr. Douglass who will continue to serve as a director, Chief Executive Officer and acting Chief Financial Officer.

Promissory Note with Shareholder, Costa Brava Partnership III, L.P.

Effective March 23, 2010, O21NA entered into a $3.0 million Promissory Note with Costa Brava. The Promissory Note is subordinated to O21NA’s Loan Agreement, as amended, with BFI, pursuant to the terms of a Debt Subordination Agreement, dated March 23, 2010, by and between Costa Brava and BFI. The proceeds from the Note are expected to be used (i) to prepay the current balance on O21NA’s revolving line of credit balance with BFI in its entirety and (ii) if any proceeds remain after such prepayment, for working capital purposes. However, O21NA may continue to re-borrow from BFI under the Loan Agreement after such prepayment is made.

Interest under the Promissory Note accrues daily at the following rates: (i) from the date of receipt of funds under the Promissory Note through April 30, 2010, at (A) 6% per annum on the last day of each calendar month and (B) 6% per annum payable on April 30, 2010, and (ii) from May 1, 2010 through the maturity date, at (A) 9% per annum on the last day of each calendar month and (B) 3% per annum payable on the maturity date. In addition, the Promissory Note requires that O21NA pays a facility fee of 1% of the original principal amount on December 31, 2010 and the maturity date. The Promissory Note matures on July 29, 2011. The terms of the Promissory Note include customary representations and warranties, as well as reporting and financial covenants, customary for financings of this type.

The Chairman of the Company’s Board of Directors, Seth Hamot, is the President and sole member of Roark, Rearden & Hamot, LLC, which is the sole general partner of Costa Brava. Costa Brava and Seth Hamot together own approximately 28% of the Company’s common stock as of March 26, 2010.

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Orange 21 Inc. and Subsidiaries

Schedule II—Valuation and Qualifying Accounts

For the Years Ended December 31, 2009 and 2008

	Balance at Beginning of Year		Additions		Deductions			Balance at End of Year
	(Thousands)
Allowance for doubtful accounts:
Year ended December 31, 2009	$	1,052	$	—	$	(567	)	$	485
Year ended December 31, 2008	$	775	$	690	$	(413	)	$	1,052
Allowance for sales returns:
Year ended December 31, 2009	$	2,026	$	—	$	(553	)	$	1,473
Year ended December 31, 2008	$	1,955	$	88	$	(17	)	$	2,026
Allowance for inventory reserve:
Year ended December 31, 2009	$	1,284	$	922	$	(1,018	)	$	1,188
Year ended December 31, 2008	$	2,264	$	307	$	(1,287	)	$	1,284

Note: Additions to the allowance for doubtful accounts are charged to bad debt expense. Additions to the allowance for sales returns are charged against revenues. Additions to the allowance for inventory reserve are charged against cost of goods sold.

All other schedules have been omitted because they are either inapplicable or the required information has been provided in the Consolidated Financial Statements or the Notes thereto.

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Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A(T). Controls and Procedures

Disclosure Control and Procedures

Management, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (Exchange Act)) as of December 31, 2009, the end of the period covered by this report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed is recorded, processed, summarized and reported within the time frames specified by the SEC’s rules and forms. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2009.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) under the Exchange Act). Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those policies and procedures that: (i) in reasonable detail accurately and fairly reflect our transactions; (ii) provide reasonable assurance that transactions are recorded as necessary for preparation of our financial statements in accordance with generally accepted accounting principles, and that provide reasonable assurance that our receipts and expenditures are made in accordance with management authorization; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting, however well designed and operated, can provide only reasonable, and not absolute, assurance that the controls will prevent or detect misstatements. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there is only the reasonable assurance that our controls will succeed in achieving their goals under all potential future conditions.

Management, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, conducted an evaluation of our internal control over financial reporting as of December 31, 2009, based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (or the “COSO” criteria). Based on our evaluation under the COSO framework, management concluded that our internal control over financial reporting was effective as of December 31, 2009.

This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this Annual Report.

Changes in Internal Control over Financial Reporting

During the fiscal quarter ended December 31, 2009, there were no changes in our internal control over financial reporting identified in connection with the evaluation described above that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Item 9B. Other Information

Promissory Note with Shareholder, Costa Brava Partnership III, L.P.

Effective March 23, 2010, we entered into a $3.0 million Promissory Note with Costa Brava Partnership III, L.P. (“Costa Brava”). The Promissory Note is subordinated to our Loan and Security Agreement with BFI Business Finance (“BFI”), pursuant to the terms of a Debt Subordination Agreement, dated March 23, 2010, by and between Costa Brava and BFI. The proceeds from the Note are expected to be used (i) to prepay the current balance on our revolving line of credit balance with BFI in its entirety and (ii) if any proceeds remain after such prepayment, for working capital purposes. However, we may continue to re-borrow from BFI under the Loan and Security Agreement after such prepayment is made.

Interest under the Promissory Note accrues daily at the following rates: (i) from the date of receipt of funds under the Promissory Note through April 30, 2010, at (A) 6% per annum on the last day of each calendar month and (B) 6% per annum payable on April 30, 2010, and (ii) from May 1, 2010 through the maturity date, at (A) 9% per annum on the last day of each calendar month and (B) 3% per annum payable on the maturity date. In addition, the Promissory Note requires that we pay a facility fee of 1% of the original principal amount on December 31, 2010 and the maturity date. The Promissory Note matures on July 29, 2011. The terms of the Promissory Note include customary representations and warranties, as well as reporting and financial covenants, customary for financings of this type.

The Chairman of our Board of Directors, Seth Hamot, is the President and sole member of Roark, Rearden & Hamot, LLC, which is the sole general partner of Costa Brava. Costa Brava and Seth Hamot together own approximately 28% of our common stock as of March 26, 2010.

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PART III

Documents Incorporated by Reference

In response to Part III, Items 10, 11, 12, 13 and 14, parts of the Company’s definitive proxy statement (to be filed pursuant to Regulation 14A within 120 days after Registrant’s fiscal year-end of December  31, 2009) for its annual stockholders’ meeting are incorporated by reference in this Form 10-K.

Item 10. Directors, Executive Officers and Corporate Governance

The information required by Item 10 will be contained in, and is hereby incorporated by reference to, our Proxy Statement relating to our 2010 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year ended December 31, 2009.

Item 11. Executive Compensation

The information required by Item 11 will be contained in, and is hereby incorporated by reference to, our Proxy Statement relating to our 2010 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year ended December 31, 2009.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters

The information required by Item 12 will be contained in, and is hereby incorporated by reference to, our Proxy Statement relating to our 2010 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year ended December 31, 2009.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by Item 13 will be contained in, and is hereby incorporated by reference to, our Proxy Statement relating to our 2010Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year ended December 31, 2009.

Item 14. Principal Accounting Fees and Services

The information required by Item 14 will be contained in, and is hereby incorporated by reference to, our Proxy Statement relating to our 2010 Annual Meeting of Stockholders.

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PART IV

Item 15. Exhibits and Financial Statement Schedules

(a) Documents filed as part of this report:

(1) Financial Statements

Reference is made to the Index to Consolidated Financial Statements of Orange 21 Inc., under Item 8 of Part II hereof.

(2) Financial Statement Schedules

The following financial statement schedule of Orange 21 Inc. is filed as part of this Form 10-K (under Item 8 of Part II hereof):

Schedule II – Valuation and Qualifying Accounts

All other financial statement schedules have been omitted because they are not applicable or not required or because the information is included elsewhere in the Consolidated Financial Statements or the Notes thereto.

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Exhibits

Exhibit Number	Description of Document
3.2	Restated Certificate of Incorporation (incorporated by reference to Form S-1 (File No. 333-119024) declared effective on December 13, 2004)
3.4	Amended and Restated Bylaws (incorporated by reference to Form S-1 (File No. 333-119024) declared effective on December 13, 2004)
4.1	Form of Common Stock Certificate (incorporated by reference to Form S-1 (File No. 333-119024) declared effective on December 13, 2004)
4.2	Common Stock Purchase Warrant to Purchase 142,000 shares of Common Stock of Orange 21 Inc. issued to Roth Capital Partners, LLC dated June 22, 2005 (incorporated by reference to Form 10-Q filed August 11, 2005)
4.3	Common Stock Purchase Warrant to Purchase 5,000 shares of Common Stock of Orange 21 Inc. issued to Dana Mackie dated June 22, 2005 (incorporated by reference to Form 10-Q filed August 11, 2005)
10.2+	2004 Stock Incentive Plan (incorporated by reference to Form S-1 (File No. 333-119024) declared effective on December 13, 2004)
10.3+	Form of Stock Option Agreement under the 2004 Stock Incentive Plan (incorporated by reference to Form 10-Q filed November 14, 2005)
10.42	Loan and Security Agreement entered February 26, 2007 by and between Orange 21 North America Inc. (fka Spy Optic, Inc.) and BFI Business Finance (incorporated by reference to Form 8-K filed March 2, 2007)
10.43	General Continuing Guaranty entered February 26, 2007 by and between Orange 21 Inc. and BFI Business Finance (incorporated by reference to Form 8-K filed March 2, 2007)
10.44	First modification to Loan and Security Agreement entered into on December 7, 2007 by and between Orange 21 North America Inc. and BFI Business Finance (incorporated by reference to Form 8-K filed December 12, 2007)
10.45	Second modification to Loan and Security Agreement entered into on February 12, 2008 by and between Orange 21 North America Inc. and BFI Business Finance (incorporated by reference to Form 10-K filed April 8, 2008)
10.46+	Executive Employment Agreement, dated January 19, 2009, between Orange 21Inc. and A. Stone Douglass (incorporated by reference to Form 8-K filed January 26, 2009)
10.47*	Settlement Agreement and Mutual General Release dated April 28, 2009 by and between the Company, Orange 21 North America Inc., Orange 21 Europe S.r.l., (fka Spy Optic, S.r.l.) and LEM S.r.l., on the one hand, and Mark Simo, Simo Holdings (fka No Fear, Inc.) No Fear Retail Stores, Inc. and MX No Fear Europe SAS, on the other hand (incorporated by reference to Form 10-Q filed August 13, 2009)
10.48+	Amendment No. 1 to Orange 21 Inc. Notice of Stock Option Grant and Stock Agreement, dated as of May 20, 2009, by and between the Company and A. Stone Douglass, the Company’s Chief Executive Officer and Acting Chief Financial Officer (incorporated by reference to Form 10-Q filed August 13, 2009)
10.49+	Amendment No. 1 to Orange 21 Inc. Notice of Stock Option Grant and Stock Option Agreement dated as of May 26, 2009 by and between the Company and Jerry Collazo, the Company’s former Chief Financial Officer (incorporated by reference to Form 10-Q filed August 13, 2009)

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Exhibit Number	Description of Document
10.50+	Amendment No. 2 to Orange 21 Inc. Notice of Stock Option Grant and Stock Option Agreement dated as of May 26, 2009 by and between the Company and Jerry Collazo, the Company’s former Chief Financial Officer (incorporated by reference to Form 10-Q filed August 13, 2009)
10.51+	Letter Agreement dated May 20, 2009 by and between the Company and Erik Darby, the Company’s Vice President of Sales
10.52	Promissory Note effective March 23, 2010 by and between Orange 21 North America Inc. and Costa Brava
14.1	Code of Ethics for Senior Officers (incorporated by reference to Form 10-K filed March 31, 2005)
14.2	Code of Business Conduct (incorporated by reference to Form 10-K filed March 31, 2005)
21.1	List of subsidiaries
23.1	Consent of Mayer Hoffman McCann P.C., independent registered certified public accountants
24.1	Power of Attorney (included in signature page)
31.1	Section 302 Certification of the Company’s Chief Executive Officer
32.1	Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)

+ Management contract or compensatory plan or arrangement.

* Portions of the exhibit have been omitted pursuant to a request for confidential treatment.

76

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Orange 21 Inc.
Date: March 26, 2010
	By	/s/ A. Stone Douglass
		A. Stone Douglass
		Chief Executive Officer and Acting Chief Financial Officer

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints A. Stone Douglass, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any amendments to this report on Form 10-K and each amendment hereto and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Name	Title	Date
/s/ A. Stone Douglass A. Stone Douglass	Chief Executive Officer, Acting Chief Financial Officer and Director (principal executive, financial and accounting officer)	March 26, 2010
/s/ Seth W. Hamot Seth W. Hamot	Chairman of the Board of Directors	March 26, 2010
/s/ Harry Casari Harry Casari	Director	March 26, 2010
/s/ David Mitchell David Mitchell	Director	March 26, 2010
/s/ John Pound John Pound	Director	March 26, 2010
/s/ Stephen Roseman Stephen Roseman	Director	March 26, 2010
/s/ Greg Theiss Greg Theiss	Director	March 26, 2010

77

EX-10.51

Exhibit 10.51

Spy Optic, Inc. 2070 Las Palmas Drive Carlsbad, CA 92011 PH: (760) 804-8420 FX: (760) 804-8442 www.spyoptic.com

May 20, 2009

Erik Darby

7631 Circulo Sequoia

Carlsbad, CA 92009

Re: Employment Offer – Revised

Dear Erik,

Pursuant to our discussions, the following is a summary of Spy Optic’s employment offer to you with respect to the Vice President of Sales position which reports directly to the CEO.

Start Date:	June 8, 2009
Salary:	$190,000 annually (paid on bi-weekly payroll cycle = gross $7307.69 per pay period). Less company wide 10% reduction, estimated for 4 months.
Hiring Bonus:	$6333.33 to be paid in monthly installments of $1583.33 each month during the estimated 4 month company wide 10% reduction period.
Stock:	80,000 shares of stock options. The stock option price and vesting will be determined by the Comp Committee within a reasonable time period after start date.
Bonus:	Potential cumulative total of 30% of base. Criteria for bonus achievement to be determined within a reasonable time period after your start date as discussed.
Benefits:	Health, Dental, Vision, FSA, Life & AD&D Insurance, 401K, Paid Vacation & Sick. You will begin to accrue 120 hours of vacation (3 weeks) per year within the pay period of your hire date. Your effective date for insurance coverage will be the first of the month after your start date. The monthly premium for you and your family for medical, dental and vision insurance will be paid by the company. Employee contributions are required for enrollment in the FSA, Supplemental Life/AD&D and 401k plans. A company cell phone will also be provided.
Severance:	6 (six) months severance if you are terminated without cause.

Darby – Offer Letter Revised – Page 2

At-Will Employment: You are free to terminate your employment with Spy Optic, Inc. at any time, with or without a reason, and Spy has the right to terminate your employment at any time, with or without a reason. Although Spy may choose to terminate employment for cause, cause is not required. This is called “at-will” employment.

Introductory Period: All offers of employment are contingent on verification of your right to work in the United States. On your first day of work you will be asked to provide original documents verifying your right to work and to sign a verification form required by federal law. If you cannot, at any time, verify your right to work in the United States, Spy may be obligated to terminate your employment.

New employees are introductory employees for a period which begins on the date of commencement of employment and ends on the last day of the third full calendar month after the date of commencement of employment. During your introductory period, you will have an opportunity to learn your new position and see whether you enjoy your employment at Spy. Spy will use this period to see if you are able to meet Spy’s expectations. If, at any time during your introductory period, Spy determines that you are not meeting Spy’s expectations, Spy may terminate your employment.

Successful completion of your introductory period is not a guarantee of continued employment. Introductory periods may be extended for business reasons, or because of permitted time off taken by the employee.

We look forward to having you as part of the Spy Optic team. If you have any other questions concerns related to this Employment Offer, please do not hesitate to contact me.

Sincerely,

/s/ Jerry Collazo

Jerry Collazo

Chief Financial Officer

Spy Optic, Inc.

/s/ Erik Darby	7/15/09
Erik Darby	Date

EX-10.52

Exhibit 10.52

THIS PROMISSORY NOTE IS SUBORDINATE TO CERTAIN OBLIGATIONS OF THE COMPANY AS DESCRIBED IN THE BFI LOAN DOCUMENTS (DEFINED HEREIN) AND SUBJECT TO THAT CERTAIN DEBT SUBORDINATION AGREEMENT DATED THE DATE HEREOF AMONG BFI BUSINESS FINANCE AND THE HOLDER.

THIS PROMISSORY NOTE HAS BEEN ACQUIRED FOR INVESTMENT AND HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, OR QUALIFIED UNDER ANY STATE SECURITIES LAWS. THIS NOTE MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR QUALIFICATION OR AN EXEMPTION THEREFROM UNDER SAID ACT AND ANY APPLICABLE STATE SECURITIES LAWS.

THIS PROMISSORY NOTE HAS BEEN ISSUED WITH “ORIGINAL ISSUE DISCOUNT” WITHIN THE MEANING OF SECTION 1273 OF THE INTERNAL REVENUE CODE OF 1986, AS AMENDED. UPON WRITTEN REQUEST, THE COMPANY WILL PROMPTLY MAKE AVAILABLE TO ANY HOLDER OF THIS NOTE THE FOLLOWING INFORMATION: (1) THE ISSUE PRICE AND DATE OF THE NOTE, (2) THE AMOUNT OF ORIGINAL ISSUE DISCOUNT ON THE NOTE AND (3) THE YIELD TO MATURITY OF THE NOTE. TO OBTAIN THIS INFORMATION, A HOLDER SHOULD CONTACT THE CHIEF FINANCIAL OFFICER AT 2070 LAS PALMAS DRIVE, CARLSBAD, CA 92011.

PROMISSORY NOTE

$3,000,000	March 19, 2010
	San Diego, California

FOR VALUE RECEIVED, Spy Optic, Inc., a California corporation (the “Company”), promises to pay to the order of Costa Brava Partnership III, L.P., a Delaware limited partnership, or its registered assigns (“Holder”), the principal sum of Three Million Dollars ($3,000,000) on July 29, 2011 (the “Maturity Date”), together with fees and interest thereon as provided in Section 2 of this Note (the “Note”).

1. Definitions. For purposes of this Note, the following terms shall have the following meanings:

“Affiliate” shall mean with respect to any Person, any other Person which directly or indirectly through one or more intermediaries Controls, or is Controlled by, or is under common Control with, such first Person.

“BFI Loan Documents” shall mean the Loan and Security Agreement, dated as of February 26, 2007, between the Company and BFI Business Finance, as modified by the First Modification to Loan and Security Agreement, dated as of December 7, 2007, as further modified by the Second Modification to Loan and Security Agreement dated as of February 12, 2008, and as further modified by the Third Modification to Loan and Security Agreement dated as of June 23, 2008 and the other Loan Documents as defined therein.

“Business” means the business of the Company its Subsidiaries of designing, developing, manufacturing and marketing products for the action sports, motorsports and youth lifestyle markets, and related activities, as conducted or proposed to be conducted by the Company its Subsidiaries on the date hereof and reasonable extensions thereof.

“Business Day” means any day which is not a Saturday or Sunday or a legal holiday on which national banks are authorized or required to be closed.

“Control” shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of a person, whether through the ownership of voting securities, by contract or otherwise, and the terms “Controlling” and “Controlled” (and the lower-case versions of the same) shall have meanings correlative thereto.

“Debt” shall mean all liabilities, obligations and indebtedness of every kind and nature of any Person, including, without limitation: (i) all obligations for borrowed money, including, without limitation, all obligations of such Person evidenced by bonds, debentures, notes, loan agreements or other similar instruments or deferred purchase price of property; (ii) obligations as lessee under any leases (including under any capital leases); (iii) any reimbursement or other obligations under any performance or surety bonds, any letters of credit and similar instruments issued for the account of such Person; (iv) all net obligations in respect of any derivative products; (v) all guaranties, endorsements (other than for collection or deposit in the ordinary course of business), and other contingent obligations to purchase, to provide funds for payment, to supply funds to invest in any other Person, or otherwise to assure a creditor against loss; and (vi) obligations secured by any Lien on property owned by such Person, whether or not the obligations have been assumed or are limited in recourse.

“GAAP” means generally accepted principles of good accounting practice in the United States, consistently applied.

“Governmental Authority” shall mean any federal, state, local or other governmental department, commission, board, bureau, agency or other instrumentality or authority, domestic or foreign, exercising executive, legislative, judicial, regulatory or administrative authority or functions of or pertaining to government.

“Investment” shall mean, with respect to any Person, any direct or indirect acquisition or investment by such Person, whether by means of any loan, advance to, guarantee or assumption of Debt of, or purchase or other acquisition or any other debt participation or interest in such Person, any purchase or other acquisition of any capital stock, debt or other securities of such Person, any capital contribution to such Person in, or any other investment in, or acquisition (in one transaction or a series of transactions) of, any interest or all or substantially all of the property and assets or business of another Person or assets constituting a business unit, line of business or division of, such Person.

“Legal Requirement” means any present or future requirement imposed upon the Company or any of its Subsidiaries by any law, statute, rule, regulation, directive, order, decree or guideline (or any interpretation thereof by courts or of administrative bodies) of the United States of America, or any state, or other political subdivision thereof, or by any board, governmental or administrative agency, central bank or monetary authority of the United States of America or any other jurisdiction in which the Company owns property or conducts its business, or any political subdivision of any of the foregoing.

“Lien” shall mean any security interest, mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory, judgment or other), claim or other priority or preferential arrangement of any kind or nature whatsoever, including any conditional sale or other title retention

agreement, any easement, right of way or other encumbrance on title to real property, and any capital lease having substantially the same economic effect as any of the foregoing (other than a financing statement filed by a lessor in respect of an operating lease not intended as security).

“Material Adverse Effect” shall mean any event, matter, condition or circumstance which (i) has or would reasonably be expected to have a material adverse effect on the business, properties, operations, condition (financial or otherwise) or prospects of the Company and its Subsidiaries, taken as a whole; (ii) would materially impair the ability of the Company or any other Person to perform or observe their respective obligations under or in respect of this Note; (iii) would materially impair the rights and remedies of Holder under this Note, or (iv) affects the legality, validity, binding effect or enforceability of this Note.

“Obligations” shall mean all debts, liabilities, obligations, covenants and duties of the Company howsoever created, arising or evidenced, whether direct or indirect, joint or several, absolute or contingent, or now or hereafter existing, or due or to become due, which arise out of or in connection with this Note, including, without limitation, all costs and expenses incurred by Holder in connection with the enforcement of this Note and any interest and fees that accrue to Holder after the commencement by or against the Company of any proceeding under any laws naming the Company as a debtor in such proceeding, regardless of whether such interest and fees are allowed claims in such proceeding.

“Organic Document” means, relative to any Person, its articles or certificate of incorporation, or certificate of limited partnership or formation, its bylaws, partnership or operating agreement or other organizational documents, and all stockholders agreements, voting trusts and similar arrangements applicable to any of its capital stock, partnership interests or other ownership interests.

“Permitted Debt” shall mean (i) Obligations of the Company to Holder hereunder or under any other document related to or in connection with the Note; (ii) Debt of the Company under the BFI Loan Documents not to exceed $4,000,0000 at any one time outstanding, or extensions, renewals and refinancings of such Debt, provided that the principal amount of such Debt being extended, renewed or refinanced under the BFI Loan Documents does not increase, the terms thereof are not modified to impose more burdensome terms upon the Company, and in no case shall the Company be permitted to draw in excess of $4,000,000 at any one time outstanding under the BFI Loan Documents; (iii) Debt of the Company and any Subsidiary of the Company existing on the date hereof and disclosed to Holder on Schedule A hereto¹ or extensions, renewals and refinancings of such Debt, provided that the principal amount of such Debt being extended, renewed or refinanced does not increase and the terms thereof are not modified to impose more burdensome terms upon Company or the relevant Subsidiary; (iv) Debt of Orange 21 Europe, S.r.l. (formerly known as Spy Optic, S.r.l.) and LEM S.r.l. and extensions, renewals and refinancings of such Debt; (v) accounts payable to trade creditors for goods and services and current operating liabilities (not the result of the borrowing of money) incurred in the ordinary course of business of Company or any Subsidiary of the Company in accordance with customary terms; (vi) Debt consisting of guarantees resulting from endorsement of negotiable instruments for collection by the Company or a Subsidiary of the Company in the ordinary course of business; (vii) interest rate swaps, currency swaps and similar financial products entered into or obtained in the ordinary course of business; and (viii) capital leases or other Debt incurred solely to acquire equipment, computers, software or implement tenant improvements which is secured in accordance with clause (viii) of the definition of “Permitted Liens” and is not in excess of the lesser of the purchase price or the fair market value of such equipment, computers, software or tenant improvements on the date of acquisition.

¹ If referencing SEC Reports to disclose Debt, please make specific references (page numbers) to such SEC reports.

“Permitted Investments” shall mean debt obligations maturing within twelve months of the time of acquisition thereof which are accorded a rating of AA- or better by S&P (or an equivalent rating by another recognized credit rating agency of similar standing), commercial paper with a maturity of 270 calendar days or less which is accorded a rating of A4 or better by S&P (or an equivalent rating by another recognized credit rating agency of similar standing), certificates of deposit maturing within twelve months of the time of acquisition thereof issued by commercial banks that are accorded a rating by a recognized rating service then in the business of rating commercial banks which is in the first quartile of the rating categories used by such service, obligations maturing within twelve months of the time of acquisition thereof of any Governmental Authority which obligations from time to time are accorded a rating of BBB or better by S&P (or an equivalent rating by another recognized credit rating agency of similar standing), and demand deposits, certificates of deposit, bankers acceptance and time deposits (having a tenor of less than one year) of United States banks having total assets in excess of $1,000,000,000.

“Permitted Liens” shall mean (i) the existing Liens as of the date hereof disclosed to Holder on Schedule B hereto², or incurred in connection with the extension, renewal or refinancing of the Debt secured by such existing Liens, provided that any extension, renewal or replacement Lien shall be limited to the property encumbered by the existing Lien and the principal amount of the Debt being extended, renewed or refinanced does not increase; (ii) Liens on the assets of Orange 21 Europe, S.r.l. (formerly known as Spy Optic, S.r.l.) and LEM S.r.l. securing Debt permitted by clause (iv) of the definition of Permitted Debt; (iii) Liens for taxes, fees, assessments or other governmental charges or levies, either not delinquent or being contested in good faith by appropriate proceedings and which are adequately reserved for in accordance with GAAP; (iv) Liens of materialmen, mechanics, warehousemen, carriers or employees or other like Liens arising in the ordinary course of business and securing obligations either not delinquent or being contested in good faith by appropriate proceedings which are adequately reserved for in accordance with GAAP and which do not in the aggregate materially impair the use or value of the property or risk the loss or forfeiture of title thereto; (v) Liens consisting of deposits or pledges to secure the payment of worker’s compensation, unemployment insurance or other social security benefits or obligations, or to secure the performance of bids, trade contracts, leases, public or statutory obligations, surety or appeal bonds or other obligations of a like nature incurred in the ordinary course of business (other than for Debt or any Liens arising under ERISA); (vi) easements, rights of way, servitudes or zoning or building restrictions and other minor encumbrances on real property and irregularities in the title to such property which do not in the aggregate materially impair the use or value of such property or risk the loss or forfeiture of title thereto; (vii) statutory landlord’s Liens under leases to which Company or any of its Subsidiaries is a party; and (viii) Liens (A) upon or in any equipment, computers or software acquired or held by Company or any of its Subsidiaries or tenant improvements implemented by Company or any of its Subsidiaries to secure the purchase price of such equipment, computers or software or Debt incurred solely for the purpose of financing the acquisition of such equipment, computers or software or the implementation of such tenant improvements, or (B) existing on such equipment, computers or software at the time of its acquisition, provided that the Lien is confined solely to the property so acquired and improvements thereon, or the proceeds of such equipment, computers, software or tenant improvements.

“Person” shall mean an individual, a partnership, a corporation, a limited liability company, an association, a joint stock company, a trust, a joint venture, an unincorporated organization and a governmental entity or any department, agency or political subdivision thereof.

“SEC Reports” shall mean reports, schedules, forms and registration statements, and any amendments thereto, filed with the Securities and Exchange Commission (the “Commission”) pursuant to

² If referencing SEC Reports to disclose Liens, please make specific references (page numbers) to such SEC reports.

the Securities Act of 1933 or Securities Exchange Act of 1934 and the rules and regulations of the Commission promulgated thereunder.

“Subsidiary” shall mean, with respect to any Person (herein referred to as the “parent”), any corporation, limited liability company, partnership, association or other business entity (i) of which securities or other ownership interests representing more than 50% of the equity or more than 50% of the ordinary voting power or more than 50% of the general partnership interests are, at the time any determination is being made, owned, controlled or held by the parent, or (ii) that is, at any time any determination is made, otherwise Controlled by, the parent or one or more Subsidiaries of the parent and one or more Subsidiaries of the parent.

2. Payment of Interest and Fees.

(a) Interest Generally. Interest shall accrue from the date hereof on a daily basis on the unpaid principal amount of this Note outstanding from time to time (computed on the basis of actual calendar days elapsed and a year of 365 days) at a rate equal to, (a) from the date hereof through April 30, 2010, (i) 6% per annum payable in cash monthly in arrears on the last day of each calendar month, and (ii) 6% per annum payable in cash on April 30, 2010, and (b) from May 1, 2010 through the Maturity Date, (i) 9% per annum payable in cash monthly in arrears on the last day of each calendar month, and (ii) 3% per annum payable in cash on the Maturity Date.

(b) Default Interest. Upon the occurrence and during the continuance of any Event of Default, this Note shall bear interest at a rate per annum equal to 2% plus the rate otherwise applicable to the Note.

(c) Fees. On each of December 31, 2010 and the Maturity Date, the Company shall pay the Holder a facility fee of 1% of the original principal amount of this Note.

3. Payments.

(a) Form of Payment. All payments of interest and principal shall be in lawful money of the United States of America by a check drawn on the account of the Company and sent via overnight courier service to Holder at such address as previously provided to the Company in writing (which address, in the case of Holder as of the date of issuance hereof, shall initially be the address for Holder as set forth in this Note); provided that Holder may elect to receive a payment of cash via wire transfer of immediately available funds by providing the Company with prior written notice setting out such request and Holder’s wire transfer instructions. Whenever any payment to be made shall otherwise be due on a day which is not a Business Day, such payment shall be made on the immediately succeeding Business Day and such extension of time shall be included in the computation of accrued interest. All payments shall be applied first to accrued interest, and thereafter to principal.

(b) No Set-Off. The Company agrees to make all payments under this Note without set-off or deduction and regardless of any counterclaim or defense.

(c) Prepayment. The Company shall have the right to prepay all amounts owed under this Note in whole or in part at any time upon five (5) Business Days prior written notice to Holder.

4. Representations and Warranties. The Company hereby makes the following representations and warranties to Holder, which are made and given subject to, and qualified in their entirety by the schedule of exceptions attached hereto as Schedule C³:

(a) Organization, Good Standing and Qualification. The Company is duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, and has all requisite power and authority to execute, deliver and perform its obligations under this Note. Each of the Company and its Subsidiaries is qualified to do business and is in good standing in each jurisdiction in which the failure so to qualify or be in good standing would have a Material Adverse Effect, and has all requisite power and authority to own its assets and carry on its business.

(b) Corporate Power and Authorization; Consents. The execution, delivery and performance by the Company of this Note have been duly authorized by all necessary action of the Company and do not and will not (i) contravene the terms of the Company’s Organic Documents; (ii) result in a breach of, or constitute a default (or an event that with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation (with or without notice, lapse of time or both) of, any lease, instrument, contract or other agreement to which the Company or any of its Subsidiaries are party or by which they or their properties may be bound or affected; (iii) necessitate the consent, approval, order or authorization of, or registration, qualification, designation, declaration or filing with, any Governmental Authority or any third party; or (iv) violate any provision of any law, rule, regulation, order, judgment, decree or the like binding on or affecting the Company, except in the case of each of clauses (ii), (iii) and (iv), such as would not result in a Material Adverse Effect.

(c) Enforceability. This Note constitutes the legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms.

(d) Financial Statements and Other Information. Orange 21, Inc., a Delaware corporation and sole owner of the Company (“Parent”), has previously furnished to Holder copies of (i) its audited consolidated financial statements for the fiscal year ended December 31, 2008, including the balance sheet as of the close of the fiscal year and the income statement for such year, together with a statement of cash flows and (ii) unaudited copies of its consolidated balance sheet, income statement and statement of cash flows as of and for the nine month period ended September 30, 2009 (the “Financial Statements”). The Financial Statements fairly present, in all material respects, in conformity with GAAP (except as may be indicated in the notes thereto), the financial position of the Company taken as a whole as of the date thereof for the period specified therein (subject to normal year-end adjustments). There are no material liabilities required in accordance with GAAP to be set forth in the Financial Statements that are not so set forth. Since September 30, 2009, there has been no event or circumstance, either individually or in the aggregate, that has had or would reasonably be expected to have a Material Adverse Effect. All forecasts and projections that Parent and/or the Company have provided to Holder have been prepared in good faith on the basis of the assumptions stated therein, which assumptions were believed to be reasonable at the time made, it being understood that projections as to future events are not to be viewed as facts and actual results may vary materially from such forecasts.

(e) Litigation. There is no action, suit, proceeding or investigation pending or, to the knowledge of Company and its Subsidiaries, currently threatened against the Company and its Subsidiaries which questions the validity of this Note or any related document or the right of the Company and its Subsidiaries to enter into such agreements, or to consummate the transactions contemplated hereby or thereby, or which would reasonably be expected to result, either individually or in

³ Please make specific references (page numbers) to SEC Reports in specific reps.

the aggregate, in any Material Adverse Effect, nor, to the knowledge of the Company, is there any reasonable basis for the foregoing. The Company and its Subsidiaries are not parties or subject to the provisions of any order, writ, injunction, judgment or decree of any court or government agency or instrumentality which would reasonably be expected to have a Material Adverse Effect. There is no material action, suit, proceeding or investigation by Company and its Subsidiaries currently pending or which Company and its Subsidiaries intend to initiate.

(f) Operations in Conformity With Law, etc. The operations of the Business as conducted by the Company and its Subsidiaries are not in violation of any Legal Requirement presently in effect, except for such violations and defaults as do not and will not, in the aggregate, result, or create a material risk of resulting, in any Material Adverse Effect. The Company and its Subsidiaries have not received notice of any such violation or default, and the Company and its Subsidiaries have no knowledge of any reasonable basis on which the operations of the Business as conducted by the Company and its Subsidiaries would reasonably be expected to violate or to give rise to any such violation or default.

(g) Intellectual Property. The Company and its Subsidiaries have obtained all material patents, trademarks, service marks, trade names, copyrights, licenses and other rights, free from materially burdensome restrictions, that are necessary for the operation of the Business, except for those for which the failure to obtain is not reasonably likely to have a Material Adverse Effect. The Company and its Subsidiaries have not received or otherwise been made aware of any communications alleging that the Company and its Subsidiaries have violated or, by conducting the Business, would violate, in any material respect, any patents, trademarks, service marks, trade names, copyrights, trade secrets, information, proprietary rights and processes of any other person or entity used in the conduct of its Business.

(h) Title to Property and Assets. The Company and its Subsidiaries have good and marketable title to, or valid leasehold interests in or rights to use, all of the material assets and properties used by the Company and its Subsidiaries in the Business (collectively, the “Properties and Facilities”), subject to no Liens except for the Permitted Liens. Taken as a whole, the Properties and Facilities are in good repair, working order and condition (ordinary wear and tear excepted) and all such assets and properties are owned or leased by the Company and its Subsidiaries free and clear of all Liens, except for the Permitted Liens, or as otherwise permitted hereunder. The Properties and Facilities constitute all of the material assets, properties and rights of any type used in or necessary for the conduct of the Business.

(i) Tax Returns, Payments and Elections. The Company and its Subsidiaries have filed all material tax returns and reports (or timely extensions) as required by law relating to any material tax liability of the Company and its Subsidiaries. Such returns and reports are true and correct in all material respects and the Company and its Subsidiaries have paid all material taxes and other assessments due, except where the validity or amount thereof is being contested in good faith by appropriate proceedings and adequate reserves have been set aside on the Financial Statements. There are no pending, or to the knowledge of the Company and its Subsidiaries, contemplated reviews, audits or proceedings with respect to any tax return, report or other tax liability of the Company or any of its Subsidiaries, which, in either case, relates to any material tax liability of the Company or any such Subsidiary.

(j) Employment Matters. The Company and its Subsidiaries have complied in all material respects with all applicable state and federal equal employment opportunity laws and with other laws related to employment, including without limitation all laws relating to withholding of taxes and other sums. All persons classified by the Company and its Subsidiaries as independent contractors for employee benefit and state and federal tax purposes are appropriately classified, except where the failure to do so would not reasonably be expected to have a Material Adverse Effect. The Company and its Subsidiaries are not delinquent in material payments to any of its employees, consultants or independent

contractors for any wages, salaries, commissions, bonuses or other direct compensation for any services performed for it to the date hereof, except where such a delinquency would not reasonably be expected to have a Material Adverse Effect.

(k) Affiliate Arrangements. There are no contractual arrangements or obligations owed to or by the Company and its Subsidiaries by or to any Affiliate other than this Note and obligations to employees and officers for (i) payment of salary and commissions and bonuses for services rendered, (ii) reimbursement for reasonable expenses incurred on its behalf and (iii) other standard employee benefits made generally available to all employees.

(l) Permits and Licenses. The Company and its Subsidiaries have all permits, licenses and any similar authority necessary for the conduct of their Business, the lack of which could reasonably be expected to have a Material Adverse Effect. The Company and its Subsidiaries are not in default in any material respect under any of such permits, licenses or other similar authority.

(m) Customer and Trade Relations. As of date hereof, there exists no actual or, to the knowledge of the Company and its Subsidiaries, threatened termination or cancellation of, or any material adverse modification or change in the business relationship of the Company and its Subsidiaries with any customer, supplier or licensor material to its operations.

5. Affirmative Covenants. So long as any indebtedness under this Note remains outstanding, the Company shall, and shall cause each of its Subsidiaries to:

(a) Compliance with Laws. Comply in all material respects with applicable laws, rules, regulations and orders, such compliance to include, without limitations, paying before the same become delinquent all taxes, assessments, and charges imposed upon it or upon its property by any Governmental Authority except for good faith contests for which adequate reserves are being maintained.

(b) Insurance. Carry and maintain in full force and effect, at its own expense and with financially sound and reputable insurance companies, insurance in such amounts, with such deductibles and covering such risks as is customarily carried by companies engaged in the same or similar businesses and owning similar properties in the localities where the Company or any such Subsidiary operates.

(c) Continuance of Business. Maintain its legal existence, licenses and privileges in good standing under and in compliance with all applicable laws and continue to operate its business as currently conducted. Without limiting the generality of the foregoing, the Company and its Subsidiaries shall do and cause to be done all things necessary to apply for, preserve, maintain and keep in full force and effect all of its registrations of trademarks, service marks and other marks, trade names and other trade rights, patents, copyrights and other intellectual property in accordance with prudent business practices.

(d) Maintenance. Conduct its business in a manner consistent with relevant industry standards, keep its material assets and properties in good working order and condition and make all needful and proper repairs, replacements and improvements thereof so that such business may be properly and prudently conducted at all times.

(e) Leases. Pay when due all rents and other amounts payable under any leases to which the Company or any Subsidiary is a party or by which the Company or such Subsidiary’s properties and assets are bound, unless such payments are the subject of a permitted protest.

(f) Books and Records. Keep adequate records and books of account, in which complete entries will be made in accordance with GAAP, reflecting all financial transactions of the Company and any such Subsidiary.

(g) Inspection. At any reasonable time and from time to time permit Holder or any of its agents or representatives to visit and inspect any of the properties of the Company and any such Subsidiary and to examine and make copies of and abstracts from the records and books of account of the Company and such Subsidiary, and to discuss the business affairs, finances and accounts of the Company and such Subsidiary with any of the officers, employees or accountants of such Loan Party and such Subsidiary. The Company hereby irrevocably authorizes all accountants and third parties to disclose and deliver to Holder at the Company’s expense all financial information, books and records, work papers, management reports and other information in their possession relating to the Company whether verbally, in writing (by record or authenticated record) or otherwise.

(h) Notice of Litigation. Provide to Holder promptly after the filing or commencement thereof, notice of all actions, suits, and proceedings before any court or Governmental Authority affecting the Company or any such Subsidiary, and in any event within three (3) days after the occurrence thereof, which could have a Material Adverse Effect.

(i) Notice of Material Adverse Effect, Etc. So long as any amount payable hereunder shall remain unpaid, furnish to Holder: (i) prompt written notice, and in any event within three (3) days after the occurrence thereof, of any other condition or event, which has resulted, or that could reasonably be expected to result, in a Material Adverse Effect; and (ii) such other statements, lists of property and accounts, budgets, forecasts, projections, reports, or other information respecting the operations, properties, business or condition (financial or otherwise) of the Company or any Subsidiary as Holder may from time to time reasonably request; provided that any such information shall be kept confidential and will be subject to the terms and conditions of a non-disclosure agreement between the parties.

(j) Notice of Defaults and Events of Defaults. Provide to Holder, as soon as possible and in any event within three (3) days after the occurrence thereof, written notice of each event which either (i) is an Event of Default, or (ii) with the giving of notice or lapse of time or both would constitute an Event of Default, in each case setting forth the details of such event and the action which is proposed to be taken by the Company and any such Subsidiary with respect thereto.

(k) Taxes. Pay and discharge (i) all federal and other material taxes, fees, assessments and governmental charges or levies imposed upon it or upon its properties or assets prior to the date on which penalties attach thereto, and all lawful claims for labor, materials and supplies which, if unpaid, might become a Lien upon any of its properties or assets, except to the extent such taxes, fees, assessments or governmental charges or levies, or such claims, are being contested in good faith by appropriate proceedings and are adequately reserved against in accordance with GAAP; and (ii) all other lawful claims which, if unpaid, would by law become a Lien upon its property not constituting a Permitted Lien.

(l) Governmental Approvals. Promptly obtain and maintain any and all authorizations, consents, approvals, licenses, franchises, concessions, leases, rulings, permits, certifications, exemptions, filings or registrations by or with any Governmental Authority material and necessary for the Company and any such Subsidiary to conduct its business and own (or lease) its properties or to execute, deliver and perform this Note.

(m) Preliminary Annual Financial Statements. If Seth Hamot is no longer a member of Parent’s board of directors, provide Holder as soon as possible after the end of each fiscal year of the Company, and in any event within sixty (60) days of the end of the Company’s fiscal year, preliminary

year end financial statements, including but not limited to, the balance sheet and income statement for such year.

(n) Reviewed Annual Financial Statements. If Seth Hamot is no longer a member of Parent’s board of directors, provide Holder as soon as possible after the end of each fiscal year of the Company, and in any event within one hundred twenty (120) days of the end of the Company’s fiscal year:

(i) a complete copy of the Company’s financial statements, including but not limited to (1) the management letter, if any; (2) the balance sheet as of the close of the fiscal year; and (3) the income statement for such year, together with a statement of cash flows, reviewed by a firm of independent certified public accountants of recognized standing and acceptable to Holder, or if permitted by Holder in writing, by the Company.

(ii) a statement certified by the chief financial officer of the Company that the Company is in compliance with all the terms, conditions, covenants, and warranties of this Note; and

(iii) a complete copy of all filings required under securities law.

(o) Other Financial Statements. No later than thirty (30) days after the close of each month (each, an “Accounting Period”), if Seth Hamot is no longer a member of Parent’s board of directors, provide Holder with the balance sheet of the Company as of the close of such Accounting Period and its income statement for that portion of the then current fiscal year through the end of such Accounting Period certified by the chief financial officer of the Company as being complete, correct, and fairly representing its financial condition and the results of operations.

(p) Tax Returns. If Seth Hamot is no longer a member of Parent’s board of directors, provide Holder copies of each of the Company’s federal income tax returns, and any amendments thereto, within one hundred twenty (120) days after the end of the Company’s fiscal year.

(q) Fees and Expenses. Pay the out-of-pocket fees and expenses incurred by Holder in connection with the preparation and administration of this Note and any amendments, modifications or waivers of the provisions hereof, including attorneys’ fees. Such fees will be indebtedness under this Note, and shall be due and payable on the date hereof and deducted from the proceeds of this Note.

6. Negative Covenants. So long as Obligations under this Note remain outstanding, the Company shall not, and, with respect to paragraphs (a) through (g) below, shall not permit any of its Subsidiaries to:

(a) Liens. Create or suffer to exist any Lien on any assets of the Company or any such Subsidiary except Permitted Liens.

(b) Debt. Incur any Debt other than Permitted Debt; prepay, redeem, purchase, defease or otherwise satisfy in any manner prior to the scheduled repayment thereof any Permitted Debt (other than amounts due or permitted to be prepaid in respect of this Note and Debt permitted by clause (iv) of the definition of Permitted Debt); or amend, modify or otherwise change the terms of any Permitted Debt (other than this Note and Debt permitted by clause (iv) of the definition of Permitted Debt) so as to accelerate the scheduled repayment thereof or increase the principal amount of such Permitted Debt.

(c) Restrictions on Fundamental Changes. Enter into any acquisition, merger, consolidation, reorganization, or recapitalization, or reclassify its capital stock, or liquidate, wind up, or dissolve itself

(or suffer any liquidation or dissolution), become a partner in a partnership, a member or equityholder of a joint venture, limited liability company or similar entity, or convey, sell, assign, lease, license, transfer, or otherwise dispose of, in one transaction or a series of transactions, all or any substantial part of its business, property, or assets (including shares of capital stock of the Company or any of its Subsidiaries), whether now owned or hereafter acquired, or acquire by purchase or otherwise all or substantially all of the properties, assets, stock, or other evidence of beneficial ownership of any Person.

(d) Extraordinary Transactions and Disposal of Assets. Enter into any transaction not in the ordinary course of the Business, including the sale, lease, license, moving, relocation, transfer or other disposition, whether by sale or otherwise, of any of the assets of the Company or its Subsidiaries except for sales of inventory in the ordinary course of business and except as expressly permitted by this Note.

(e) Change Name. Change the name of the Company or any of its Subsidiaries, Federal Employer Identification Number, business structure, or identity, or add any new fictitious name. To that effect, the Company shall not do business under any name other than the correct legal name of the Company and its Subsidiaries, unless the Company has provided to Holder evidence that Company or such Subsidiary has taken such legal steps required with respect to fictitious or assumed names under the applicable laws of the jurisdictions in which the Company or such Subsidiary is located and/or does business.

(f) Changes in Business. Enter into or engage in any business other than that carried on (or contemplated to be carried on) as of the date hereof.

(g) Distributions. Declare or pay any dividends or make any distribution of any kind on the Company’s or any such Subsidiary’s capital stock, or purchase, redeem or otherwise acquire, directly or indirectly, any shares of the Company’s or such Subsidiary’s capital stock, any rights to acquire shares of capital stock of the Company or such Subsidiary, except for the repurchase of such securities from former employees of or consultants to the Company or such Subsidiary at the original issue price paid therefor pursuant to contractual rights of the Company or such Subsidiary upon the termination of such employees’ or consultants’ employment by or provision of service to the Company or such Subsidiary.

(h) Amendment of Organic Documents. Amend, supplement, or otherwise modify any of the provisions of the Organic Documents of the Company.

(i) Investments. Make any Investments except Permitted Investments.

(j) Accounting Changes. Change its fiscal year or make or permit any change in accounting policies or reporting practices, except as required by GAAP.

(k) Subsidiaries. Organize, create or acquire any Subsidiary.

(l) Transactions with Affiliates. Directly or indirectly enter into or permit to exist any material transaction with any of its Affiliates except for transactions that are in the ordinary course of the business of the Company or unanimously approved by the Parent’s board of directors, upon fair and reasonable terms, that are fully disclosed to Holder prior to the entering of such transactions, and that are no less favorable to the Company than would be obtained in arm’s length transaction with a non-Affiliate.

(m) Management. Make any significant change in its management without a minimum thirty (30) days’ prior written notice to Holder.

(n) Suspension. Suspend or cease operations with respect to a substantial portion of its business except as unanimously approved by the Parent’s board of directors.

7. Use of Proceeds. The Company shall use the proceeds from the amounts loaned to the Company under this Note (i) first, to prepay the amount of the revolving loans under the BFI Loan Documents outstanding on the date hereof, and (ii) if any proceeds remain after the Company makes such prepayment described in the foregoing clause (i), for general working capital purposes.

8. Default.

(a) Events of Default. For purposes of this Note, any of the following events which shall occur shall constitute an “Event of Default”:

(i) any indebtedness under this Note is not paid when and as the same shall become due and payable, whether at maturity, by acceleration, five (5) days following notice of prepayment or otherwise;

(ii) default shall occur in the observance or performance of (A) any covenant, obligation or agreement of the Company contained in Sections 5 or 6, or (B) any other provision of this Note, and, in the case of this clause (B), such default shall continue uncured for a period of ten (10) days;

(iii) any representation, warranty or certification made herein by or on behalf of the Company or any of its Subsidiaries shall prove to have been false or incorrect in any material respect on the date or dates as of which made (any such falsity being a “Representation Default”);

(iv) the Company shall (A) apply for or consent to the appointment of a receiver, trustee, custodian or liquidator of itself or any part of its property, (B) become subject to the appointment of a receiver, trustee, custodian or liquidator for itself or any part of its property, (C) make an assignment for the benefit of creditors, (D) fail generally, become unable or admit in writing to its inability to pay its debts as they become due, (E) institute any proceedings under the United States Bankruptcy Code or any other federal or state bankruptcy, reorganization, receivership, insolvency or other similar law affecting the rights of creditors generally, or file a petition or answer seeking reorganization or an arrangement with creditors to take advantage of any insolvency law, or file an answer admitting the material allegations of a bankruptcy, reorganization or insolvency petition filed against it, or (F) become subject to any involuntary proceedings under the United States Bankruptcy Code or any other federal or state bankruptcy, reorganization, receivership, insolvency or other similar law affecting the rights of creditors generally;

(v) the Company shall (i) liquidate, wind up or dissolve (or suffer any liquidation, wind-up or dissolution), except to the extent expressly permitted by Section 6, (ii) suspend its operations other than in the ordinary course of business, or (iii) take any action to authorize any of the actions or events set forth above in this Section 8(a)(v);

(vi) the Company or any Subsidiary (i) fails to make any payment beyond the applicable grace period, if any, whether by scheduled maturity, required prepayment, acceleration, demand, or otherwise, (a) under the BFI Loan Documents, or (b) in respect of any Debt (other than the Debt hereunder and the Debt under the BFI Loan Documents) having an aggregate outstanding principal amount (individually or in the aggregate with all other Debt as to which such a failure shall exist) of not less than $5,000, (ii) fails to observe or perform any other agreement or condition relating to (a) the BFI Loan Documents, or (b) any such Debt described in clause (i)(b) above, or any other event occurs, the

effect of which default or other event is to cause, or to permit the holder or holders of the BFI Loan Documents or any such Debt described in (i)(b) above (or a trustee or agent on behalf of such holder or holders or beneficiary or beneficiaries) to cause, with the giving of notice if required, the Debt under the BFI Loan Documents or the Debt described in (i)(b) above to become due or to be repurchased, prepaid, defeased or redeemed (automatically or otherwise);

(vii) Parent shall breach the terms of the Design, Manufacturing and Distribution License between O’Neill Trademark BV as Licensor and Parent as Licensee, or the Trademark Sublicense Agreement by and between Margaritaville Eyewear, LLC as Sublicensor and Parent as Sublicensee (each, a “License Agreement”), or any other event occurs under or in connection with a License Agreement, the effect of such breach or other event is to cause, or to permit to cause, the licensor under such License Agreement to terminate the License Agreement or reduce in scope or duration any aspect of the License Agreement;

(viii) any final judgment or judgments for the payment of money shall be rendered against the Company in excess of $5,000 which judgments are not, within thirty (30) days after the entry thereof, bonded, discharged or stayed pending appeal, or are not discharged within thirty (30) days after the expiration of such stay, other than any judgment which is covered by insurance or an indemnity from a credit worthy party; provided that the Company provides Holder a written statement from such insurer or indemnity provider (which written statement shall be reasonably satisfactory to Holder) to the effect that such judgment is covered by insurance or an indemnity and the Company will receive the proceeds of such insurance or indemnity within 30 days of the issuance of such judgment; or

(ix) this Note shall for any reason cease to be, or shall be asserted by the Company not to be, a legal, valid and binding obligation of the Company.

(b) Consequences of Events of Default.

(i) If any Event of Default shall occur for any reason, whether voluntary or involuntary, and be continuing, Holder may, upon notice or demand, declare the outstanding Obligations under this Note to be due and payable, whereupon the outstanding Obligations under this Note shall be and become immediately due and payable, and the Company shall immediately pay to Holder all such Obligations. Upon the occurrence of an actual or deemed entry of an order for relief with respect to the Company under the United States Bankruptcy Code, then all Obligations under this Note shall automatically be due immediately without notice of any kind. The Company agrees to pay Holder all out-of-pocket costs and expenses incurred by Holder (including attorney’s fees) in connection with the enforcement or protection of its rights in relation to this Agreement, including any suit, action, claim or other activity of the Holder to collect or otherwise enforce the Obligations under this Note or any portion thereof, or in connection with the transactions contemplated hereby.

(ii) Holder shall also have any other rights which Holder may have been afforded under any contract or agreement at any time and any other rights which Holder may have pursuant to applicable law.

9. Lost, Stolen, Destroyed or Mutilated Note. In case this Note shall be mutilated, lost, stolen or destroyed, the Company shall issue a new Note of like date, tenor and denomination and deliver the same in exchange and substitution for and upon surrender and cancellation of such mutilated Note, or in lieu of this Note being lost, stolen or destroyed, upon receipt of evidence satisfactory to the Company of such loss, theft or destruction.

10. Waiver of Jury Trial. TO THE EXTENT NOT PROHIBITED BY APPLICABLE LAW WHICH CANNOT BE WAIVED, THE COMPANY (BY ITS EXECUTION HEREOF) AND THE HOLDER (BY ITS ACCEPTANCE OF THIS NOTE) WAIVES AND COVENANTS THAT IT WILL NOT ASSERT (WHETHER AS PLAINTIFF, DEFENDANT OR OTHERWISE) ANY RIGHT TO TRIAL BY JURY IN ANY FORUM IN RESPECT OF ANY ISSUE OR ACTION ARISING OUT OF OR BASED UPON OR RELATING TO THIS NOTE OR IN ANY WAY CONNECTED WITH OR RELATED OR INCIDENTAL TO THE TRANSACTIONS CONTEMPLATED HEREBY, IN EACH CASE WHETHER NOW EXISTING OR HEREAFTER ARISING.

11. Governing Law. This Note shall be deemed to be a contract made under the laws of the State of New York and for all purposes shall be governed by, construed under, and enforced in accordance with the laws of the State of New York.

12. Amendment and Waiver. Any term of this Note may be amended and the observance of any term of this Note may be waived (either generally or in a particular instance and either retroactively or prospectively), only with the written consent of the Company and Holder.

13. Notices. Any notice or other communication in connection with this Note may be made and is deemed to be given as follows: (i) if in writing and delivered in person or by courier, on the date when it is delivered; (ii) if by facsimile, when received at the correct number (proof of which shall be an original facsimile transmission confirmation slip or equivalent); or (iii) if sent by certified or registered mail or the equivalent (return receipt requested), on the date such mail is delivered, unless the date of that delivery is not a Business Day or that communication is delivered on a Business Day but after the close of business on such Business Day in which case such communication shall be deemed given and effective on the first following Business Day. Any such notice or communication given pursuant to this Note shall be addressed to the intended recipient at its address or number (which may be changed by either party at any time) specified as follows:

If to the Company:	Spy Optic, Inc. 2070 Las Palmas Drive Carlsbad, CA 92011 Facsimile No.: (760) 804-8420 Telephone No.: (760) 804-8421 Attention: Chief Executive Officer
With a copy to:	Morrison & Foerster LLP 12531 High Bluff Drive, Suite 100 San Diego, CA 92130 Facsimile No.: (858) 523-2809 Attention: Christopher M. Forrester, Esq.
If to Holder:	Costa Brava Partnership III, L.P. c/o Roark, Rearden & Hamot, LLC 420 Boylston St, Suite 5-F Boston, MA 02116 Facsimile No: (617) 267-6785 Attention: Seth W. Hamot, President
With a copy to:	Ropes & Gray LLP One International Place

Boston, MA 02110

Facsimile No: (617) 951-7050

Attention: David A. Fine, Esq. and Jeffrey R. Katz, Esq.

14. Severability. If at any time any provision of this Note shall be held by any court of competent jurisdiction to be illegal, void or unenforceable, such provision shall be of no force and effect, but the illegality or unenforceability of such provision shall have no effect upon the legality or enforceability of any other provision of this Note.

15. Assignment. The provisions of this Note shall be binding upon and inure to the benefit of each of the Company and the Holder and their respective successors and assigns, provided that the Company shall not have the right to assign its rights and obligations hereunder or any interest herein. This Note may be endorsed, assigned and transferred in whole or in part by the Holder to any other Person.

16. Indemnity. The Company agrees to indemnify the Holder, and its respective directors, officers, employees and agents (each such Person being called an “Indemnitee”) against, and to hold each Indemnitee harmless from, any and all losses, claims, damages, liabilities and related expenses, including reasonable counsel fees, charges and disbursements, incurred by or asserted against any Indemnitee arising out of in any way connected with, or as a result of (i) the execution or delivery of this Note or any agreement or instrument contemplated thereby, the performance by the parties thereto of their respective obligations thereunder or the consummation of the transactions contemplated thereby, (ii) any breach by the Company of its obligations under this Note or any agreement or instrument contemplated thereby.

17. Remedies Cumulative; Failure or Indulgence Not a Waiver. The remedies provided in this Note shall be cumulative and in addition to all other remedies available under this Note. No failure or delay on the part of Holder in the exercise of any power, right or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such power, right or privilege preclude other or further exercise thereof or of any other right, power or privilege.

18. Excessive Interest. Notwithstanding any other provision herein to the contrary, this Note is hereby expressly limited so that the interest rate charged hereunder shall at no time exceed the maximum rate permitted by applicable law. If, for any circumstance whatsoever, the interest rate charged exceeds the maximum rate permitted by applicable law, the interest rate shall be reduced to the maximum rate permitted, and if Holder shall have received an amount that would cause the interest rate charged to be in excess of the maximum rate permitted, such amount that would be excessive interest shall be applied to the reduction of the principal amount owing hereunder (without charge for prepayment) and not to the payment of interest, or if such excessive interest exceeds the unpaid balance of principal, such excess shall be refunded to the Company.

Further, notwithstanding any other provision herein to the contrary, and without any further action from the parties to this Note, if the fees (except with respect to paragraph 16) and interest charged hereunder shall be determined by a court of competent jurisdiction to be a “financial benefit” for purposes of 8 § 203(c)(v) of the General Corporation Law of the State of Delaware, this Note shall be deemed amended to eliminate such fees and reduce such interest rate to 0%. If Holder shall have received any such fees or interest, such amounts shall be applied to the reduction of the principal amount owing hereunder (without charge for prepayment), or if such fees and interest paid to the Holder exceed the unpaid balance of principal, such excess shall be refunded to the Company.

19. Registered Obligation. The Company shall establish and maintain a record of ownership (the “Register”) in which it will register by book entry the interest of the initial Holder and of each subsequent assignee in this Note, and in the right to receive any payments of principal and interest or any other payments hereunder, and any assignment of any such interest. The Company shall make appropriate entries in the Register to reflect any assignment promptly following receipt of written notice from the assignor of such assignment. Notwithstanding anything herein to the contrary, this Note is intended to be treated as a registered obligation for federal income tax purposes and the right, title, and interest of the Holder and its assignees in and to payments under this Note shall be transferable only upon notation of such transfer in the Register. This Section shall be construed so that the Note is at all times maintained in “registered form” within the meaning of Sections 163(f), 871(h)(2) and 881(c)(2) of the Internal Revenue Code and any related regulations (or any successor provisions of the Code or such regulations).

20. Entire Agreement. This Note contains the entire understanding of the parties with respect to the subject matter hereof and supersedes all prior agreements, understandings, discussions and representations, oral or written, with respect to such matters, which the parties acknowledge have been merged into this Note.

21. Waiver of Notice. To the extent permitted by law, the Company hereby waives demand, notice, protest and all other demands and notices in connection with the delivery, acceptance, performance, default or enforcement of this Note.

22. Subordination. This Promissory Note and each of Holder’s rights and privileges hereunder is expressly subject to the terms of that certain Debt Subordination Agreement by and between BFI Business Finance and Holder dated the date hereof.

[Remainder of Page Intentionally Left Blank]

IN WITNESS WHEREOF, the each of the undersigned has caused this Note to be duly executed by its officers, thereunto duly authorized as of the date first above written.

THE COMPANY: ORANGE 21 NORTH AMERICA, INC.
By:	/s/ A. Stone Douglass
Name:	A. STONE DOUGLASS
Title:	CEO

EX-21.1

Exhibit 21.1

List of Subsidiaries

Name	Jurisdiction of Organization
Orange 21 North America Inc.	California
Orange 21 Europe	Italy
LEM S.r.l.	Italy

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the previously filed Registration Statement (No. 333 -121223) on Form S-8 and the previously filed Prospectus constituting a part of the Registration Statement (No. 333-121223) on Form S-3 of Orange 21 Inc. of our report dated March 26, 2010 relating to the consolidated financial statements and the financial statement schedule of Orange 21 Inc. and subsidiaries, appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

/s/ Mayer Hoffman McCann P.C.

San Diego, California

March 26, 2010

EX-31.1

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

I, A. Stone Douglass, certify that:

1.        I have reviewed this annual report on Form 10-K for the year ended December 31, 2009 of Orange 21 Inc.;

2.        Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.        Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.        The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f), for the registrant and have:

a)    Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)    Designed such internal control over financial reporting or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)    Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d)    Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.        The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s Board of Directors (or persons performing the equivalent functions):

a)    All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)    Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 26, 2010
By:	/s/ A. Stone Douglass
	A. Stone Douglass
	Chief Executive Officer
	(Principal Executive Officer and Principal Financial Officer)

EX-32.1

Exhibit 32.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER UNDER 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT 0F 2002

I, A. Stone Douglass, the Chief Executive Officer of Orange 21 Inc. (the “Company”), certify for the purposes of Section 1350 of Chapter 63 of Title 18 of the United States Code that, to my knowledge,

(i) the Annual Report of the Company on Form 10-K for the year ended December 31, 2009 (the “Report”), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 26, 2010
By:	/s/ A. Stone Douglass
	A. Stone Douglass
	Chief Executive Officer
	(Principal Executive Officer and Principal Financial Officer)