10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2014

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

 SPY 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
(Address of principal executive offices)	(Zip Code)

(760) 804-8420

(Registrant’s telephone number, including area code)

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

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 [X]    No [   ]

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]

As of May 1, 2014, there were 13,337,165 shares of Common Stock, par value $0.0001 per share, issued and outstanding.

SPY INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

		Page
	PART I – FINANCIAL INFORMATION	2
Item 1.	Financial Statements	2
	Consolidated Balance Sheets as of March 31, 2014 (Unaudited) and December 31, 2013	2
	Consolidated Statements of Comprehensive Loss (Unaudited) for the three months ended March 31, 2014 and 2013	3
	Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2014 and 2013	4
	Notes to Unaudited Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 4.	Controls and Procedures	25
	PART II – OTHER INFORMATION	25
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3.	Defaults Upon Senior Securities	25
Item 4.	Mine Safety Disclosures	25
Item 5.	Other Information	25
Item 6.	Exhibits	25
		25
Signatures		26

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Forward-Looking Statements

 This Quarterly Report on Form 10-Q contains forward-looking statements.  The words or phrases "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements."  Actual results could differ materially from those projected in the forward looking statements as a result of a number of risks and uncertainties, including those risks factors contained in our Annual Report on Form 10-K for the year ended December 31, 2013, previously filed with the Securities and Exchange Commission on March 20, 2014, which Annual Report is incorporated herein by reference.  Statements made herein are as of the date of the filing of this Form 10-Q with the Securities and Exchange Commission and should not be relied upon as of any subsequent date.  Unless otherwise required by applicable law, we do not undertake, and specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

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PART I.  FINANCIAL INFORMATION

ITEM 1.  Financial Statements

SPY INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

	March 31,		December 31,
	2014		2013
	(Unaudited)
Assets
Current assets
Cash	$	688	$	686
Accounts receivable, net		5,622		6,543
Inventories, net		4,344		5,872
Prepaid expenses and other current assets		691		680
Income taxes receivable		—		3
Total current assets		11,345		13,784
Property and equipment, net		394		438
Intangible assets, net of accumulated amortization of $792 and $782 at March 31, 2014 and December 31, 2013, respectively		63		72
Other assets		44		63
Total assets	$	11,846	$	14,357
Liabilities and Stockholders’ Deficit
Current liabilities
Lines of credit	$	1,686	$	4,024
Current portion of capital leases		71		77
Current portion of notes payable		16		16
Accounts payable		1,047		1,302
Accrued expenses and other liabilities		3,655		3,069
Total current liabilities		6,475		8,488
Capital leases, less current portion		75		92
Notes payable, less current portion		12		16
Notes payable to stockholders		21,452		21,452
Total liabilities		28,014		30,048
Commitments and Contingencies Stockholders’ deficit
Preferred stock: par value $0.0001; 5,000,000 authorized; none issued		—		—
Common stock: par value $0.0001; 100,000,000 shares authorized; 13,324,037 and 13,184,876 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively		1		1
Additional paid-in capital		45,597		45,331
Accumulated other comprehensive income		519		520
Accumulated deficit		(62,285)		(61,543)
Total stockholders’ deficit		(16,168)		(15,691)
Total liabilities and stockholders’ deficit	$	11,846	$	14,357

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

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SPY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Thousands, except per share amounts)

	Three Months Ended
	March 31,
	2014		2013
		(Unaudited)
Net sales	$	9,192	$	9,008
Cost of sales		4,412		4,407
Gross profit		4,780		4,601
Operating expenses:
Sales and marketing		2,920		2,854
General and administrative		1,483		1,447
Shipping and warehousing		140		169
Research and development		153		102
Total operating expenses		4,696		4,572
Income from operations		84		29
Other income (expense):
Interest expense		(757)		(732)
Foreign currency transaction loss		(67)		(18)
Other Income		1		—
Total other expense		(823)		(750)
Loss before provision for income taxes		(739)		(721)
Income tax expense		3		—
Net loss	$	(742)	$	(721)
Net loss per share of Common Stock
Basic	$	(0.06)	$	(0.05)
Diluted	$	(0.06)	$	(0.05)
Shares used in computing net loss per share of Common Stock
Basic		13,222		13,115
Diluted		13,222		13,115
Other comprehensive income (loss)
Foreign currency translation adjustment (loss) gain	$	(94)	$	177
Unrealized gain (loss) on foreign currency exposure of net investment in foreign operations		93		(194)
Total other comprehensive loss		(1)		(17)
Comprehensive loss	$	(743)	$	(738)

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

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SPY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Thousands)

	Three Months Ended
	March 31,
	2014		2013
	(Unaudited)
Operating Activities
Net loss	$	(742)	$	(721)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		68		77
Paid-in-kind interest		632		569
Share-based compensation		142		166
Non-cash board of directors fees		26		26
Provision for doubtful accounts		(29)		38
Gain on sale of property or equipment		(3)		—
Foreign currency transaction gain		—		(17)
Amortization of debt discount		18		30
Change in operating assets and liabilities:
Accounts receivable, net		950		567
Inventories, net		1,528		368
Prepaid expenses and other current assets		(13)		(83)
Other assets		2		20
Accounts payable		(256)		415
Accrued expenses and other liabilities		(45)		91
Income taxes payable/receivable		3		1
Net cash provided by operating activities		2,281		1,547
Investing Activities
Purchases of property and equipment		(28)		(43)
Proceeds from sale of property and equipment		16		—
Net cash used in investing activities		(12)		(43)
Financing Activities
Line of credit, net		(2,338)		(873)
Principal payments on secured notes payable		(4)		(4)
Principal payments on capital leases		(23)		(24)
Proceeds from exercise of stock options		98		—
Net cash used in financing activities		(2,267)		(901)
Net increase in cash		2		603
Cash at beginning of period		686		818
Cash at end of period	$	688	$	1,421
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	110	$	163
Income taxes	$	3	$	—
Summary of non-cash financing and investing activities:
Accrued board of directors fees paid in fully vested non-restricted stock awards	$	26	$	26
Acquisition of property and equipment through capital leases	$	—	$	103

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

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.  Description of Business and Liquidity

  SPY Inc. (the “Company”) happily designs, markets and distributes premium sunglasses, goggles and prescription frame eyewear.  In 1994, the Company began as a grassroots brand in Southern California with the goal of creating innovative and aesthetically progressive eyewear, and, in doing so, the Company believes it has captured the imagination of the action sports market with authentic, distinctive, performance-driven products under the SPY® brand.  Today, the Company believes the SPY® brand, symbolized by the distinct “cross” logo, is a well recognized eyewear brand in its segment of the action sports industry, with a reputation for its high quality products, style and innovation, most notably showcased in its Happy Lens™ technology.

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

  The Company operates through its subsidiaries and currently has one wholly-owned subsidiary incorporated in California, Spy Optic Inc. (“SPY North America”), and one wholly-owned subsidiary incorporated in Italy, Spy Optic Europe S.r.l. S.U. (“SPY Europe”). In March 2014, the Company received permission from the Italian government to dissolve SPY Europe. The company expects to complete this process late in 2014, and does not anticipate any material expenses to dissolve SPY Europe.

Capital Resources

 During the three-months ended March 31, 2014 and year ended December 31, 2013, the Company had positive cash flow from operations principally as a result of a significant reduction in operating expenses and increases in gross profit. However, the Company has a history of incurring significant negative cash flow from operations, operating and net losses, and has significant working capital requirements. The Company anticipates that it will continue to have ongoing cash requirements to finance its seasonal and ongoing working capital needs and net losses.

           In order to finance the Company's working capital requirements, the Company has relied and anticipates that it will continue to rely on SPY North America’s credit line with BFI Business Finance (“BFI”) (the “BFI Line of Credit”) and its credit facilities with Costa Brava Partnership III, L.P. (“Costa Brava”).  In addition, SPY North America has relied on debt and equity financing from Harlingwood (Alpha), LLC (“Harlingwood”).  Costa Brava and Harlingwood are related parties.  The total outstanding indebtedness of the Company was $23.9 million and $25.7 million at March 31, 2014 and December 31, 2013 respectively.  (See Note 7 “Short-Term Debt ”, Note 8 “Long-Term Debt”, Note 11 “Related Party Transactions” and Note 14 “Subsequent Events”).

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

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 The Company does not anticipate that it can generate sufficient cash from operations to repay the amounts due under the BFI Line of Credit which is scheduled to renew in February 2015, and the borrowings from Costa Brava and Harlingwood due, as amended, in December 31, 2016 (see Note 14 “Subsequent Event”), consisting of (i) $15.5 million aggregate original principal borrowings from Costa Brava and $1.5 million in borrowings from Harlingwood as of March 31, 2014, (ii) an additional amount of approximately $4.8 million and $0.3 million, respectively, of unpaid interest related to Costa Brava and Harlingwood loans, which was added to the principal balance of each respective borrowing as of March 31, 2014, and (iii) future interest amounts added to the outstanding principal amounts due under the Harlingwood loans, rather than paid in cash (“Accrued PIK Interest”).  The Company will therefore need to renew the BFI Line of Credit at its annual renewal in February 2015 and continue to extend the future maturity dates of the Costa Brava and Harlingwood indebtedness. If the Company is unable to renew the BFI Line of Credit and extend future maturity dates of the Costa Brava and Harlingwood indebtedness, it will need to raise substantial additional capital through debt or equity financing to continue its operations. No assurances can be given that any such financing will be available to the Company on favorable terms, if at all. The inability to obtain debt or equity financing in a timely manner and in amounts sufficient to fund the Company’s operations, or the inability to renew the BFI Line of Credit or to extend future maturity dates of the Costa Brava and Harlingwood indebtedness, if necessary, would have an immediate and substantial adverse impact on the Company’s business, financial condition and results of operations.

2.  Basis of Presentation and Recently Issued Accounting Principles

 Basis of Presentation

 The accompanying Consolidated Financial Statements of SPY Inc. and its wholly owned 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.  The Consolidated Financial Statements contained in this Form 10-Q should be read in conjunction with the Consolidated Financial Statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.

 Recently Issued Accounting Principles

 There are no recently issued accounting principles subsequent to the Company’s disclosure in the Annual Report on Form 10-K for the year ended December 31, 2013, which would have a significant impact on the Company’s Consolidated Financial Statements.

3.  Loss Per Share

 Basic loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period.  Diluted loss per share is calculated by including the additional shares of common stock issuable upon the conversion of convertible debt and the exercise of outstanding options and warrants, 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 loss per share for the periods presented:

	Three Months Ended  March 31,
	2014		2013
	(Thousands)
Weighted average common shares outstanding – basic		13,222		13,115
Assumed conversion of dilutive stock options, warrants and convertible debt		—		—
Weighted average common shares outstanding – dilutive		13,222		13,115

-6-

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

	Three Months Ended  March 31,
Shares Issuable through Exercise or Conversion of:	2014		2013
	(Thousands)
Stock options		3,052		2,790
Warrants		244		244
Convertible debt		2,240		2,133
Total		5,536		5,167

4.  Accumulated Other Comprehensive Income

 Accumulated other comprehensive income represents the results of operations adjusted to reflect all items recognized under accounting standards as components of comprehensive income.

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

	March 31, 2014		December 31, 2013
	(Thousands)
Equity adjustment from foreign currency translation	$	422	$	275
Unrealized gain on foreign currency exposure of net investment in foreign operations		97		245
Accumulated other comprehensive income	$	519	$	520

5.  Accounts Receivable

 Accounts receivable consisted of the following:

	March 31, 2014		December 31, 2013
	(Thousands)
Trade receivables	$	7,810	$	8,539
Less allowance for doubtful accounts		(332)		(369)
Less allowance for returns		(1,856)		(1,627)
Accounts receivable, net	$	5,622	$	6,543

6.  Inventories

 Inventories consisted of the following:

	March 31, 2014		December 31, 2013
	(Thousands)
Raw materials	$	17	$	11
Finished goods		4,619		6,097
Less allowance for excess and obsolete inventory		(292)		(236)
Inventories, net	$	4,344	$	5,872

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7.  Short-Term Debt

 SPY North America has a Loan and Security Agreement with BFI with a maximum borrowing limit of $7.0 million.  The maximum availability was $5.2 million and $5.1 million at March 31, 2014 and December 31, 2013, respectively, of which SPY North America had borrowed $1.7 million and $4.0 million, respectively, as of those dates. The BFI Line of Credit renews annually in February for one additional year unless otherwise terminated by either SPY North America or BFI. The Company had $3.5 million and $1.1 million in unused availability as of March 31, 2014 and December 31, 2013, respectively.

 Actual borrowing availability under the BFI Line of Credit is based on eligible trade receivable and inventory levels of SPY North America, subject to the following limitations: (i) up to 80% of eligible United States accounts receivable, (ii) 80% of eligible Canadian receivables, (iii) 50% of eligible United States inventory, provided, however, such amount does not exceed 50% of eligible United States and Canadian accounts receivable and does not exceed the maximum inventory borrowing amount of $2.5 million, and (iv) advances against eligible foreign accounts receivable (excluding Canadian accounts receivable) up to $0.4 million.  Borrowings under the BFI Line of Credit bear interest at a rate per annum equal to the prime rate, as reported in the Western Edition of The Wall Street Journal, plus 1.75%, with a minimum monthly interest charge of $2,000. The interest rate was 5.0% per annum at March 31, 2014. The Company and SPY North America granted BFI a security interest in substantially all of SPY North America’s assets, and substantially all of the Company’s accounts receivable and inventories to secure BFI’s position under the BFI Line of Credit.  Additionally, the obligations under the BFI Line of Credit are guaranteed by SPY Inc.

 The BFI Line of Credit imposes certain covenants on SPY North America, including, but not limited to, covenants requiring SPY North America to provide certain periodic reports to BFI, to inform BFI of certain changes in the business, to refrain from incurring additional debt in excess of $100,000 and to refrain from paying dividends.  The BFI Line of Credit also contains cross default provisions. BFI may declare SPY North America in default if SPY North America experiences a material adverse change in its business, financial condition, or in its ability to perform the obligations owed under the BFI Line of Credit.  BFI’s prior consent, which BFI will not unreasonably withhold, is required in the event that SPY North America seeks additional debt financing, including debt financing subordinate to BFI.  SPY North America has also established bank accounts in BFI’s name in the United States and Canada into which collections on accounts receivable and other collateral are deposited (the “Collateral Accounts”).  Pursuant to the deposit control account agreements between BFI and SPY North America, BFI is entitled to sweep all amounts deposited into the Collateral Accounts and apply the funds to outstanding obligations under the BFI Line of Credit; provided that BFI is required to distribute to SPY North America any amounts remaining after payment of all amounts due under the BFI Line of Credit.  SPY North America was in compliance with all covenants under the BFI Line of Credit at March 31, 2014.

8.  Long-Term Debt

Costa Brava Term Note

 SPY North America issued a promissory note to Costa Brava in the principal amount of $7.0 million (“Costa Brava Term Note”), which amount was outstanding at each of March 31, 2014 and December 31, 2013 (excluding Accrued PIK Interest of $2.4 million and $2.1 million, respectively). As of March 31, 2014, approximately $264,000 of accrued interest was reclassified to accrued liabilities and was paid in April 2014. The Costa Brava Term Note was amended in April 2014 to extend the due date from April 1, 2015 to December 31, 2016.  The Costa Brava Term Note is subordinate to the BFI Line of Credit, pursuant to the terms of a debt subordination agreement between Costa Brava and BFI.

-8-

 Interest attributable to the Costa Brava Term Note accrues daily at a rate equal to 12% per annum.On January 1, 2012, SPY North America began adding Accrued PIK Interest as an addition to the outstanding principal amount due, rather than making interest payments in cash.The Costa Brava Term Note, as amended, also requires that SPY North America pay a facility fee equal to 1% of the outstanding principal amount in cash (without giving effect to the Accrued PIK Interest) in June 2014. The Company has approximately $17,000 in accrued expenses and other liabilities related to facility fee as of March 31, 2014 and the total facility fee of $70,000 is due in June 2014.  In April 2014, the Costa Brava Term Note was amended to reduce the interest rate from 12% to 7% and to eliminate the facility fee, both of which are effective July 1, 2014.  Effective with the amendment, the Company will no longer add Accrued PIK Interest to the outstanding principal and will begin making quarterly cash payments starting in June 2014.

 During the term of the Costa Brava Term Note, Costa Brava may, at its discretion, convert up to $2,250,000 of the principal amount of the Costa Brava Term Note (excluding the Accrued PIK Interest) into shares of the Company’s common stock at a conversion price of $2.25 per share. In April 2014, the Costa Brava Term Note was amended to increase the amount Costa Brava may convert from $2,250,000 to $6,000,000 and reduce the conversion price from $2.25 to $2.00. (See Note 11 “Related Party Transactions” and Note 14 “Subsequent Events”).

 Costa Brava Line of Credit

 SPY North America has an additional $9.0 million line of credit from Costa Brava (“Costa Brava Line of Credit”) of which $8.5 million was outstanding at March 31, 2014 and December 31, 2013 (excluding Accrued PIK Interest of $2.4 million and $2.1 million, respectively). As of March 31, 2014, approximately $316,000 of accrued interest was reclassified to accrued liabilities and the amount was paid in April 2014. The Costa Brava Line of Credit was amended in April 2014 to extend the maturity date from April 1, 2015 to December 31, 2016. The Costa Brava Line of Credit is subordinate to BFI Line of Credit, pursuant to the terms of a debt subordination agreement between Costa Brava and BFI.

  Interest on the outstanding borrowings under the Costa Brava Line of Credit accrues daily at a rate equal to 12% per annum.  On January 1, 2012, SPY North America began paying monthly interest payments in kind, as an addition to the outstanding principal amount due, rather than making interest payments in cash.  Monthly interest accrued prior to January 1, 2012 was paid in cash. In April 2014, the Costa Brava Line of Credit was amended to reduce the interest rate from 12% to 7% and to eliminate the facility fee, both of which are effective July 1, 2014. Effective with the amendment, the Company will no longer add Accrued PIK Interest to the outstanding principal and will begin making quarterly cash payments starting in June 2014.

 In addition, the Costa Brava Line of Credit, as amended, requires that SPY North America pay a facility fee in June 2014 calculated as the lesser of (i) 1% of the average daily outstanding principal amount owed under the note (excluding Accrued PIK Interest) for the 365 day period ending on such payment date or (ii) $90,000.  The Company has approximately $66,000 in accrued expenses and other liabilities related to facility fee as of March 31, 2014 and the total facility fee of $85,000 is due in June 2014.

 Costa Brava Loans

  The total outstanding borrowings under all credit facilities entered into with Costa Brava at March 31, 2014 and December 31, 2013 was $15.5 million (excluding $4.8 million and $4.2 million of Accrued PIK Interest, respectively).  The Costa Brava Term Loan and Costa Brava Line of Credit are pari passu with respect to the rights and preferences of the Harlingwood Notes (defined below).

 Harlingwood Convertible Debt

  In 2012, SPY North America entered into convertible note purchase agreements with Harlingwood under which SPY North America issued two promissory notes to Harlingwood in the principal amounts of $1.0 million and $0.5 million (“Harlingwood Notes”).  Total outstanding borrowings under the Harlingwood Notes at each of March 31, 2014 and December 31, 2013 were $1.5 million (excluding Accrued PIK Interest of $0.3 million and $0.2 million, respectively).  As of March 31, 2014, approximately $52,000 of accrued interest was reclassified to accrued liabilities and the amount was paid in April 2014. The Harlingwood Notes were amended in April 2014 to extend the maturity date from April 1, 2015 to December 31, 2016.  The Harlingwood Notes are subordinate to the amounts owed by SPY North America under the BFI Line of Credit, pursuant to the terms of a debt subordination agreement between Harlingwood and BFI.

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 The Harlingwood Notes accrue interest at the rate of 12% per annum.  

 The $1.0 million promissory note requires a facility fee equal to the lesser of $10,000 or 1% of the average daily outstanding principal amount due under the Harlingwood Notes (without giving effect to the Accrued PIK Interest).   SPY North America paid $20,000 to Harlingwood for initial aggregate facility fees in 2012.  Facility fees are due in advance on the respective anniversary date of the $1.0 million promissory note until maturity.  The $0.5 million promissory note has a facility fee of $10,000. The Company paid $10,000 and $10,000 to Harlingwood in September 2013 and January 2014, respectively related to facility fees on the Harlingwood Notes.

 The principal amount due under the Harlingwood Notes (including Accrued PIK Interest) is convertible into shares of the Company’s common stock at $1.40 per share, subject to adjustment for stock splits or stock dividends.  The Harlingwood Notes contain standard representations, warranties and reporting requirements that are customary for financings of this type, and cross default provisions with respect to the Costa Brava indebtedness.  SPY North America was in compliance with all covenants under the Harlingwood Notes at March 31, 2014. The Harlingwood Notes are pari passu with the respect to the rights and preferences of Costa Brava Term Note and Costa Brava Line of Credit.  (See Note 11 “Related Party Transactions” and Note 14 “Subsequent Events”).

 Long-Term Debt

  Notes payable at March 31, 2014 consist of the following:

	(Thousands)
Costa Brava Term Loan, as amended (subordinated debt, of which up to $2.25 million is convertible into shares of common stock at a conversion price of $2.25 per share).  Effective April 30, 2014, up to $6.0 million is convertible into shares of Common Stock at a conversion price of $2.00 per share.	$	10,579
Costa Brava Line of Credit (subordinated debt)		9,137
Harlingwood Notes (subordinated convertible debt, all of which is convertible into shares of common stock at a conversion price of $1.40 per share )		1,736
Secured note payable for vehicle purchases, 4.69% interest rate with monthly payments of $1,400 due through December 2015, secured by vehicles		28
Subtotal		21,480
Less current portion		16
Notes payable, less current portion	$	21,464

9.  Fair Value of Financial Instruments

 The Company’s financial instruments include cash, accounts receivable and payable, short-term borrowings, accrued liabilities, other short-term liabilities, capital leases, notes payable and related party debt.  The carrying amount of these instruments approximates fair value because of their short-term nature.  The carrying value of the Company’s long-term debt, including the current portion approximates fair value as of March 31, 2014.

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10.  Share-Based Compensation

Stock Option Activity	Shares		Weighted- Average Exercise  Price		Weighted- Average Remaining Contractual Term (years)		Aggregate Intrinsic  Value
							(Thousands)
Options outstanding at December 31, 2013		3,090,801	$	1.76
Granted		110,000		1.39
Exercised		(120,000)		0.81
Expired		(29,167)		1.07
Forfeited		-		-
Options outstanding at March 31, 2014		3,051,634	$	1.79		7.01	$	335
Options exercisable at March 31, 2014		1,994,147	$	2.02		5.98	$	235

 Intrinsic value is defined as the difference between the relevant current market value of the Company’s common stock and the grant price for options with exercise prices less than the market values on such dates.  During the three months ended March 31, 2014, there were 120,000 stock options exercised.  The Company received cash proceeds of $97,600 related to the stock options exercised in 2014. No options were exercised during the three months ended March 31, 2013.

 The weighted-average estimated fair value of employee stock options granted during the three months ended March 31, 2014 and 2013 was $0.86 and $0.90, respectively.

 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).  There were no restricted stock awards issued during the three months ended March 31, 2014. However, the Company awarded 19,161 fully vested, non-restricted shares at a $1.37 weighted-average grant date fair value during the three months ended March 31, 2014.  These shares were issued to certain members of the Company’s board of directors in lieu of cash payment for quarterly board fees.  The expense related to these shares was $26,250 during the three months ended March 31, 2014, and was recorded in general and administrative expense.

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 The Company recognized the following share-based compensation expense during the three months ended March 31, 2014 and 2013:

	Three Months Ended  March 31,
	2014		2013
	(Thousands)
Stock options
General and administrative expense	$	99	$	119
Cost of sales		5		5
Selling and marketing		34		38
Shipping and warehouse		1		1
Research and development		3		3
Total share-based compensation for stock options		142		166
Restricted stock
General and administrative expense (Board of Directors fees in lieu of cash payments)		26		26
Total share-based compensation for restricted stock		26		26
Total Share-based compensation expense	$	168	$	192

 Total unrecognized share-based compensation expense for outstanding stock option awards at March 31, 2014 is approximately $0.5 million, which will be recognized over a weighted average remaining life of 1.7 years.

11.  Related Party Transactions

 Promissory Notes with Shareholder, Costa Brava

 See Note 8 “Long-Term Debt” to the Consolidated Financial Statements regarding promissory notes held by Costa Brava, an entity that owned, at March 31, 2014, approximately 47.6%, or 51.3% on an as converted basis, of the Company’s common stock.  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.

 The total outstanding borrowings under all promissory notes the Company has entered into with Costa Brava at March 31, 2014 and December 31, 2013 was $20.3 million (including $4.8 million Accrued PIK Interest) and $19.7 million (including $4.2 million Accrued PIK Interest), respectively.

 Convertible Notes with Shareholder, Harlingwood

 See Note 8, “Long-Term Debt” to the Consolidated Financial Statements regarding $1.5 million in total promissory notes held by Harlingwood, an entity that owned, at March 31, 2014, approximately 5.3%, or 13.6% on an as converted basis, of the Company’s common stock.  Mr. Fir Geenen, a member of the Company’s Board of Directors, is the manager of a limited liability company that manages Harlingwood.

 The total outstanding borrowings under all promissory notes issued by the Company to Harlingwood at March 31, 2014 and December 31, 2013 was $1.8 million (including $0.3 million Accrued PIK Interest) and $1.7 million (including less than $0.2 million Accrued PIK Interest), respectively.

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12.  Commitments and Contingencies

 Operating Leases

 The Company’s corporate headquarters totals 32,551 square feet and is located in Carlsbad, California.  Effective November 2010, the Company entered into an amended lease for this facility with average monthly rent payments of approximately $29,000 per month.  In April 2013, the Company amended this lease to (i) extend the expiration date to December 31, 2019, and (ii) give the Company the right to terminate the lease commencing on April 1, 2015 with nine-months written notice.  The monthly rent payments after 2014 will increase by 3% per year. The Company also leases approximately 6,500 square feet of a facility in Varese, Italy with monthly lease payments effective March 2013 of €1,500 per month. On March 10, 2014, the Company elected to terminate its lease in Italy, effective September 10, 2014. In addition, the Company leases an office space totaling approximately 400 square feet in Vancouver, Canada at a monthly rate of CAD$1,352 (approximately $1,312).  The Company also leases certain computer equipment and vehicles.

 Total rent expense was approximately $106,000 and $105,000 for the three months ended March 31, 2014 and 2013, 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:

	(Thousands)
Year Ending December 31,
2014	$	326
2015		393
2016		398
2017		409
2018		420
Thereafter		411
Total	$	2,357

 Capital Leases

  Future minimum lease payments under capital leases at March 31, 2014 are as follows:

	(Thousands)
Year Ending December 31,
2014	$	57
2015		76
2016		23
Total minimum lease payments		156
Amount representing interest		(10)
Present value of minimum lease payments		146
Less current portion		71
Noncurrent portion	$	75

Athlete Contracts

At March 31, 2014, the Company has entered into endorsement contracts with certain athletes to actively wear and endorse the Company’s products.  Payments under these contracts total approximately $258,000, $145,000 and $83,000 in 2014, 2015 and 2016, respectively, and may include additional performance-based incentives and/or product-specific sales incentives.  At March 31, 2014, the Company also had pending endorsement contracts with certain athletes to actively wear and endorse the Company’s products, with payments totaling approximately $547,000.

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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, which it believes will have a material adverse impact on its financial position.

13.  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, prescription frames, and branded apparel and accessories for the action sports, snow sports and lifestyle markets.

 The Company markets its products in North America and internationally.  Revenue is attributed to the location to which the product is shipped.  Beginning on January 1, 2013, substantially all sales to international customers were made by SPY North America.  During and prior to 2012, substantially all sales to international customers were made by SPY Europe.  Identifiable assets are based on location of domicile:

	North America (U.S. and Canada)		International (Europe, Asia Pacific And Latin America)		Consolidated
	(Thousands)		(Thousands)		(Thousands)
	Three Months Ended March 31, 2014
Net sales	$	7,982	$	1,210	$	9,192
	Three Months Ended March 31, 2013
Net sales	$	8,209	$	799	$	9,008

	March 31, 2014		December 31, 2013
	(Thousands)
Tangible long-lived assets:
U.S. and Canada	$	394	$	438
Europe and Asia Pacific		—		—
Total	$	394	$	438

14.  Subsequent Events

In April 2014, the Costa Brava Term Note, Costa Brava Line of Credit and Harlingwood Notes were amended to extend the respective maturity dates from April 1, 2015 to December 31, 2016 (See Note 8 “Long-term Debt”).  Additionally, the interest rates on the Costa Brava Term Note and Costa Brava Line of Credit were reduced from 12% to 7%, and the facility fees were eliminated, effective July 1, 2014. The Costa Brava Term Note was also amended to increase the amount that Costa Brava may, at its discretion, convert (excluding the Accrued PIK Interest) into shares of the Company’s common stock from $2,250,000 to $6,000,000 and to reduce the conversion price from $2.25 to $2.00. Effective with the Costa Brava Term Note and Costa Brava Line of Credit amendments, the Company will no longer add Accrued PIK Interest to the outstanding principal and will begin making quarterly cash payments starting in June 2014.

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ITEM 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements.  The words or phrases "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements."  Actual results could differ materially from those projected in the forward looking statements as a result of a number of risks and uncertainties, including those risks factors contained in our Annual Report on Form 10-K for the year ended December 31, 2013, previously filed with the Securities and Exchange Commission on March 20, 2014, which Annual Report is incorporated herein by reference.  Statements made herein are as of the date of the filing of this Form 10-Q with the Securities and Exchange Commission and should not be relied upon as of any subsequent date.  Unless otherwise required by applicable law, we do not undertake, and specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

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

Overview

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

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

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

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

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Our Products and Target Markets

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

We create products that we believe lead our industry in terms of style and quality, and we continually seek to serve both active lifestyle participants and their aspirational counterparts. We separate our eyewear products into three groups: (i) sunglasses, which includes fashion, Happy Lens™, performance sport and women specific sunglasses; (ii) goggles, which includes snow sport and motocross goggles created for our core demographics, and a new goggle line extension for the SPY® brand that targets new distribution opportunities and customers; and (iii) prescription frames, which includes optical-quality frames and sunglasses for our youthful demographic.  In addition, we sell branded accessories for sunglasses and goggles, as well as a variety of other accessories and apparel. In December 2013, we entered into a merchandising license agreement, pursuant to which we licensed certain trade styles, trademarks logos, designs and other proprietary materials (“SPY IP”) to a third party (“Licensee”).  The agreement provides that the Licensee shall develop, introduce, market and sell certain licensed products incorporating the SPY IP, including men’s and boy’s apparel, bags and luggage, consumer electronics, protective cases, and other unisex accessories, throughout North America through certain distribution channels, other than deep discount retail channels. We currently anticipate that licensed products incorporating SPY IP will generate revenue beginning in late 2014.

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

 SPY’s newest product innovation is the Happy Lens™, which is a patent-pending proprietary technology that was developed over the course of several years and released in February of 2013. The Happy Lens™ enjoyed a successful initial pre-launch marketing and promotion campaign during the fall of 2012, which was followed by strong initial sales of the collection during the year ended December 31, 2013. We believe Happy Lens™ is a natural product extension of the happy and irreverent SPY® brand positioning and we anticipate that it will continue to be an important part of the SPY® collection moving forward.

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Results of Operations

Comparison of Three Months Ended March 31, 2014 to the Three Months Ended March 31, 2013

 Net Sales

 Consolidated net sales increased by $0.2 million or 2.0% to $9.2 million for the three months ended March 31, 2014 from $9.0 million for the three months ended March 31, 2013.The increase in sales growth was from sales of our prescription frame product line which increased by 97.3% or $0.5 million to $1.0 million for the three months ended March 31, 2014, compared to $0.5 million during the same period last year. SPY® sales amounts included approximately $0.4 million and $0.6 million of sales during the three months ended March 31, 2014 and March 31, 2013, respectively, which were considered to be closeouts, defined as (i) older styles not in the current product offering or (ii) the sales of certain excess inventory of current products sold at reduced pricing levels.

 Sunglasses represented approximately 79.4% and 83.8% of net sales during the three months ended March 31, 2014 and 2013, respectively.  Goggle sales represented approximately 8.9% and 9.0% of net sales during each of the three months ended March 31, 2014 and 2013, respectively.  Prescription frames represented approximately 10.5% and 5.4% of net sales during the three months ended March 31, 2014 and 2013, respectively. Apparel and accessories represented approximately 1.2% and 1.8% of net sales each of the three months ended March 31, 2014 and 2013, respectively.  Sales to customers in North America represented 86.8% and 91.7% of total net sales for the three months ended March 31, 2014 and 2013, respectively.  Sales to international customers (excluding Canada) represented 13.2% and 8.3% of total net sales for the three months ended March 30, 2014 and 2013, respectively.

 Gross Profit

 Our consolidated gross profit increased by $0.2 million or 3.9% to $4.8 million for the three months ended March 31, 2014 from $4.6 million for the three months ended March 31, 2013, primarily attributable to an increase in our overall gross margins, as discussed below.

 Gross profit as a percentage of net sales was 52.0% for the three months ended March 31, 2014, compared to 51.1% for the three months ended March 31, 2013.  The increase in our gross profit as a percent of net sales during the three months ended March 31, 2014 compared to the same period in 2013 was primarily due to: (i) improved overall sales mix of our higher margin products; (ii) a higher percentage of lower cost inventory purchases from China; and (iii) lower sales of closeout products at reduced price levels.

 Sales and Marketing Expense

Sales and marketing expense was essentially unchanged at $2.9 million for three months ended March 31, 2014. While the expense remained relatively unchanged, the Company spent a higher percentage of the marketing related costs on trade shows to further develop the SPY brand, which was offset by a reduction in salary related costs.

 General and Administrative Expense

 General and administrative expense increased by $0.1 million or 2.5% to $1.5 million for the three months ended March 31, 2014 from $1.4 million for the three months ended March 31, 2013.  The increase is primarily due to increased use of outside consultants and higher bonus accrual in 2014 compared to 2013.

 Shipping and Warehousing Expense

 Shipping and warehousing expense decreased by $0.1 million or 17.5% to $0.1 million for the three months ended March 31, 2014 from $0.2 million for the three months ended March 31, 2013.  The decrease was primarily due to a decline in the use of temporary labor.

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 Research and Development Expense

 Research and development expense increased by $0.1 million or 50.8% to $0.2 million for the three months ended March 31, 2014 compared to $0.1 million for the three months ended March 31, 2013, due to testing performed on our lenses.

 Other Net Expense

Other net expense was essentially unchanged at $0.8 million for the three months ended March 31, 2014 and 2013. While our net expenses remained relatively unchanged, interest expense increased slightly due to higher debt balances with Costa Brava and Harlingwood.

 Income Tax Provision

 Income tax expense was approximately $3,000 for the three months ended March 31, 2014 and 2013, respectively.  We have recorded a full valuation allowance for deferred tax assets both in the U.S. and in Italy at March 31, 2014 and 2013.  The effective tax rate for the three months ended March 31, 2014 and 2013 was less than 1% in both periods.

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

Liquidity and Capital Resources

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

Cash on hand at March 31, 2014 was $0.7 million.  At March 31, 2014, we had a total of $23.9 million in debt under all lines of credit, capital leases and notes payable, of which $2.4 million was classified as current liabilities and $21.5 million was classified as long-term liabilities in the Company's Consolidated Balance Sheet.  Our primary debt arrangements as of March 31, 2014 are further described below in Short-Term Debt and Long-Term Debt.

 Future Capital Requirements and Resources

 During the three-months ended March 31, 2014 and the year ended December 31, 2013, we had positive cash flow from operations principally as a result of a significant reduction in operating expenses and increases in gross profit. However, we have a history of incurring significant negative cash flow from operations, operating and net losses and significant working capital requirements. The Company anticipates that it will continue to have ongoing cash requirements to finance its seasonal and ongoing working capital requirements and net losses.

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

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

 We do not anticipate that we can generate sufficient cash from operations to repay the amounts due under the BFI Line of Credit, which is scheduled for its next annual renewal in February 2015, and the borrowings from Costa Brava and Harlingwood notes, as amended, when they become due in December 2016.  Therefore, we will need to renew the BFI Line of Credit at its annual renewal in February 2015 and continue to extend the maturity dates of the Costa Brava and Harlingwood indebtedness.  If we are unable to renew the BFI Line of Credit and further extend future maturity dates of the Costa Brava and Harlingwood indebtedness, we will need to raise substantial additional capital through debt or equity financing to continue our operations.  No assurances can be given that any such financing will be available to us on favorable terms, if at all.  The inability to obtain debt or equity financing in a timely manner and in amounts sufficient to fund our operations, or the inability to renew the BFI Line of Credit or to extend future maturity dates of the Costa Brava and Harlingwood indebtedness, if necessary, would have an immediate and substantial adverse impact on our business, financial condition or results of operations.

 Our access to additional financing will depend on a variety of factors (many of which we maintain little or no control) such as market conditions, the general availability of credit, the overall availability of credit to its industry, its credit ratings and credit capacity, as well as the possibility that lenders could develop a negative perception of its long-term or short-term financial prospects.  The current economic environment could also cause lenders, vendors and other counterparties who provide credit to us to breach their obligations or otherwise reduce the level of credit granted to us, which could include, without limitation, lenders or other financial services companies failing to fund required borrowings under our credit arrangements.  If access to our existing credit facilities is not available or is not available on acceptable terms, we may not be able to fund our planned operations if we require such capital, which could have an adverse effect on our business.

 Cash Flow Activities

 Cash used in operating activities consists primarily of the net loss adjusted for certain non-cash items, including depreciation and amortization, paid-in-kind interest on borrowings, share-based compensation, provision for doubtful accounts, impairment of property and equipment, foreign currency gains and losses, amortization of debt discount, and the effect of changes in working capital and other activities.

 Cash provided by operating activities for the three months ended March 31, 2014 was $2.3 million, which consisted of a net loss of $0.7 million, adjustments for aggregate non-cash items of $0.9 million (primarily Accrued PIK Interest of $0.6 million, share-based compensation of $0.1 million, depreciation and amortization of $0.1 million and others of $0.1 million) and an aggregate $2.2 million provided by working capital.  Working capital changes include sources of cash of $2.5 million primarily from: (i) a net increase of $1.5 million related to decrease in inventory from sales and timing if inventory purchase and (ii) $1.0 million from lower accounts receivable due to increased collection efforts. The sources of cash from working capital were partially offset by uses of cash from working capital of $0.3 million primarily related to decreased accounts payable of $0.3 million primarily due to the timing of inventory purchases.

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Cash provided by operating activities for the three months ended March 31, 2013 was $1.5 million, which consisted of a net loss of $0.7 million, adjustments for aggregate non-cash items of $0.9 million (primarily Accrued PIK Interest of $0.6 million, share-based compensation of $0.2 million, depreciation and amortization of $0.1 million and others of less than $0.1 million) and an aggregate $1.4 million provided by working capital.  Working capital changes include sources of cash of $1.5 million primarily from (i) a $0.6 million decrease in accounts receivable, due to timing of collections of 2012 seasonal snow goggle sales in the first quarter of 2013, (ii) $0.4 million from lower inventories, and (iii) a net increase of $0.5 million in the net amount of accounts payable, accrued expenses and other liabilities, primarily due to the timing of payments made for inventory purchases.  The sources from working capital were partially offset by uses of cash from working capital related to increased prepaid expenses and other current assets of less than $0.1 million.

 Cash used in investing activities during the three months ended March 31, 2014 was less than $0.1 million, and was attributable to the purchase of property and equipment, which was slightly offset by a small gain on disposal a vehicle.

 Cash used in investing activities during the three months ended March 31, 2013 was less than $0.1 million and was primarily attributable to the purchase of property and equipment.

 Cash used in financing activities for the three months ended March 31, 2014 was $2.3 million, and was attributable primarily to a $2.3 million reduction in debt under our BFI Line of Credit due to our improved liquidity and timing of working capital requirements.

Cash used in financing activities for the three months ended March 31, 2013 was $0.9 million, and was attributable primarily to $0.9 million in reduction in debt under our BFI Line of Credit due to our improved liquidity and other debt reductions aggregating less than $0.1 million.

 Short-Term and Long-Term Debt

 Summary.  As of March 31, 2014, we had a total of $23.9 million in debt under all lines of credit, capital leases and notes payable.  A brief summary of our primary short-term and long-term debt facilities outstanding and available sources of liquidity from debt at March 31, 2014 is as follows:

● BFI Line of Credit.  A short-term line of credit with BFI with a maximum borrowing limit of $7.0 million.  The maximum availability based on eligible accounts receivable and inventory at March 31, 2014 was $5.2 million, of which $1.7 million was outstanding at that date;

● Costa Brava Term Note.  A $7.0 million subordinated term loan with Costa Brava, of which $6.0 million is convertible into common stock; due December 31, 2016, as amended in April 2014.  $7.0 million outstanding at March 31, 2014 (excluding Accrued PIK Interest of $2.4 million).  (“Costa Brava Term Note”);

● Costa Brava Line of Credit.  A $9.0 million subordinated line of credit with Costa Brava, due December 31, 2016 as amended in April 2014. $8.5 million outstanding as of March 31, 2014 (excluding Accrued PIK Interest of $2.4 million).  ("Costa Brava Line of Credit");

● Harlingwood Notes.  Two subordinated convertible term loans with Harlingwood aggregating $1.5 million; due December 31, 2016 as amended in April 2014.  $1.5 million outstanding at March 31, 2014 (excluding Accrued PIK Interest of $0.3 million).  ("Harlingwood Notes"); and

● Interest attributable to the Costa Brava Term Note and Costa Brava Line of Credit due subsequent to January 1, 2012, and on Harlingwood Notes has been be paid in kind.  Aggregate Accrued PIK Interest was $5.1 million at March 31, 2014.

 Each of our primary debt facilities is more fully described in Note 8, “Long-Term Debt”, in the notes to our unaudited Consolidated Financial Statements.

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Off-Balance Sheet Arrangements

 We did not enter into any off-balance sheet arrangements during the three months ended March 31, 2014 and 2013, respectively, nor did we have any off-balance sheet arrangements outstanding at March 31, 2014 and December 31, 2013.

 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 SPY North America and SPY Europe at March 31, 2014 and December 31, 2013.

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

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 during August to October.

Seasonality

 Our net sales fluctuate from quarter to quarter as a result of changes in demand for our products.  Historically, we experience 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 are traditionally 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 second half of the fiscal year. We anticipate 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.

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, warranty and severance.  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.

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 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, prescription frames, 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, sometimes 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, at 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: (i) calculating an average of actual returns as a percentage of sales over a rolling twelve month period; (ii) estimating the average time period between a sale and the return of the product (13 months at March 31, 2014) and (iii) 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 percentages at March 31, 2014, the range of the weighted average cumulative return percentages over the past two years and the effect on the liability and net sales if the highest average percentage over the past years had been used at March 31, 2014 are shown below in our sensitivity analysis.  Historically, actual returns had been within our expectations.  If future returns are higher than our estimates, our earnings would be adversely affected.

	Sales Return Reserve Sensitivity Analysis
	(A)		(B)	(C)		(D)
	Average  Returns % at March 31, 2014		Average Returns % Range during past two years	Decrease to Net Sales if highest average return rate in (B) increased by 10%		Increase to Net Sales if current average return rate decreased by 10%
				(Thousands)		(Thousands)
SPY		7.9%	5.1% — 7.9%		186		(186)

 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.  Stock options generally vest annually over a three year period and the corresponding expense is ratably recognized over the same time 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 record share-based compensation expense only for those awards that are expected to vest.

Inventories.

 Inventories consist primarily of finished products, including sunglasses, goggles, prescription frames, apparel and accessories, product components such as replacement lenses along with purchasing and quality control costs.  Inventory items are carried on the books at the lower of cost or market 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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 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 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 our foreign wholly owned subsidiary, SPY Europe, is the respective local currency.  Accordingly, we are exposed to transaction gains and losses that could result from fluctuations 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 the translation of foreign subsidiary financial statements are included in accumulated other comprehensive income (loss).

 Debt Modifications

 From time to time, we have modified and also anticipate modifying certain debt agreements.  We have accounted for and expect to account for future changes in debt agreements as debt modifications, where applicable, based on the relevant authoritative accounting guidance after considering the specific terms of any future debt modifications. 

Recently Issued Accounting Principles

 There are no recently issued accounting principles subsequent to the Company’s disclosure in the Annual Report on Form 10-K which would have a significant impact on the Company’s Consolidated Financial Statements.

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Item 4.  Controls and Procedures

Disclosure Control and Procedures

 Management, under the supervision and with the participation of our Chief Executive Officer and 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 March 31, 2014, 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 Securities and Exchange Commission’s rules and forms.  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2014.

Changes in Internal Control over Financial Reporting

 During the three months ended March 31, 2014, 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.

PART II – OTHER INFORMATION

Item 1.  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 1A.  Risk Factors

 As of the date of this report, there has not been any material changes to the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013.  You should carefully consider the risk factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2013, which could materially affect our business, financial position and results of operations.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 None.

Item 3.  Defaults Upon Senior Securities

 None.

Item 4.  Mine Safety Disclosures

 Not Applicable.

Item 5.  Other Information

 None.

Item 6.  Exhibits

 See accompanying exhibit index included after the signature page to this report. 

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SIGNATURES

 Pursuant to the requirements 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.

	SPY Inc.
Date:  May 6, 2014	By:	/s/ James McGinty
		James McGinty
		Chief Financial Officer, Treasurer and Secretary
		(Principal Financial and Accounting Officer)

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Exhibit Index

Exhibit No.	Description of Document	Incorporation by Reference
10.1*	Second Amendment to Promissory Note and Promissory Note No. 2, by and between SPY Optic, Inc. and Harlingwood (Alpha), LLC, dated April 30, 2014
10.2*	Fourth Amended and Restated Promissory Note, by and between SPY Optic, Inc. and Costa Brava Partnership III, L.P., dated April 30, 2014
10.3*	Fifth Amended and Restated Promissory Note, by and between SPY Optic, Inc. and Costa Brava Partnership III, L.P., dated April 30, 2014
31.1	Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Furnished herewith.
31.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Furnished herewith.

32.1#	Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Furnished herewith.
101.INS	XBRL Instance Document	Furnished herewith
101.SCH	XBRL Taxonomy Extension Schema Document	Furnished herewith
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document	Furnished herewith
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document	Furnished herewith
101.LAB	XBRL Taxonomy Extension Label Linkbase Document	Furnished herewith
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document	Furnished herewith

* Filed herewith.  

# This certification is being furnished solely to accompany this report pursuant to 18 U.S.C. 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and is not to be incorporated by reference into any filing of the registrant, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

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EX-31.1

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

I, Michael Marckx, certify that:

1.    I have reviewed this Quarterly Report on Form 10-Q of SPY 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: May 6, 2014
By:	/s/ Michael Marckx
	Michael Marckx
	President, Chief Executive Officer and Director
	(Principal Executive Officer)

EX-31.2

Exhibit 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

I, Jim McGinty, certify that:

1.     I have reviewed this Quarterly Report on Form 10-Q of SPY 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.     I am 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.    I have disclosed, based on my 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: May 6, 2014
By:	/s/ Jim McGinty
	Jim McGinty
	Chief Financial Officer, Treasurer and Secretary
	(Principal Financial and Accounting Officer)

EX-32.1

Exhibit 32.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER

UNDER 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906

OF THE SARBANES-OXLEY ACT 0F 2002

I, Michael Marckx, the President and Chief Executive Officer of SPY 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 Quarterly Report of the Company on Form 10-Q for the quarter ended March 31, 2014 (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: May 6, 2014
By:	/s/ Michael Marckx
	Michael Marckx
	President, Chief Executive Officer and Director
	(Principal Executive Officer)

I, James McGinty, Chief Financial Officer and Treasurer of SPY 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 Quarterly Report of the Company on Form 10-Q for the quarter ended March 31, 2014 (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: May 6, 2014
By:	/s/ Jim McGinty
	Jim McGinty
	Chief Financial Officer, Treasurer and Secretary
	(Principal Financial and Accounting Officer)

EX-10.1

Exhibit 10.1

SECOND AMENDMENT

 TO

 PROMISSORY NOTE AND PROMISSORY NOTE NO. 2

This SECOND AMENDMENT TO PROMISSORY NOTE AND PROMISSORY NOTE NO. 2 (this "Second Amendment") is entered into as of May 1, 2014 between SPY OPTIC INC., a California corporation (the "Company"), and HARLINGWOOD (ALPHA), LLC, a Delaware limited liability company,  ("Holder").

RECITALS

A.           The Company is currently indebted to Holder pursuant to the terms and conditions of the Promissory Note, dated September 6, 2012, in the principal amount of $1,000,000, and a Promissory Note No. 2, dated December 18, 2012, in the principal amount of $500,000 (together, the “Notes”), which Notes were amended on May 8, 2013 pursuant to the terms of an Amendment to Promissory Note and Promissory Note No. 2 (“First Amendment “);

B.The Company has requested that Holder amend the Maturity Date of the Notes, as such term is defined therein, and further amended by the First Amendment; and

C.Holder is willing to amend the Notes as requested by Holder, subject to the other terms and conditions set forth herein.

AGREEMENT

NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Company and Holder hereby agree as follows:

1.Recitals.  The foregoing recitals of facts and understandings of the parties are incorporated herein as the agreement of the parties.

2.Amendment to Maturity Date.  The Maturity Date of the Notes, as defined therein and further amended by the First Amendment, is hereby further amended so that the Maturity Date of such Notes shall be December 31, 2016.

3.           Legal Effect

.  Except as expressly set forth herein, the Notes shall not be affected hereby and shall remain in full force and effect in accordance with their respective terms.

4.           Counterparts

.  This Second Amendment may be executed in any number of counterparts, all of which, taken together, shall constitute a single original.  Signatures delivered by facsimile or electronic file format will be treated in all respects as originals.

5.           Successors and Assigns

.  This Second Amendment is binding upon and shall inure to the benefit of the successors and assigns hereof.

6.           Governing Law

.  This Second Amendment shall be governed by California law without regard to conflict of law principles.

7.           Integrated Agreement. This is an integrated Second Amendment and supersedes all prior negotiations and agreements regarding the subject matter hereof.  Any further amendments to the Notes hereto must be in writing and signed by the parties.

IN WITNESS WHEREOF, the parties hereto have caused this Second Amendment to be executed as of the day and year first written above.

SPY OPTIC INC.,

a California corporation

By: /s/ Jim McGinty

Name: Jim McGinty

Title: Chief Financial Officer

HARLINGWOOD (ALPHA), LLC

a Delaware limited partnership

By:          /s/ Fir Geenen

Name:     Fir Geenen

Title:       Managing Member

EX-10.2

Exhibit 10.2

THIS 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 MARCH 19, 2010, AS AMENDED OR MODIFIED FROM TIME TO TIME, AMONG BFI BUSINESS FINANCE AND THE HOLDER.

THIS 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 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 THIS NOTE, (2) THE AMOUNT OF ORIGINAL ISSUE DISCOUNT ON THIS NOTE AND (3) THE YIELD TO MATURITY OF THIS NOTE. TO OBTAIN THIS INFORMATION, A HOLDER SHOULD CONTACT THE CHIEF FINANCIAL OFFICER AT 2070 LAS PALMAS DRIVE, CARLSBAD, CA 92011.

THIS FOURTH AMENDED AND RESTATED PROMISSORY NOTE AMENDS AND RESTATES IN ITS ENTIRETY THE THIRD AMENDED AND RESTATED PROMISSORY NOTE, DATED MAY 8, 2013.

FOURTH AMENDED AND RESTATED PROMISSORY NOTE

$7,000,000  April 30, 2014 San Diego, California

FOR VALUE RECEIVED, Spy Optic Inc., a California corporation, formerly known as Orange 21 North America Inc. (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 Seven Million Dollars ($7,000,000) on December 31, 2016 (the "Maturity Date"), together with fees and interest thereon as provided in Section 2 of this Third Amended and Restated Promissory Note (this "Note").

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

"Affiliate" means 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" means 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, and, in each case, as may be further amended, restated, extended, supplemented, or otherwise modified from time to time.

"Business" means the business of the Company or 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 or 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.

"Common Stock" means the common stock of SPY Inc., a Delaware corporation ("Parent").

"Common Stock Equivalents" means any securities of Parent which would entitle the holder thereof to acquire at any time Common Stock, including any debt, preferred stock, rights, options, warrants or other instrument that is at any time convertible into or exercisable or exchangeable for, or otherwise entitles the holder thereof to receive, Common Stock.

"Conversion Shares" means, collectively, the shares of Common Stock issuable upon conversion of this Note in accordance with the terms hereof.

"Control" means 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" means 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" means 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.

"Harlingwood Notes" means, collectively, (i) the Promissory Note, dated as of September 6, 2012, by the Company in favor of Harlingwood (Alpha), LLC, a Delaware limited liability company ("Harlingwood"), in the original principal amount of $1,000,000, as the same may be amended, restated, extended, supplemented, or otherwise modified from time to time in accordance with the terms thereof, and (ii) the Promissory Note, dated as of December 18, 2012, by the Company in favor of Harlingwood in the original principal amount of $500,000, as the same may be amended, restated, extended, supplemented, or otherwise modified from time to time in accordance with the terms thereof.

"Investment" means, 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" means 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).

"Line of Credit Note" means the Fifth Amended and Restated Promissory Note of even date herewith by the Company in favor of Holder in the original principal amount of $9,000,000 (without giving effect to any accrued PIK Interest), as the same may be amended, restated, extended, supplemented, or otherwise modified from time to time (“$9.0M Note”).

"Material Adverse Effect" means 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" means 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.

"Original Term Note" means the Second Amended and Restated Promissory Note, dated as of August 2, 2012, by the Company in favor Holder in the original principal amount of $7,000,000 (without giving effect to any accrued PIK Interest).

"Permitted Debt" means: (i) Obligations of the Company to Holder hereunder or under any other document related to or in connection with this Note; (ii) Debt of the Company under the BFI Loan Documents, or amendments, extensions, renewals, refinancings, or replacements of such Debt with (A) BFI Business Finance or (B) with any other lender, provided that any refinancing or replacement of the BFI Loan Documents with loans from any other lender shall be on terms and in the form reasonably acceptable to Holder; (iii) Debt of the Company under the Line of Credit Note; (iv) Debt of the Company under the Harlingwood Notes; (v) Debt of the Company and any Subsidiary of the Company existing on the date hereof and disclosed to Holder on Schedule A hereto and 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; (vi) Debt of Spy Optic Europe S.r.l.S.U. (formerly known as Orange 21 Europe, S.r.l. and Spy Optic, S.r.l.) and extensions, renewals and refinancings of such Debt; (vii) 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; (viii) 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; (ix) interest rate swaps, currency swaps and similar financial products entered into or obtained in the ordinary course of business; and (x) 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.

"Permitted Investments" means 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" means: (i) the existing Liens as of the date hereof disclosed to Holder on Schedule B hereto, 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 Spy Optic Europe S.r.l.S.U. (formerly known as Orange 21 Europe, S.r.l. and Spy Optic, S.r.l.) securing Debt permitted by clause (vi) 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" means 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.

"PIK Interest" means: with respect to any Debt, accrued interest on such Debt payable in kind which is added to the principal balance and due on the Maturity Date. For sake of clarity, no PIK Interest is or may be payable in cash until the Maturity Date.

"SEC Reports" means reports, schedules, forms and registration statements, and any amendments thereto, filed with the Securities and Exchange Commission (the "Commission") pursuant to the Securities Act of 1933 or Securities Exchange Act of 1934 and the rules and regulations of the Commission promulgated thereunder.

"Securities" means, collectively, this Note and the Conversion Shares.

"Subsidiary" means, 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.

"Trading Day" means a day on which the principal Trading Market is open for trading.

"Trading Market" means any of the following markets or exchanges on which the Common Stock is listed or quoted for trading on the date in question: the NYSE Amex, the Nasdaq Capital Market, the Nasdaq Global Market, the Nasdaq Global Select Market, the New York Stock Exchange or the OTC Bulletin Board (or any successors to any of the foregoing); provided, however, if on the date in question the Common Stock is not listed or quoted for trading on any of the foregoing markets or exchanges, "Trading Market" means the New York Stock Exchange.

2.Payment of Interest and Fees.

(a)Interest Generally.  Interest shall accrue on the outstanding principal amount of this Note (including all previously capitalized PIK Interest thereon) (i) through July 1, 2014 at a rate equal to 12% per annum payable in cash, and, (ii) beginning July 1, 2014 through the Maturity Date, at a rate equal to 7% per annum payable in cash (in each case, computed on the basis of actual calendar days elapsed and a year of 365 days), in each case, quarterly in arrears on the last day of each calendar quarter (each such date, an "Interest Payment 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 this Note.  Such incremental interest (i.e., the additional 2% added during the continuance of an Event of Default) shall be payable in cash.

(c)Fees. On the date hereof, the Company shall pay in cash to Holder a facility fee equal to 1.00% of the average daily outstanding principal amount owing under this Note (without giving effect to any accrued PIK Interest) for the period commencing on December 31, 2013 and ending on the date hereof, multiplied by 0.43.

3.Payments.

(a)Form of Payment.  All payments of cash interest, principal and fees 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 outstanding fees, then 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; provided, no prepayment under this Note shall be made unless the $9.0M Note is paid in full.

4.Conversion.

(a)Voluntary Conversion.  Subject to the provisions of this Section 4, at any time after the date hereof until this Note is no longer outstanding, up to $6,000,000 of the outstanding principal amount of this Note shall be convertible, in whole or in part, into shares of Common Stock at the option of Holder, at any time and from time to time.  Holder shall effect conversions by delivering to the Company a Notice of Conversion, the form of which is attached hereto as Annex A (each, a "Notice of Conversion"), specifying therein the principal amount of this Note to be converted, which amount shall be no less than $100,000 (unless the aggregate principal amount that has not been converted is less than $100,000, in which case the amount to be converted shall be no less than remaining aggregate principal amount that has not been converted), and the date on which such conversion shall be effected, which date shall be no earlier than the tenth (10th) Business Day after such Notice of Conversion is deemed delivered hereunder (such date, the "Conversion Date").  If no Conversion Date is specified in a Notice of Conversion, the Conversion Date shall be the date that is the tenth (10th) Business Day after such Notice of Conversion is deemed delivered hereunder.  Conversions hereunder shall have the effect of lowering the outstanding principal amount of this Note in an amount equal to the applicable amount being converted.  Holder and the Company shall maintain records showing the principal amount(s) converted and the date of such conversion(s).  Holder, and any assignee by acceptance of this Note, acknowledge and agree that, by reason of the provisions of this paragraph, following conversion of a portion of the principal amount of this Note, the unpaid and unconverted principal amount of this Note may be less than the amount stated on the face hereof.

(b)Conversion Price.  The conversion price in effect on any Conversion Date shall be equal to $2.00,subject to adjustment herein (the "Conversion Price").

(c)Mechanics of Conversion.

(i)Conversion Shares Issuable Upon Conversion.  The number of Conversion Shares issuable upon a conversion hereunder shall be determined by the quotient obtained by dividing (x) the outstanding principal amount of this Note to be converted by (y) the Conversion Price.

(ii)Delivery of Certificate Upon Conversion. Not later than five (5) Trading Days after each Conversion Date, the Company shall deliver, or cause to be delivered, to Holder a certificate or certificates representing the number of Conversion Shares being acquired upon the conversion of this Note.

(iii)Reservation of Shares Issuable Upon Conversion. The Company covenants that it will at all times reserve and keep available out of its authorized and unissued shares of Common Stock for the sole purpose of issuance upon conversion of this Note as herein provided, free from preemptive rights or any other actual contingent purchase rights of Persons other than Holder, not less than such aggregate number of shares of the Common Stock as shall be issuable upon the conversion of the then outstanding principal amount of this Note.  The Company covenants that all shares of Common Stock that shall be so issuable shall, upon issue, be duly authorized, validly issued, fully paid and nonassessable.

(iv)Fractional Shares. No fractional shares or scrip representing fractional shares shall be issued upon the conversion of this Note.  As to any fraction of a share which Holder would otherwise be entitled to acquire upon such conversion, the Company shall at its election, either pay a cash adjustment in respect of such final fraction in an amount equal to such fraction multiplied by the Conversion Price or round up to the next whole share.

(v)Stock Dividends and Stock Splits.  If the Company, at any time while this Note is outstanding: (A) pays a stock dividend or otherwise makes a distribution or distributions payable in shares of Common Stock on shares of Common Stock or any Common Stock Equivalents (which, for avoidance of doubt, shall not include any shares of Common Stock issued by the Company upon conversion of, or payment of interest on, this Note); (B) subdivides outstanding shares of Common Stock into a larger number of shares; (C) combines (including by way of a reverse stock split) outstanding shares of Common Stock into a smaller number of shares; or (D) issues, in the event of a reclassification of shares of the Common Stock, any shares of capital stock of the Company, then the Conversion Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock (excluding any treasury shares of the Company) outstanding immediately before such event and of which the denominator shall be the number of shares of Common Stock outstanding immediately after such event.  Any adjustment made pursuant to this Section shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or re-classification.

(vi)Transfer Taxes.  The issuance of certificates for shares of the Common Stock on conversion of this Note shall be made without charge to Holder hereof for any documentary stamp or similar taxes that may be payable in respect of the issue or delivery of such certificates; provided, however, that, the Company shall not be required to pay any tax that may be payable in respect of any transfer involved in the issuance and delivery of any such certificate upon conversion in a name other than that of Holder and the Company shall not be required to issue or deliver such certificates unless or until the Person or Persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid.

5.Restricted Securities.  By accepting the benefits of the Securities, Holder hereby covenants, agrees, represents and warrants the following:

(a)Own Account.  The Securities are characterized as "restricted securities" under the federal securities laws, inasmuch as they are being acquired from the Company in a transaction not involving a public offering, and that under such laws and applicable regulations such securities may be resold without registration under the Securities Act of 1933, as amended (the "1933 Act") only in certain limited circumstances.  In this connection, Holder is familiar with Rule 144, as presently in effect, and understands the resale limitations imposed thereby and by the 1933 Act.  At the time of conversion, Holder agrees to execute and deliver to the Company a certificate, in such form reasonably acceptable to the Company, affirming that Holder is an accredited investor (as such term is defined by the 1933 Act), qualified to receive restricted securities as of the date of conversion, and has no intent to distribute the same in violation of the 1933 Act.

(b)Investment Risks.  The Securities will not be, and Holder does not have the right to require that the Securities be, registered under the 1933 Act.  The Securities may bear one or more of the following legends:

(i)The following legend under the 1933 Act:

"THESE SECURITIES HAVE NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE SECURITIES LAWS OF ANY STATE, AND MAY BE OFFERED, SOLD, PLEDGED OR HYPOTHECATED ONLY IF REGISTERED AND QUALIFIED PURSUANT TO THE RELEVANT PROVISIONS OF FEDERAL AND STATE SECURITIES LAWS OR IF THE COMPANY IS PROVIDED AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO THE COMPANY THAT REGISTRATION AND QUALIFICATION UNDER FEDERAL AND STATE SECURITIES LAWS IS NOT REQUIRED OR IF THE COMPANY OTHERWISE SATISFIES ITSELF THAT REGISTRATION IS NOT REQUIRED."

(ii)Any legend required by state securities laws.

The Company agrees to remove promptly, upon the request of a holder of Conversion Shares, said legend from the documents/certificates for such shares following the Company's receipt of evidence reasonably satisfactory to the Company that such shares have been transferred in compliance with the 1933 Act and such removal is also in compliance with the 1933 Act.  In addition, the Company agrees to reissue certificates representing any of such shares, without the legend, at such time as the holder of such shares, prior to making any transfer of such shares, provides written notice to the Company describing the manner and terms of such transfer as the Company shall reasonably request to confirm that such transfer will be in compliance with the 1933 Act.

(c)Purchaser Status.  At the time such Holder was offered the Securities, it was, and at the date hereof it is, and at the time of any conversion of the Note it will be, an "accredited investor" as defined in Rule 501(a) under the 1933 Act.  Holder is not required to be registered as a broker-dealer under Section 15 of the Securities Exchange Act of 1934, as amended.

(d)Residency.  Holder's principal executive offices are at the location set forth in the Section 15 of this Note.

(e)Experience of Holder.  Holder, either alone or together with its representatives (who are unaffiliated with and who are not compensated by the Company or any affiliate of the Company and who are not selling agents of the Company), has such knowledge, sophistication and experience in business and financial matters so as to be capable of evaluating the merits and risks of the prospective investment in the Securities, and has so evaluated the merits and risks of such investment.  Holder is able to bear the economic risk of an investment in the Securities and, at the present time, is able to afford a complete loss of such investment.

(f)General Solicitation. Holder is not purchasing the Securities as a result of any advertisement, article, notice or other communication regarding the Securities published in any newspaper, magazine or similar media or broadcast over television or radio or presented at any seminar or meeting or, to its knowledge, in any other form of general solicitation or general advertisement.

6.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 C:

(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 the immediately foregoing 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.  SPY Inc., a Delaware corporation, formerly known as Orange 21 Inc. 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, 2011, 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 March 31, 2012 (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 December 31, 2011, 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 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, the Line of Credit Note, the Harlingwood Notes, 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.

7.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 the Company 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 or disclosed 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.

So long as the Company files its Annual Report on Form 10K with the Securities Exchange Commission within the required timelines, the Company will not be required to additionally provide the items under the above Sections 7(n) (i) through (iii).

(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 each of the chief executive officer and 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 or within the extension periods provided by the Internal Revenue Service.

(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.

8.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.  (i) Incur any Debt other than Permitted Debt; (ii) 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, the Line of Credit Note, the Harlingwood Notes (provided that, in the case of prepayment permitted under the Harlingwood Notes, the Company shall pay the Harlingwood Notes, this Note, and the Line of Credit Note on a pro rata basis in accordance with the respective outstanding principal amounts then due and owing under such promissory notes, unless otherwise consented to by the Holder), and Debt permitted by clause (vii) of the definition of Permitted Debt); or (iii) amend, modify or otherwise change the terms of any Permitted Debt (other than this Note, the Line of Credit Note, the Harlingwood Notes, and Debt permitted by clause (vii) of the definition of Permitted Debt) so as to accelerate the scheduled repayment thereof or increase the principal amount of such Permitted Debt (provided that, notwithstanding anything to the contrary in the foregoing, the Harlingwood Notes shall not be amended, modified or otherwise changed so as to accelerate the scheduled repayment thereof or to impose materially more burdensome terms upon Company or the relevant Subsidiary).

(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 or 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 or mandated by the Securities Exchange Commission or other regulatory bodies.

(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 unless otherwise inpracticable.

(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.

9.Use of Proceeds.  The Company shall use the proceeds from the amounts loaned to the Company under this Note for general working capital and other lawful corporate purposes.

10.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 7 or 8, 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 8, (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 10(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, (b) under the Line of Credit Note, (c) under the Harlingwood Notes, or (d) in respect of any Debt (other than the Debt hereunder, the Debt under the BFI Loan Documents, the Debt under the Line of Credit Note, and the Debt under the Harlingwood Notes) 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, (b) the Line of Credit Note, (c) the Harlingwood Notes, or (d) any such Debt described in clause (i)(d) 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, the Line of Credit Note, the Harlingwood Notes or any such Debt described in clause (i)(d) 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, the Line of Credit Note, the Harlingwood Notes or the Debt described in clause (i)(d) above to become due or to be repurchased, prepaid, defeased or redeemed (automatically or otherwise);

(vii)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

(viii)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 Note, including any suit, action, claim or other activity of 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.

11.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.

12.Waiver of Jury Trial.  TO THE EXTENT NOT PROHIBITED BY APPLICABLE LAW WHICH CANNOT BE WAIVED, THE COMPANY (BY ITS EXECUTION HEREOF) AND 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.

13.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.

14.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.

15.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:	Spy Optic Inc. 2070 Las Palmas Drive Carlsbad, CA 92011 Facsimile No.: (760) 804-8420 Telephone No.: (760) 804-8421 Attention: Chief Financial Officer
With an additional copy to:	Disclosure Law Group 600 West Broadway, Suite 700 San Diego, CA 92101 Facsimile No.: (619) 330-2101 Attention: Daniel W. Rumsey, 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 Telephone No.: (617) 595-4405 Attention: Seth W. Hamot, President

With a copy to: Ropes & Gray LLP Prudential Tower 800 Boylston Street Boston, MA 02199 Facsimile No.: (617) 951-7050 Attention: David A. Fine, Esq.  and Jeffrey R. Katz, Esq.  

16.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.

17.Assignment.  The provisions of this Note shall be binding upon and inure to the benefit of each of the Company and 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 Holder to any other Person, provided, however, that no such endorsement, assignment or transfer be permitted that is not in compliance with securities law or other applicable law.

18.Indemnity.  The Company agrees to indemnify 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 or (ii) any breach by the Company of its obligations under this Note or any agreement or instrument contemplated thereby.

19.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.

20.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 Section 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 Holder exceed the unpaid balance of principal, such excess shall be refunded to the Company.

21.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 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 this 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).

22.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.

23.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.

24.Subordination.  This 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 as of March 19, 2010, as amended or modified from time to time.

25.Effect of this Note.  This Note amends and restates in its entirety the Original Term Note.

[Remainder of Page Intentionally Left Blank]

IN WITNESS WHEREOF, 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:

Spy Optic Inc.,

By: /s/ Jim McGinty

Name: Jim McGinty

Title: Chief Financial Officer

Holder:

Costa Brava Partnership III, L.P.

By: /s/ Seth Hamot

Name:   Seth Hamot                                                                  

Title:   Managing Member of the General Partner

SCHEDULE A

Debt

Disclosure contained in Note and SEC Reports is incorporated herein by this reference.

SCHEDULE B

Liens

Disclosure contained in Note and SEC Reports is incorporated herein by this reference.

SCHEDULE C

Schedule of Exceptions

1.             Building is not in good repair.

2.             The Company has been late in paying certain vendors from time to time.

3.             Maintenance is not in good repair.

4.             All risks and facts disclosed in the Company's Form 10-K for the period ending December 31, 2013, Form 10-Q for the period ending March 31, 2014, and Forms 8-K filed subsequent to the filing date of the aforementioned Form 10-K and Form 10-Q.

EX-10.3

Exhibit 10.3

THIS 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 MARCH 19, 2010, AS AMENDED OR MODIFIED FROM TIME TO TIME, AMONG BFI BUSINESS FINANCE AND THE HOLDER.

THIS 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 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 THIS NOTE, (2) THE AMOUNT OF ORIGINAL ISSUE DISCOUNT ON THIS NOTE AND (3) THE YIELD TO MATURITY OF THIS NOTE.  TO OBTAIN THIS INFORMATION, A HOLDER SHOULD CONTACT THE CHIEF FINANCIAL OFFICER AT 2070 LAS PALMAS DRIVE, CARLSBAD, CA 92011.

THIS NOTE IS INTENDED TO AMEND AND RESTATE IN ITS ENTIRETY THE FOURTH AMENDED AND RESTATED PROMISSORY NOTE, DATED APRIL 30, 2013.

FIFTH AMENDED AND RESTATED PROMISSORY NOTE

$9,000,000  April 30, 2014 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 Nine Million Dollars ($9,000,000), or such lesser amount as is advanced and outstanding hereunder, on December 31, 2016 (the "Maturity Date"), together with fees and interest thereon as provided in Section 3 of this Fourth Amended and Restated Promissory Note (this "Note").   Holder shall disburse the amount of this Note in accordance with the terms hereof.

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

"Affiliate" means 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" means the Loan and Security Agreement, dated as of February 26, 2007, between the Company and BFI Business Finance, and the other Loan Documents as defined therein, and, in each case, as further amended, restated, extended, supplemented, or otherwise modified from time to time.

"Business" means the business of the Company or 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 or 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" means 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" means 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" means 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.

"Harlingwood Notes" means, collectively, (i) the Promissory Note, dated as of September 6, 2012, by the Company in favor of Harlingwood (Alpha), LLC, a Delaware limited liability company ("Harlingwood"), in the original principal amount of $1,000,000, as the same may be amended, restated, extended, supplemented, or otherwise modified from time to time in accordance with the terms thereof, and (ii)  the Promissory Note, dated as of December 18, 2012, by the Company in favor of Harlingwood in the original principal amount of $500,000, as the same may be amended, restated, extended, supplemented, or otherwise modified from time to time in accordance with the terms thereof.

"Investment" means, 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" means 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" means 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" means 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.

"Original Line of Credit Note" means the Fourth Amended and Restated Promissory Note, dated as of April 30, 2013, by the Company in favor of Holder in the original principal amount of $9,000,000 (without giving effect to any accrued PIK Interest).

"Permitted Debt" means: (i) Obligations of the Company to Holder hereunder or under any other document related to or in connection with this Note; (ii) Debt of the Company under the BFI Loan Documents, or amendments, extensions, renewals, refinancings, or replacements of such Debt with (A) BFI Business Finance or (B) with any other lender, provided that any refinancing or replacement of the BFI Loan Documents with loans from any other lender shall be on terms and in the form reasonably acceptable to Holder; (iii) Debt of the Company under the Term Note; (iv) Debt of the Company under the Harlingwood Notes; (v) Debt of the Company and any Subsidiary of the Company existing on the date hereof and disclosed to Holder on Schedule A hereto and 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; (vi) Debt of Spy Optic Europe S.r.l.S.U. (formerly known as Orange 21 Europe, S.r.l. and Spy Optic, S.r.l.) and extensions, renewals and refinancings of such Debt; (vii) 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; (viii) 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; (ix) interest rate swaps, currency swaps and similar financial products entered into or obtained in the ordinary course of business; and (x) 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.

"Permitted Investments" means 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" means: (i) the existing Liens as of the date hereof disclosed to Holder on Schedule B hereto, 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 Spy Optic Europe S.r.l.S.U. (formerly known as Orange 21 Europe, S.r.l. and Spy Optic, S.r.l.) securing Debt permitted by clause (vi) 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" means 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.

"PIK Interest" means, with respect to any Debt, accrued interest on such Debt to the extent such interest is not paid in cash but is added to the principal balance and due on the Maturity Date.

"SEC Reports" means reports, schedules, forms and registration statements, and any amendments thereto, filed with the Securities and Exchange Commission (the "Commission") pursuant to the Securities Act of 1933 or Securities Exchange Act of 1934 and the rules and regulations of the Commission promulgated thereunder.

"Senior Debt" means all Debt of the Company under the BFI Loan Documents or any amendment, extension, renewal, refinancing, or replacement of such Debt in accordance with the terms hereof.

"Subsidiary" means, 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.

"Term Note" means the Third Amended and Restated Promissory Note of even date herewith by the Company in favor of Holder in the original principal amount of $7,000,000 (without giving effect to any accrued PIK Interest), as the same may be amended, restated, extended, supplemented, or otherwise modified from time to time.

2.Line of Credit.

(a)Subject to the terms and conditions of this Note, Holder agrees to make advances to the Company at the Company's request in an aggregate principal amount at any one time outstanding not to exceed $9,000,000 (without giving effect to any accrued PIK Interest) (the "Line of Credit") as such amount may be reduced from time to time pursuant to Section 4(c)(ii).  The Company may borrow, repay and reborrow all or any part of the Line of Credit, subject to the terms of this Note.  All advances must be requested not later than the Maturity Date.  Holder shall enter each amount borrowed and repaid in Holder's records.  No failure by Holder to make, and no error by Holder in making, any entry in such records shall affect the Company's obligation to repay the full principal amount advanced by Holder to or for the account of the Company, or to pay interest or fees thereon at the agreed-upon rates.   Holder's commitment to make advances hereunder shall be in addition to any amounts advanced under the Term Note.

(b)Each advance request shall be made (i) by telephone or in writing at the number or address, as applicable, provided for Holder in Section 15, (ii) no later than 11:00 a.m. (San Diego, California time) one Business Day prior to the requested advance date, which date shall be a Business Day, and (iii) in a minimum amount of $500,000 or, if less, the remaining amount of the availability under the Line of Credit.  The Company may not request an advance more than once in each calendar week.  Each oral advance request shall be conclusively presumed to have been made by a person authorized by the Company to do so, and any credit by Holder of an advance to or for the account of the Company shall conclusively establish the Company's obligation to repay same. Holder shall incur no liability of any kind to any Person by reason of making an advance upon an oral request, except to the extent such liability results from Holder's gross negligence or willful misconduct.

(c)The proceeds of each advance shall be disbursed in accordance with the instructions provided by the Company.

3.Payment of Interest and Fees.

(a)Interest Generally.  Interest shall accrue on the outstanding principal amount of this Note (including all previously capitalized PIK Interest thereon) (i) through July 1, 2014 at a rate equal to 12% per annum, payable in cash, and, (ii) beginning July 1, 2014 through the Maturity Date, at a rate equal to 7% per annum payable in cash (in each case, computed on the basis of actual calendar days elapsed and a year of 365 days), in each case, quarterly in arrears on the last day of each calendar quarter (each such date, an "Interest Payment Date").

(b)Default Interest.  Upon the occurrence and during the continuance of any Event of Default, all outstanding amounts under this Note shall bear interest at a rate per annum equal to 2% plus the rate otherwise applicable to this Note.  Such incremental interest (i.e., the additional 2% added during the continuance of an Event of Default) shall be payable in cash.

(c)Fees.  On the date hereof, the Company shall pay in cash to Holder a facility fee equal to 1.00% of the average daily outstanding principal amount owing under this Note (without giving effect to any accrued PIK Interest) for the period commencing on June 22, 2013 and ending on the date hereof, multiplied by 0.85.  On June 21, 2014, the Company shall pay in cash to Holder a facility fee equal to 1.00% of the average daily outstanding principal amount owing under this Note (without giving effect to any accrued PIK Interest) for the period commencing on the date hereof and ending on June 21, 2014, multiplied by a fraction of which the numerator will be the number of days elapsed since the date hereof and of which the denominator will be 365.  No additional facility fees shall be due under the terms of the Note after June 21, 2014.

4.Payments.

(a)Form of Payment.  All payments of cash interest, principal and fees 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 outstanding fees, then 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.

(d)Required Payment.  If the aggregate principal amount at any one time outstanding hereunder exceeds the lending commitment amount of $9,000,000 (without giving effect to any accrued PIK Interest), as such amount may be reduced from time to time pursuant to Section 4(c)(ii), the Company shall, at the time any such excess shall arise, promptly pay to Holder such amount as may be necessary to eliminate the excess.

5.Conditions Precedent.  Holder shall not be obligated to make any advance under this Note if any Event of Default or event with which the passing of time or providing of notice or both would constitute an Event of Default shall have occurred and is continuing.

6.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 C:

(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 the immediately foregoing 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.  SPY Inc., a Delaware corporation, formerly known as Orange 21 Inc. 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, 2011, 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 March 31, 2012 (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 December 31, 2011, 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 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, the Term Note, the Harlingwood Notes, 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.

7.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 the Company 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 or disclosed 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.

So long as the Company files its Annual Report on Form 10K with the Securities Exchange Commission within the required timelines, the Company will not be required to additionally provide the items under the above Sections 7(n) (i) through (iii).

(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 each of the chief executive officer and 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 or within the extension periods provided by the Internal Revenue Service.

(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.

8.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.  i) Incur any Debt other than Permitted Debt; (ii) 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, the Term Note, the Harlingwood Notes (provided that, in the case of prepayment permitted under the Harlingwood Notes, the Company shall prepay the Harlingwood Notes, this Note, and the Term Note on a pro rata basis in accordance with the respective outstanding principal amounts then due and owing under such promissory notes, unless otherwise consented to by the Holder), and Debt permitted by clause (vii) of the definition of Permitted Debt); or (iii) amend, modify or otherwise change the terms of any Permitted Debt (other than this Note, the Term Note, the Harlingwood Notes, and Debt permitted by clause (vii) of the definition of Permitted Debt) so as to accelerate the scheduled repayment thereof or increase the principal amount of such Permitted Debt (provided that, notwithstanding anything to the contrary in the foregoing, the Harlingwood Notes shall not be amended, modified or otherwise changed so as to accelerate the scheduled repayment thereof or to impose materially more burdensome terms upon Company or the relevant Subsidiary).

(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 or 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 or mandated by the Securities Exchange Commission or other regulatory bodies.

(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 unless otherwise inpracticable.

(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.

9.Use of Proceeds.  The Company shall use the proceeds from the amounts loaned to the Company under this Note for general working capital and other lawful corporate purposes.

10.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 7 or 8, 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 8, (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 10(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, (b) under the Term Note, (c) under the Harlingwood Notes, or (d) in respect of any Debt (other than the Debt hereunder, the Debt under the BFI Loan Documents, the Debt under the Term Note, and the Debt under the Harlingwood Notes) 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, (b) the Term Note, (c) the Harlingwood Notes, or (d) any such Debt described in clause (i)(d) 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, the Term Note, the Harlingwood Notes or any such Debt described in clause (i)(d) 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, the Term Note, the Harlingwood Notes or the Debt described in clause (i)(d) above to become due or to be repurchased, prepaid, defeased or redeemed (automatically or otherwise);

(vii)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

(viii)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 Note, including any suit, action, claim or other activity of 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.

11.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.

12.Waiver of Jury Trial.  TO THE EXTENT NOT PROHIBITED BY APPLICABLE LAW WHICH CANNOT BE WAIVED, THE COMPANY (BY ITS EXECUTION HEREOF) AND 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.

13.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.

14.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.

15.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:	Spy Optic Inc. 2070 Las Palmas Drive Carlsbad, CA 92011 Facsimile No.: (760) 804-8420 Telephone No.: (760) 804-8421 Attention: Chief Financial Officer
With an additional copy to:	Disclosure Law Group 600 West Broadway, Suite 700 San Diego, CA 92101 Facsimile No.: (619) 330-2101 Attention: Daniel W. Rumsey, 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 Telephone No.: (617) 595-4405 Attention: Seth W. Hamot, President

With a copy to: Ropes & Gray LLP Prudential Tower 800 Boylston Street Boston, MA 02199 Facsimile No.: (617) 951-7050 Attention: David A. Fine, Esq.  and Jeffrey R. Katz, Esq.  

16.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.

17.Assignment.  The provisions of this Note shall be binding upon and inure to the benefit of each of the Company and 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 Holder to any other Person, provided, however, that no such endorsement, assignment or transfer be permitted that is not in compliance with securities law or other applicable law.

18.Indemnity.  The Company agrees to indemnify 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 or (ii) any breach by the Company of its obligations under this Note or any agreement or instrument contemplated thereby.

19.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.

20.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 Section 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 Holder exceed the unpaid balance of principal, such excess shall be refunded to the Company.

21.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 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 this 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).

22.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.

23.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.

24.Subordination

.  This Note and each of Holder's rights and privileges hereunder is expressly subject to the terms of that certain Debt Subordination Agreement by and betweeBFI Business Finance and Holder dated as of March 19, 2010, as amended or modified from time to time.

25.Effect of this Note.  This Note amends and restates in its entirety the Original Line of Credit Note.

[Remainder of Page Intentionally Left Blank]

IN WITNESS WHEREOF, 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:

Spy Optic Inc.,

By: /s/ Jim McGinty

Name: Jim McGinty

Title: Chief Financial Officer

Holder:

Costa Brava Partnership III, L.P.

By: /s/ Seth Hamot

Name:   Seth Hamot                                                                  

Title:  Managing Member of the General Partner

SCHEDULE A

Debt

Disclosure contained in Note and SEC Reports is incorporated herein by this reference.

SCHEDULE B

Liens

Disclosure contained in Note and SEC Reports is incorporated herein by this reference.

SCHEDULE C

Schedule of Exceptions

1.           Building is not in good repair.

2.           The Company has been late in paying certain vendors from time to time.

3.           Maintenance is not in good repair.

4. All risks and facts disclosed in the Company's Form 10-K for the period ending December 31, 2013, Form 10-Q for the period ending March 31, 2014, and Forms 8-K filed subsequent to the filing date of the aforementioned Form 10-K and Form 10-Q.

XML

Share-Based Compensation (Details 1) (USD $)	3 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Shipping and warehousing	$ 140,000	$ 169,000
Research and development	153,000	102,000
Total Share-based compensation expense	168,000	192,000
Restricted Stock [Member]
General and administrative	26,000	26,000
Total Share-based compensation expense	26,000	26,000
Stock Option [Member]
General and administrative	99,000	119,000
Cost of sales	5,000	5,000
Selling and marketing	34,000	38,000
Shipping and warehousing	1,000	1,000
Research and development	$ 3,000	$ 3,000

XML

Operating Segments and Geographic Information (Details 1) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Summary of tangible long-lived assets by major geographic region
Tangible long-lived assets, United States and Canada	$ 394	$ 438
Tangible long-lived assets, Europe and Asia Pacific
Tangible long-lived assets	$ 394	$ 438

XML

Accounts Receivable (Details) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Accounts receivable
Trade receivables	$ 7,810	$ 8,539
Less allowance for doubtful accounts	(332)	(369)
Less allowance for returns	(1,856)	(1,627)
Accounts receivable, net	$ 5,622	$ 6,543

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Long-Term Debt (Tables)

3 Months Ended

Mar. 31, 2014

Debt Disclosure [Abstract]

Notes payable

 Notes payable at March 31, 2014 consist of the following:        

	(Thousands)
Costa Brava Term Loan, as amended (subordinated debt, of which up to $2.25 million is convertible into shares of common stock at a conversion price of $2.25 per share.)  Effective April 30, 2014, up to $6.0 million is convertible into shares of Common Stock at a conversion price of $2.00 per share.	$	10,579
Costa Brava Line of Credit (subordinated debt)		9,137
Harlingwood Notes (subordinated convertible debt, all of which is convertible into shares of common stock at a conversion price of $1.40 per share )		1,736
Secured note payable for vehicle purchases, 4.69% interest rate with monthly payments of $1,400 due through December 2015, secured by vehicles		28
Subtotal		21,480
Less current portion		16
Notes payable, less current portion	$	21,464

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Commitments and Contingencies (Details) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014
Commitments and Contingencies Disclosure [Abstract]
2014 remaining payments	$ 326
2015	393
2016	398
2017	409
2018	420
Thereafter	411
Total	$ 2,357

XML

Long-term Debt (Details Narrative) (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended			1 Months Ended	3 Months Ended	12 Months Ended	3 Months Ended	12 Months Ended		3 Months Ended	12 Months Ended	3 Months Ended				12 Months Ended
	Mar. 31, 2014	Mar. 31, 2013	Dec. 31, 2013	Apr. 30, 2014 Costa Brava Note [Member]	Mar. 31, 2014 Costa Brava Note [Member]	Dec. 31, 2013 Costa Brava Note [Member]	Mar. 31, 2014 Costa Brava LOC [Member]	Dec. 31, 2013 Costa Brava LOC [Member]	Apr. 30, 2014 Costa Brava LOC [Member]	Mar. 31, 2014 Harlingwood Note [Member]	Dec. 31, 2013 Harlingwood Note [Member]	Mar. 31, 2014 Harlingwood Note 2 [Member]	Apr. 30, 2014 Costa Brava Term Loan [Member]	Apr. 30, 2014 Harlingwood [Member]	Mar. 31, 2014 Harlingwood [Member]	Dec. 31, 2014 Costa Brava [Member]	Dec. 31, 2013 Costa Brava [Member]
Debt Instrument [Line Items]
Promissory note					$ 7,000	$ 7,000				$ 1,000		$ 500
Excluded PIK interest	632	569			2,400	2,100	2,400	2,100		300	200					4,800	4,200
Accrued interest reclassified to accrued liabilities					264		316			52
Interest rate				12.00%	7.00%		7.00%		12.00%	7.00%		7.00%	12.00%	12.00%
Interest rate paid in cash					9.00%
Interest rate paid in kind					3.00%
Accrued expenses and other liabilities related to facility fee					17		66
Converted Principal amount of promissery note				6,000	2,250
Common stock conversion price				$ 2.00	$ 2.25					$ 1.40		$ 1.40
Percentage of ownership by shareholder, on converted basis					51.30%										13.60%
Total borrowing of line of credit	15,500		15,500				8,500	8,500
Agreed facility fee maximum					70		90			10		10
Actual facility fees							$ 85			$ 20		$ 10

XML

SUBSEQUENT EVENTS (Details Narrative) (USD $) In Thousands, except Per Share data, unless otherwise specified	1 Months Ended	3 Months Ended
	Apr. 30, 2014	Mar. 31, 2014
Costa Brava Term Loan [Member]
Interest rate		7.00%
Costa Brava Note [Member]
Interest rate	12.00%	7.00%
Converted Principal amount of promissery note	$ 6,000	$ 2,250
Common stock conversion price	$ 2.00	$ 2.25
Costa Brava LOC [Member]
Interest rate	12.00%	7.00%
Costa Brava Term Loan [Member]
Interest rate	12.00%
Harlingwood [Member]
Interest rate	12.00%
Harlingwood Note [Member]
Interest rate		7.00%
Common stock conversion price		$ 1.40

XML

Accumulated Other Comprehensive Income

3 Months Ended

Mar. 31, 2014

Equity [Abstract]

Accumulated Other Comprehensive Income

 Accumulated other comprehensive income represents the results of operations adjusted to reflect all items recognized under accounting standards as components of comprehensive income.

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

	March 31, 2014		December 31, 2013
	(Thousands)
Equity adjustment from foreign currency translation	$	422	$	275
Unrealized gain on foreign currency exposure of net investment in foreign operations		97		245
Accumulated other comprehensive income	$	519	$	520

XML

Commitments and Contingencies (Details 1) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Year Ending December 31,
2014 remaining payments	$ 57
2015	76
2016	23
Total minimum lease payments	156
Amount representing interest	(10)
Present value of minimum lease payments	146
Less current portion	71	77
Noncurrent portion	$ 75	$ 92

XML

Description of Business and Liquidity (Details Narrative) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Maximum principal amount available under its credit facilities	$ 23,900	$ 25,700
Costa Brava [Member]
Aggregate original principal borrowings	15,500
Unpaid interest	4,800
Harlingwood Note [Member]
Aggregate original principal borrowings	1,500
Unpaid interest	$ 300

XML

Operating Segments and Geographic Information (Tables)

3 Months Ended

Mar. 31, 2014

Segment Reporting [Abstract]

Summary of net sales by major geographic region

	North America (U.S. and Canada)		International (Europe, Asia Pacific And Latin America)		Consolidated
	(Thousands)		(Thousands)		(Thousands)
	Three Months Ended March 31, 2014
Net sales	$	7,982	$	1,210	$	9,192
	Three Months Ended March 31, 2013
Net sales	$	8,209	$	799	$	9,008

Summary of tangible long-lived assets by major geographic region

	March 31, 2014		December 31, 2013
	(Thousands)
Tangible long-lived assets:
U.S. and Canada	$	394	$	438
Europe and Asia Pacific		—		—
Total	$	394	$	438

XML

Commitments and Contingencies (Details Narrative)	3 Months Ended	6 Months Ended			3 Months Ended
	Mar. 31, 2014 USD ($)	Jun. 30, 2012 USD ($)	Mar. 31, 2014 Endorsement [Member] USD ($)	Mar. 31, 2014 Endorsement 2 [Member] USD ($)	Mar. 31, 2014 CA Headquarters [Member] USD ($)	Mar. 31, 2014 Italy Euro [Member] EUR (€)	Mar. 31, 2014 Canada CA Dollars [Member] CAD
Commitments and contingencies (Textual) [Abstract]
Monthly rent payments					$ 29,000	€ 1,500	1,352
Total rent expense	106,000	105,000
Minimum annual contracts payments due in 2014			258,000	547,000
Minimum annual contracts payments due in 2015			145,000
Minimum annual contracts payments due in 2016			$ 83,000

XML

Loss Per Share (Details)	3 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Calculation of diluted earnings per share
Weighted average common shares outstanding - basic	13,222,000	13,115,000
Assumed conversion of dilutive stock options, warrants and convertible debt
Weighted average common shares outstanding - dilutive	13,222,000	13,115,000

XML

Loss Per Share (Details 1) In Thousands, unless otherwise specified	3 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Antidilutive securities excluded from computation of Earnings Per Share	5,536	5,167
Stock Options [Member]
Antidilutive securities excluded from computation of Earnings Per Share	3,052	2,790
Warrants [Member]
Antidilutive securities excluded from computation of Earnings Per Share	244	244
Convertible Debt [Member]
Antidilutive securities excluded from computation of Earnings Per Share	2,240	2,133

XML

Loss per Share

3 Months Ended

Mar. 31, 2014

Net loss per share of Common Stock

Loss per Share

 Basic loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period.  Diluted loss per share is calculated by including the additional shares of common stock issuable upon the conversion of convertible debt and the exercise of outstanding options and warrants, 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 loss per share for the periods presented:

	Three Months Ended  March 31,
	2014		2013
	(Thousands)
Weighted average common shares outstanding – basic		13,222		13,115
Assumed conversion of dilutive stock options, warrants and convertible debt		—		—
Weighted average common shares outstanding – dilutive		13,222		13,115

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

	Three Months Ended  March 31,
Shares Issuable through Exercise or Conversion of:	2014		2013
	(Thousands)
Stock options		3,052		2,790
Warrants		244		244
Convertible debt		2,240		2,133
Total		5,536		5,167

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Accumulated Other Comprehensive Income (Details) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Components of accumulated other comprehensive income, net of tax
Equity adjustment from foreign currency translation	$ 422	$ 275
Unrealized gain on foreign currency exposure of net investment in foreign operations	97	245
Accumulated other comprehensive income	$ 519	$ 520

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Share-Based Compensation (Details Narrative) (USD $)	3 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Cash proceeds from the exercise of stock options	$ 98,000
Share-based compensation expense	168,000	192,000
Unrecognized share-based compensation expense	500,000
Stock Option [Member]
Options Exercised	120,000
Cash proceeds from the exercise of stock options	97,600
Weighted-average grant date fair value	$ 0.86	$ 0.90
Weighted average remaining life share-based compensation expense	1 year 8 months 12 days
Restricted Stock [Member]
Weighted-average grant date fair value	$ 1.37
Share-based compensation expense	$ 26,250

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CONSOLIDATED BALANCE SHEETS (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Assets
Cash	$ 688	$ 686
Accounts receivable, net	5,622	6,543
Inventories, net	4,344	5,872
Prepaid expenses and other current assets	691	680
Income taxes receivable		3
Total current assets	11,345	13,784
Property and equipment, net	394	438
Intangible assets, net of accumulated amortization of $792 and $782 at March 31, 2014 and December 31, 2013, respectively	63	72
Other assets	44	63
Total assets	11,846	14,357
Liabilities and Stockholders' Deficit
Lines of credit	1,686	4,024
Current portion of capital leases	71	77
Current portion of notes payable	16	16
Accounts payable	1,047	1,302
Accrued expenses and other liabilities	3,655	3,069
Total current liabilities	6,475	8,488
Capital leases, less current portion	75	92
Notes payable, less current portion	12	16
Note payable to stockholders	21,452	21,452
Total liabilities	28,014	30,048
Stockholders' deficit
Preferred stock: par value $0.0001; 5,000,000 authorized; none issued
Common stock: par value $0.0001; 100,000,000 shares authorized; 13,324,037 and 13,184,876 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively	1	1
Additional paid-in-capital	45,597	45,331
Accumulated other comprehensive income	519	520
Accumulated deficit	(62,285)	(61,543)
Total stockholders' deficit	(16,168)	(15,691)
Total liabilities and stockholders' deficit	$ 11,846	$ 14,357

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Operating Segments and Geographic Information (Details) (USD $) In Thousands, unless otherwise specified	3 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Geographic Areas, Revenues from External Customers
Net sales	$ 9,192	$ 9,008
US and Canada [Member]
Geographic Areas, Revenues from External Customers
Net sales	7,982
EuropeAndAsiaPacific [Member]
Geographic Areas, Revenues from External Customers
Net sales	1,210	799
US and Canada [Member]
Geographic Areas, Revenues from External Customers
Net sales		$ 8,209

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Description of Business and Liquidity

3 Months Ended

Mar. 31, 2014

Organization, Consolidation and Presentation of Financial Statements [Abstract]

Description of Business and Liquidity

 SPY Inc. (the “Company”) happily designs, markets and distributes premium sunglasses, goggles and prescription frame eyewear.  In 1994, the Company began as a grassroots brand in Southern California with the goal of creating innovative and aesthetically progressive eyewear, and, in doing so, the Company believes it has captured the imagination of the action sports market with authentic, distinctive, performance-driven products under the SPY® brand.  Today, the Company believes the SPY® brand, symbolized by the distinct “cross” logo, is a well recognized eyewear brand in its segment of the action sports industry, with a reputation for its high quality products, style and innovation, most notably showcased in its Happy Lens™ technology.

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

 The Company operates through its subsidiaries and currently has one wholly-owned subsidiary incorporated in California, Spy Optic Inc. (“SPY North America”), and one wholly-owned subsidiary incorporated in Italy, Spy Optic Europe S.r.l. S.U. (“SPY Europe”). In March 2014, the Company received permission from the Italian government to dissolve SPY Europe. The company expects to complete this process late in 2014, and does not anticipate any material expenses to dissolve SPY Europe.

Capital Resources

During the three-months ended March 31, 2014 and year ended December 31, 2013, the Company had positive cash flow from operations principally as a result of a significant reduction in operating expenses and increases in gross profit. However, the Company has a history of incurring significant negative cash flow from operations, operating and net losses, and has significant working capital requirements. The Company anticipates that it will continue to have ongoing cash requirements to finance its seasonal and ongoing working capital needs and net losses.

           In order to finance the Company's working capital requirements, the Company has relied and anticipates that it will continue to rely on SPY North America’s credit line with BFI Business Finance (“BFI”) (the “BFI Line of Credit”) and its credit facilities with Costa Brava Partnership III, L.P. (“Costa Brava”).  In addition, SPY North America has relied on debt and equity financing from Harlingwood (Alpha), LLC (“Harlingwood”).  Costa Brava and Harlingwood are related parties.  The total outstanding indebtedness of the Company was $23.9 million and $25.7 million at March 31, 2014 and December 31, 2013 respectively.  (See Note 7 “Short-Term Debt ”, Note 8 “Long-Term Debt”, Note 11 “Related Party Transactions” and Note 14 “Subsequent Events”).

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

The Company does not anticipate that it can generate sufficient cash from operations to repay the amounts due under the BFI Line of Credit which is scheduled to renew in February 2015, and the borrowings from Costa Brava and Harlingwood due, as amended, in December 31, 2016 (see Note 14 “Subsequent Event”), consisting of (i) $15.5 million aggregate original principal borrowings from Costa Brava and $1.5 million in borrowings from Harlingwood as of March 31, 2014, (ii) an additional amount of approximately $4.8 million and $0.3 million, respectively, of unpaid interest related to Costa Brava and Harlingwood loans, which was added to the principal balance of each respective borrowing as of March 31, 2014, and (iii) future interest amounts added to the outstanding principal amounts due under the Harlingwood loans, rather than paid in cash (“Accrued PIK Interest”). The Company will therefore need to renew the BFI Line of Credit at its annual renewal in February 2015 and continue to extend the future maturity dates of the Costa Brava and Harlingwood indebtedness. If the Company is unable to renew the BFI Line of Credit and extend future maturity dates of the Costa Brava and Harlingwood indebtedness, it will need to raise substantial additional capital through debt or equity financing to continue its operations. No assurances can be given that any such financing will be available to the Company on favorable terms, if at all. The inability to obtain debt or equity financing in a timely manner and in amounts sufficient to fund the Company’s operations, or the inability to renew the BFI Line of Credit or to extend future maturity dates of the Costa Brava and Harlingwood indebtedness, if necessary, would have an immediate and substantial adverse impact on the Company’s business, financial condition and results of operations.

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Short-term Debt (Details Narrative) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Line of Credit Facility [Line Items]
Outstanding borrowings	$ 20,300	$ 19,700
Maximum Borrowing Rate Accounts Receivable [Member]
Line of Credit Facility [Line Items]
Borrowing available rate by account	50.00%
Inventory Borrowing Limit 1 [Member]
Line of Credit Facility [Line Items]
Inventory Borrowing maximum	2,500
Inventory Borrowing Limit 2 [Member]
Line of Credit Facility [Line Items]
Inventory Borrowing maximum	400
BFI [Member]
Line of Credit Facility [Line Items]
Maximum borrowing limit	7,000
Maximum availability	5,200	5,100
Outstanding borrowings	1,700	4,000
Remaining unused borrowing availability	3,500	1,100
Minimum monthly interest charge	2
Maximum other indebtedness pursuant to Line of Credit agreement	$ 100
Interest rate	5.00%
US Accounts Receivable [Member]
Line of Credit Facility [Line Items]
Borrowing available rate by account	80.00%
Canada Accounts Receivable [Member]
Line of Credit Facility [Line Items]
Borrowing available rate by account	80.00%
Inventories [Member]
Line of Credit Facility [Line Items]
Borrowing available rate by account	50.00%

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Accumulated Other Comprehensive Income (Tables)

3 Months Ended

Mar. 31, 2014

Equity [Abstract]

Accumulated other comprehensive income

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

	March 31, 2014		December 31, 2013
	(Thousands)
Equity adjustment from foreign currency translation	$	422	$	275
Unrealized gain on foreign currency exposure of net investment in foreign operations		97		245
Accumulated other comprehensive income	$	519	$	520

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Long-Term Debt (Details) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014
Notes payable
Secured note payable for vehicle purchases, 4.69% interest rate with monthly payments of $1,400 due through December 2015, secured by vehicles	$ 28
Subtotal	21,480
Less current portion	16
Notes payable, less current portion	21,464
Costa Brava Term Loan [Member]
Notes payable
Subordinated convertible debt	10,579
Line of Credit (subordinated debt)	9,137
Harlingwood Note [Member]
Notes payable
Subordinated convertible debt	$ 1,736

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Inventories (Tables)

3 Months Ended

Mar. 31, 2014

Inventory Disclosure [Abstract]

Inventories

 Inventories consisted of the following:

	March 31, 2014		December 31, 2013
	(Thousands)
Raw materials	$	17	$	11
Finished goods		4,619		6,097
Less allowance for excess and obsolete inventory		(292)		(236)
Inventories, net	$	4,344	$	5,872

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Basis of Presentation and Recently Issued Accounting Principles

3 Months Ended

Mar. 31, 2014

Accounting Policies [Abstract]

Basis of Presentation and Recently Issued Accounting Principles

Basis of Presentation

 The accompanying Consolidated Financial Statements of SPY Inc. and its wholly owned 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.  The Consolidated Financial Statements contained in this Form 10-Q should be read in conjunction with the Consolidated Financial Statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.

 Recently Issued Accounting Principles

 There are no recently issued accounting principles subsequent to the Company’s disclosure in the Annual Report on Form 10-K for the year ended December 31, 2013, which would have a significant impact on the Company’s Consolidated Financial Statements.

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CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $) In Thousands, except Share data, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Current assets
Intangible assets, accumulated amortization	$ 792	$ 782
Stockholders' equity (deficit)
Preferred stock, par value	$ 0.0001	$ 0.0001
Preferred stock, shares authorized	5,000,000	5,000,000
Preferred stock, shares issued	0	0
Common stock, par value	$ 0.0001	$ 0.0001
Common stock, shares authorized	100,000,000	100,000,000
Common stock, shares issued	13,324,037	13,184,876
Common stock, shares outstanding	13,324,037	13,184,876

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Commitments and Contingencies

3 Months Ended

Mar. 31, 2014

Commitments and Contingencies Disclosure [Abstract]

Commitments and Contingencies

Operating Leases

 The Company’s corporate headquarters totals 32,551 square feet and is located in Carlsbad, California.  Effective November 2010, the Company entered into an amended lease for this facility with average monthly rent payments of approximately $29,000 per month.  In April 2013, the Company amended this lease to (i) extend the expiration date to December 31, 2019, and (ii) give the Company the right to terminate the lease commencing on April 1, 2015 with nine-months written notice.  The monthly rent payments after 2014 will increase by 3% per year. The Company also leases approximately 6,500 square feet of a facility in Varese, Italy with monthly lease payments effective March 2013 of €1,500 per month. On March 10, 2014, the Company elected to terminate its lease in Italy, effective September 10, 2014. In addition, the Company leases an office space totaling approximately 400 square feet in Vancouver, Canada at a monthly rate of CAD$1,352 (approximately $1,312).  The Company also leases certain computer equipment and vehicles.

 Total rent expense was approximately $106,000 and $105,000 for the three months ended March 31, 2014 and 2013, 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:

	(Thousands)
Year Ending December 31,
2014	$	326
2015		393
2016		398
2017		409
2018		420
Thereafter		411
Total	$	2,357

 Capital Leases

 Future minimum lease payments under capital leases at March 31, 2014 are as follows:

	(Thousands)
Year Ending December 31,
2014	$	57
2015		76
2016		23
Total minimum lease payments		156
Amount representing interest		(10)
Present value of minimum lease payments		146
Less current portion		71
Noncurrent portion	$	75

Athlete Contracts

At March 31, 2014, the Company has entered into endorsement contracts with certain athletes to actively wear and endorse the Company’s products.  Payments under these contracts total approximately $258,000, $145,000 and $83,000 in 2014, 2015 and 2016, respectively, and may include additional performance-based incentives and/or product-specific sales incentives.  At March 31, 2014, the Company also had pending endorsement contracts with certain athletes to actively wear and endorse the Company’s products, with payments totaling approximately $547,000.

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, which it believes will have a material adverse impact on its financial position.

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Document and Entity Information (USD $)	3 Months Ended
	Mar. 31, 2014	Nov. 01, 2013
Document And Entity Information
Entity Registrant Name	Spy Inc.
Entity Central Index Key	0000932372
Document Type	10-Q
Document Period End Date	Mar. 31, 2014
Amendment Flag	false
Current Fiscal Year End Date	--12-31
Is Entity a Well-known Seasoned Issuer?	No
Is Entity a Voluntary Filer?	No
Is Entity's Reporting Status Current?	Yes
Entity Filer Category	Smaller Reporting Company
Entity Public Float		$ 20,200,000
Entity Common Stock, Shares Outstanding		13,337,165
Document Fiscal Period Focus	Q1
Document Fiscal Year Focus	2014

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Operating Segments and Geographic Information

3 Months Ended

Mar. 31, 2014

Segment Reporting [Abstract]

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, prescription frames, and branded apparel and accessories for the action sports, snow sports and lifestyle markets.

 The Company markets its products in North America and internationally.  Revenue is attributed to the location to which the product is shipped.  Beginning on January 1, 2013, substantially all sales to international customers were made by SPY North America.  During and prior to 2012, substantially all sales to international customers were made by SPY Europe.  Identifiable assets are based on location of domicile:

	North America (U.S. and Canada)		International (Europe, Asia Pacific And Latin America)		Consolidated
	(Thousands)		(Thousands)		(Thousands)
	Three Months Ended March 31, 2014
Net sales	$	7,982	$	1,210	$	9,192
	Three Months Ended March 31, 2013
Net sales	$	8,209	$	799	$	9,008

	March 31, 2014		December 31, 2013
	(Thousands)
Tangible long-lived assets:
U.S. and Canada	$	394	$	438
Europe and Asia Pacific		—		—
Total	$	394	$	438

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (USD $) In Thousands, except Share data, unless otherwise specified	3 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Income Statement [Abstract]
Net sales	$ 9,192	$ 9,008
Cost of sales	4,412	4,407
Gross profit	4,780	4,601
Operating expenses:
Sales and marketing	2,920	2,854
General and administrative	1,483	1,447
Shipping and warehousing	140	169
Research and development	153	102
Total operating expenses	4,696	4,572
Income from operations	84	29
Other income (expense):
Interest expense	(757)	(732)
Foreign currency transaction loss	(67)	(18)
Other Income	1
Total other expense	(823)	(750)
Loss before provision for income taxes	(739)	(721)
Income tax expense	3
Net loss	(742)	(721)
Net loss per share of Common Stock
Basic	$ (0.06)	$ (0.05)
Diluted	$ (0.06)	$ (0.05)
Shares used in computing net loss per share of Common Stock
Basic	13,222,000	13,115,000
Diluted	13,222,000	13,115,000
Other comprehensive income (loss)
Foreign currency translation adjustment (loss) gain	(94)	177
Unrealized gain (loss) on foreign currency exposure of net investment in foreign operations	93	(194)
Total other comprehensive loss	(1)	(17)
Comprehensive loss	$ (743)	$ (738)

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Short-Term Debt

3 Months Ended

Mar. 31, 2014

Debt Disclosure [Abstract]

Short-Term Debt

SPY North America has a Loan and Security Agreement with BFI with a maximum borrowing limit of $7.0 million.  The maximum availability was $5.2 million and $5.1 million at March 31, 2014 and December 31, 2013, respectively, of which SPY North America had borrowed $1.7 million and $4.0 million, respectively, as of those dates. The BFI Line of Credit renews annually in February for one additional year unless otherwise terminated by either SPY North America or BFI. The Company had $3.5 million and $1.1 million in unused availability as of March 31, 2014 and December 31, 2013, respectively.

 Actual borrowing availability under the BFI Line of Credit is based on eligible trade receivable and inventory levels of SPY North America, subject to the following limitations: (i) up to 80% of eligible United States accounts receivable, (ii) 80% of eligible Canadian receivables, (iii) 50% of eligible United States inventory, provided, however, such amount does not exceed 50% of eligible United States and Canadian accounts receivable and does not exceed the maximum inventory borrowing amount of $2.5 million, and (iv) advances against eligible foreign accounts receivable (excluding Canadian accounts receivable) up to $0.4 million.  Borrowings under the BFI Line of Credit bear interest at a rate per annum equal to the prime rate, as reported in the Western Edition of The Wall Street Journal, plus 1.75%, with a minimum monthly interest charge of $2,000. The interest rate was 5.0% per annum at March 31, 2014. The Company and SPY North America granted BFI a security interest in substantially all of SPY North America’s assets, and substantially all of the Company’s accounts receivable and inventories to secure BFI’s position under the BFI Line of Credit.  Additionally, the obligations under the BFI Line of Credit are guaranteed by SPY Inc.

 The BFI Line of Credit imposes certain covenants on SPY North America, including, but not limited to, covenants requiring SPY North America to provide certain periodic reports to BFI, to inform BFI of certain changes in the business, to refrain from incurring additional debt in excess of $100,000 and to refrain from paying dividends.  The BFI Line of Credit also contains cross default provisions. BFI may declare SPY North America in default if SPY North America experiences a material adverse change in its business, financial condition, or in its ability to perform the obligations owed under the BFI Line of Credit.  BFI’s prior consent, which BFI will not unreasonably withhold, is required in the event that SPY North America seeks additional debt financing, including debt financing subordinate to BFI.  SPY North America has also established bank accounts in BFI’s name in the United States and Canada into which collections on accounts receivable and other collateral are deposited (the “Collateral Accounts”).  Pursuant to the deposit control account agreements between BFI and SPY North America, BFI is entitled to sweep all amounts deposited into the Collateral Accounts and apply the funds to outstanding obligations under the BFI Line of Credit; provided that BFI is required to distribute to SPY North America any amounts remaining after payment of all amounts due under the BFI Line of Credit.  SPY North America was in compliance with all covenants under the BFI Line of Credit at March 31, 2014.

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Inventories

3 Months Ended

Mar. 31, 2014

Inventory Disclosure [Abstract]

Inventories

 Inventories consisted of the following:

	March 31, 2014		December 31, 2013
	(Thousands)
Raw materials	$	17	$	11
Finished goods		4,619		6,097
Less allowance for excess and obsolete inventory		(292)		(236)
Inventories, net	$	4,344	$	5,872

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Accounts Receivable (Tables)

3 Months Ended

Mar. 31, 2014

Receivables [Abstract]

Accounts receivable

 Accounts receivable consisted of the following:

	March 31, 2014		December 31, 2013
	(Thousands)
Trade receivables	$	7,810	$	8,539
Less allowance for doubtful accounts		(332)		(369)
Less allowance for returns		(1,856)		(1,627)
Accounts receivable, net	$	5,622	$	6,543

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Subsequent Events

3 Months Ended

Mar. 31, 2014

Subsequent Events [Abstract]

Subsequent Events

In April 2014, the Costa Brava Term Note, Costa Brava Line of Credit and Harlingwood Notes were amended to extend the respective maturity dates from April 1, 2015 to December 31, 2016 (See Note 8 “Long-term Debt”).  Additionally, the interest rates on the Costa Brava Term Note and Costa Brava Line of Credit were reduced from 12% to 7%, and the facility fees were eliminated, effective July 1, 2014. The Costa Brava Term Note was also amended to increase the amount that Costa Brava may, at its discretion, convert (excluding the Accrued PIK Interest) into shares of the Company’s common stock from $2,250,000 to $6,000,000 and to reduce the conversion price from $2.25 to $2.00. Effective with the Costa Brava Term Note and Costa Brava Line of Credit, the Company will no longer add Accrued PIK Interest to the outstanding principal and will begin making quarterly cash payments starting in June 2014.

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Share-Based Compensation

3 Months Ended

Mar. 31, 2014

Disclosure of Compensation Related Costs, Share-based Payments [Abstract]

Share-Based Compensation

Stock Option Activity	Shares		Weighted- Average Exercise  Price		Weighted- Average Remaining Contractual Term (years)		Aggregate Intrinsic  Value
							(Thousands)
Options outstanding at December 31, 2013		3,090,801	$	1.76
Granted		110,000		1.39
Exercised		(120,000)		0.81
Expired		(29,167)		1.07
Forfeited		-		-
Options outstanding at March 31, 2014		3,051,634	$	1.79		7.01	$	335
Options exercisable at March 31, 2014		1,994,147	$	2.02		5.98	$	235

 Intrinsic value is defined as the difference between the relevant current market value of the Company’s common stock and the grant price for options with exercise prices less than the market values on such dates.  During the three months ended March 31, 2014, there were 120,000 stock options exercised.  The Company received cash proceeds of $97,600 related to the stock options exercised in 2014. No options were exercised during the three months ended March 31, 2013.

 The weighted-average estimated fair value of employee stock options granted during the three months ended March 31, 2014 and 2013 was $0.86 and $0.90, respectively.

 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).  There were no restricted stock awards issued during the three months ended March 31, 2014. However, the Company awarded 19,161 fully vested, non-restricted shares at a $1.37 weighted-average grant date fair value during the three months ended March 31, 2014.  These shares were issued to certain members of the Company’s board of directors in lieu of cash payment for quarterly board fees.  The expense related to these shares was $26,250 during the three months ended March 31, 2014, and was recorded in general and administrative expense.

 The Company recognized the following share-based compensation expense during the three months ended March 31, 2014 and 2013:

	Three Months Ended  March 31,
	2014		2013
	(Thousands)
Stock options
General and administrative expense	$	99	$	119
Cost of sales		5		5
Selling and marketing		34		38
Shipping and warehouse		1		1
Research and development		3		3
Total share-based compensation for stock options		142		166
Restricted stock
General and administrative expense (Board of Directors fees in lieu of cash payments)		26		26
Total share-based compensation for restricted stock		26		26
Total Share-based compensation expense	$	168	$	192

 Total unrecognized share-based compensation expense for outstanding stock option awards at March 31, 2014 is approximately $0.5 million, which will be recognized over a weighted average remaining life of 1.7 years.  

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Long-Term Debt

3 Months Ended

Mar. 31, 2014

Debt Disclosure [Abstract]

Long-Term Debt

 Costa Brava Term Note

 SPY North America issued a promissory note to Costa Brava in the principal amount of $7.0 million (“Costa Brava Term Note”), which amount was outstanding at each of March 31, 2014 and December 31, 2013 (excluding Accrued PIK Interest of $2.4 million and $2.1 million, respectively). As of March 31, 2014, approximately $264,000 of accrued interest was reclassified to accrued liabilities and was paid in April 2014. The Costa Brava Term Note was amended in April 2014 to extend the due date from April 1, 2015 to December 31, 2016.  The Costa Brava Term Note is subordinate to the BFI Line of Credit, pursuant to the terms of a debt subordination agreement between Costa Brava and BFI.

 Interest attributable to the Costa Brava Term Note accrues daily at a rate equal to 12% per annum.  On January 1, 2012, SPY North America began adding Accrued PIK Interest as an addition to the outstanding principal amount due, rather than making interest payments in cash.  The Costa Brava Term Note, as amended, also requires that SPY North America pay a facility fee equal to 1% of the outstanding principal amount in cash (without giving effect to the Accrued PIK Interest) in June 2014. The Company has approximately $17,000 in accrued expenses and other liabilities related to facility fee as of March 31, 2014 and the total facility fee of $70,000 is due in June 2014.  In April 2014, the Costa Brava Term Note was amended to reduce the interest rate from 12% to 7% and to eliminate the facility fee, both of which are effective July 1, 2014. Effective with the amendment, the Company will no longer add Accrued PIK Interest to the outstanding principal and will begin making quarterly cash payments starting in June 2014.

 During the term of the Costa Brava Term Note, Costa Brava may, at its discretion, convert up to $2,250,000 of the principal amount of the Costa Brava Term Note (excluding the Accrued PIK Interest) into shares of the Company’s common stock at a conversion price of $2.25 per share. In April 2014, the Costa Brava Term Note was amended to increase the amount Costa Brava may convert from $2,250,000 to $6,000,000 and reduce the conversion price from $2.25 to $2.00. (See Note 11 “Related Party Transactions” and Note 14 “Subsequent Events”).

 Costa Brava Line of Credit

 SPY North America has an additional $9.0 million line of credit from Costa Brava (“Costa Brava Line of Credit”) of which $8.5 million was outstanding at March 31, 2014 and December 31, 2013 (excluding Accrued PIK Interest of $2.4 million and $2.1 million, respectively). As of March 31, 2014, approximately $316,000 of accrued interest was reclassified to accrued liabilities and the amount was paid in April 2014. The Costa Brava Line of Credit was amended in April 2014 to extend the maturity date from April 1, 2015 to December 31, 2016. The Costa Brava Line of Credit is subordinate to BFI Line of Credit, pursuant to the terms of a debt subordination agreement between Costa Brava and BFI.

 Interest on the outstanding borrowings under the Costa Brava Line of Credit accrues daily at a rate equal to 12% per annum.  On January 1, 2012, SPY North America began paying monthly interest payments in kind, as an addition to the outstanding principal amount due, rather than making interest payments in cash.  Monthly interest accrued prior to January 1, 2012 was paid in cash. In April 2014, the Costa Brava Line of Credit was amended to reduce the interest rate from 12% to 7% and to eliminate the facility fee, both of which are effective July 1, 2014. Effective with the amendment, the Company will no longer add Accrued PIK Interest to the outstanding principal and will begin making quarterly cash payments starting in June 2014.

           In addition, the Costa Brava Line of Credit, as amended, requires that SPY North America pay a facility fee in June 2014 calculated as the lesser of (i) 1% of the average daily outstanding principal amount owed under the note (excluding Accrued PIK Interest) for the 365 day period ending on such payment date or (ii) $90,000.  The Company has approximately $66,000 in accrued expenses and other liabilities related to facility fee as of March 31, 2014 and the total facility fee of $85,000 is due in June 2014.

 Costa Brava Loans

 The total outstanding borrowings under all credit facilities entered into with Costa Brava at March 31, 2014 and December 31, 2013 was $15.5 million (excluding $4.8 million and $4.2 million of Accrued PIK Interest, respectively).  The Costa Brava Term Loan and Costa Brava Line of Credit are pari passu with respect to the rights and preferences of the Harlingwood Notes (defined below).

 Harlingwood Convertible Debt

 In 2012, SPY North America entered into convertible note purchase agreements with Harlingwood under which SPY North America issued two promissory notes to Harlingwood in the principal amounts of $1.0 million and $0.5 million (“Harlingwood Notes”).  Total outstanding borrowings under the Harlingwood Notes at each of March 31, 2014 and December 31, 2013 were $1.5 million (excluding Accrued PIK Interest of $0.3 million and $0.2 million, respectively).  As of March 31, 2014, approximately $52,000 of accrued interest was reclassified to accrued liabilities and the amount was paid in April 2014. The Harlingwood Notes were amended in April 2014 to extend the maturity date from April 1, 2015 to December 31, 2016.  The Harlingwood Notes are subordinate to the amounts owed by SPY North America under the BFI Line of Credit, pursuant to the terms of a debt subordination agreement between Harlingwood and BFI.

 The Harlingwood Notes accrue interest at the rate of 12% per annum.  

The $1.0 million promissory note requires a facility fee equal to the lesser of $10,000 or 1% of the average daily outstanding principal amount due under the Harlingwood Notes (without giving effect to the Accrued PIK Interest).   SPY North America paid $20,000 to Harlingwood for initial aggregate facility fees in 2012.  Facility fees are due in advance on the respective anniversary date of the $1.0 million promissory note until maturity.  The $0.5 million promissory note has a facility fee of $10,000. The Company paid $10,000 and $10,000 to Harlingwood in September 2013 and January 2014, respectively related to facility fees on the Harlingwood Notes.

 The principal amount due under the Harlingwood Notes (including Accrued PIK Interest) is convertible into shares of the Company’s common stock at $1.40 per share, subject to adjustment for stock splits or stock dividends.  The Harlingwood Notes contain standard representations, warranties and reporting requirements that are customary for financings of this type, and cross default provisions with respect to the Costa Brava indebtedness.  SPY North America was in compliance with all covenants under the Harlingwood Notes at March 31, 2014. The Harlingwood Notes are pari passu with the respect to the rights and preferences of Costa Brava Term Note and Costa Brava Line of Credit.  (See Note 11 “Related Party Transactions” and Note 14 “Subsequent Events”).

 Long-Term Debt

 Notes payable at March 31, 2014 consist of the following:        

	(Thousands)
Costa Brava Term Loan, as amended (subordinated debt, of which up to $2.25 million is convertible into shares of common stock at a conversion price of $2.25 per share.)  Effective April 30, 2014, up to $6.0 million is convertible into shares of Common Stock at a conversion price of $2.00 per share.	$	10,579
Costa Brava Line of Credit (subordinated debt)		9,137
Harlingwood Notes (subordinated convertible debt, all of which is convertible into shares of common stock at a conversion price of $1.40 per share )		1,736
Secured note payable for vehicle purchases, 4.69% interest rate with monthly payments of $1,400 due through December 2015, secured by vehicles		28
Subtotal		21,480
Less current portion		16
Notes payable, less current portion	$	21,464

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Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2014

Fair Value Disclosures [Abstract]

Fair Value of Financial Instruments

 The Company’s financial instruments include cash, accounts receivable and payable, short-term borrowings, accrued liabilities, other short-term liabilities, capital leases, notes payable and related party debt.  The carrying amount of these instruments approximates fair value because of their short-term nature.  The carrying value of the Company’s long-term debt, including the current portion approximates fair value as of March 31, 2014.

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Related Party Transactions

3 Months Ended

Mar. 31, 2014

Related Party Transactions [Abstract]

Related Party Transactions

 Promissory Notes with Shareholder, Costa Brava

 See Note 8 “Long-Term Debt” to the Consolidated Financial Statements regarding promissory notes held by Costa Brava, an entity that owned, at March 31, 2014, approximately 47.6%, or 51.3% on an as converted basis, of the Company’s common stock.  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.

 The total outstanding borrowings under all promissory notes the Company has entered into with Costa Brava at March 31, 2014 and December 31, 2013 was $20.3 million (including $4.8 million Accrued PIK Interest) and $19.7 million (including $4.2 million Accrued PIK Interest), respectively.

 Convertible Notes with Shareholder, Harlingwood

 See Note 8, “Long-Term Debt” to the Consolidated Financial Statements regarding $1.5 million in total promissory notes held by Harlingwood, an entity that owned, at March 31, 2014, approximately 5.3%, or 13.6% on an as converted basis, of the Company’s common stock.  Mr. Fir Geenen, a member of the Company’s Board of Directors, is the manager of a limited liability company that manages Harlingwood.

 The total outstanding borrowings under all promissory notes issued by the Company to Harlingwood at March 31, 2014 and December 31, 2013 was $1.8 million (including $0.3 million Accrued PIK Interest) and $1.7 million (including less than $0.2 million Accrued PIK Interest), respectively.

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Inventories (Details) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Inventories
Raw materials	$ 17	$ 11
Finished goods	4,619	6,097
Less allowance for excess and obsolete inventory	(292)	(236)
Inventories, net	$ 4,344	$ 5,872

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Loss per Share (Tables)

3 Months Ended

Mar. 31, 2014

Net loss per share of Common Stock

Calculation of diluted loss per share

  The following table lists the potentially dilutive equity instruments, each convertible into one share of common stock, used in the calculation of diluted loss per share for the periods presented:

	Three Months Ended  March 31,
	2014		2013
	(Thousands)
Weighted average common shares outstanding – basic		13,222		13,115
Assumed conversion of dilutive stock options, warrants and convertible debt		—		—
Weighted average common shares outstanding – dilutive		13,222		13,115

Excluded antidilutive instruments

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

	Three Months Ended  March 31,
Shares Issuable through Exercise or Conversion of:	2014		2013
	(Thousands)
Stock options		3,052		2,790
Warrants		244		244
Convertible debt		2,240		2,133
Total		5,536		5,167

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Share-Based Compensation (Tables)

3 Months Ended

Mar. 31, 2014

Disclosure of Compensation Related Costs, Share-based Payments [Abstract]

Stock Option Activity

Stock Option Activity	Shares		Weighted- Average Exercise  Price		Weighted- Average Remaining Contractual Term (years)		Aggregate Intrinsic  Value
							(Thousands)
Options outstanding at December 31, 2013		3,090,801	$	1.76
Granted		110,000		1.39
Exercised		(120,000)		0.81
Expired		(29,167)		1.07
Forfeited		-		-
Options outstanding at March 31, 2014		3,051,634	$	1.79		7.01	$	335
Options exercisable at March 31, 2014		1,994,147	$	2.02		5.98	$	235

Stock-based compensation expense

The Company recognized the following share-based compensation expense during the three months ended March 31, 2014 and 2013:

	Three Months Ended  March 31,
	2014		2013
	(Thousands)
Stock options
General and administrative expense	$	99	$	119
Cost of sales		5		5
Selling and marketing		34		38
Shipping and warehouse		1		1
Research and development		3		3
Total share-based compensation for stock options		142		166
Restricted stock
General and administrative expense (Board of Directors fees in lieu of cash payments)		26		26
Total share-based compensation for restricted stock		26		26
Total Share-based compensation expense	$	168	$	192

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Related Party Transactions (Details Narrative) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2014	Dec. 31, 2013
Related Party Transactions (Textual) [Abstract]
Outstanding borrowings of promissory notes	$ 20,300	$ 19,700
Accrued Interest	4,800	4,200
Costa Brava Note [Member]
Related Party Transactions (Textual) [Abstract]
Percentage of Common stock owned	47.60%
Percentage of Common stock owned on converted basis	51.30%
Harlingwood [Member]
Related Party Transactions (Textual) [Abstract]
Percentage of Common stock owned	5.30%
Percentage of Common stock owned on converted basis	13.60%
Outstanding borrowings of promissory notes	1,800	1,700
Accrued Interest	300	200
Long-term Debt	$ 1,500

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CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $) In Thousands, unless otherwise specified	3 Months Ended
	Mar. 31, 2014	Mar. 31, 2013
Operating Activities
Net loss	$ (742)	$ (721)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	68	77
Paid-in-kind interest	632	569
Share-based compensation	142	166
Non-cash board of directors fees	26	26
Provision for doubtful accounts	(29)	38
Gain on sale of property or equipment	(3)
Foreign currency transaction gain		(17)
Amortization of debt discount	18	30
Change in operating assets and liabilities:
Accounts receivable, net	950	567
Inventories, net	1,528	368
Prepaid expenses and other current assets	(13)	(83)
Other assets	2	20
Accounts payable	(256)	415
Accrued expenses and other liabilities	(45)	91
Income taxes payable/receivable	3	1
Net cash provided by operating activities	2,281	1,547
Investing Activities
Purchases of property and equipment	(28)	(43)
Proceeds from sale of property and equipment	16
Net cash used in investing activities	(12)	(43)
Financing Activities
Line of credit, net	(2,338)	(873)
Principal payments on secured notes payable	(4)	(4)
Principal payments on capital leases	(23)	(24)
Proceeds from exercise of stock options	98
Net cash used in financing activities	(2,267)	(901)
Net increase in cash	2	603
Cash at beginning of period	686	818
Cash at end of period	688	1,421
Cash paid during the period for:
Interest	110	163
Income taxes	3
Summary of non-cash financing and investing activities:
Accrued board of directors fees paid in fully vested non-restricted stock awards	26	26
Acquisition of property and equipment through capital leases		$ 103

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Accounts Receivable

3 Months Ended

Mar. 31, 2014

Receivables [Abstract]

Accounts Receivable

 Accounts receivable consisted of the following:

	March 31, 2014		December 31, 2013
	(Thousands)
Trade receivables	$	7,810	$	8,539
Less allowance for doubtful accounts		(332)		(369)
Less allowance for returns		(1,856)		(1,627)
Accounts receivable, net	$	5,622	$	6,543

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Commitments and Contingencies (Tables)

3 Months Ended

Mar. 31, 2014

Commitments and Contingencies Disclosure [Abstract]

Future minimum rental payments

 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:

	(Thousands)
Year Ending December 31,
2014	$	326
2015		393
2016		398
2017		409
2018		420
Thereafter		411
Total	$	2,357

Future minimum lease payments

 Future minimum lease payments under capital leases at March 31, 2014 are as follows:

	(Thousands)
Year Ending December 31,
2014	$	57
2015		76
2016		23
Total minimum lease payments		156
Amount representing interest		(10)
Present value of minimum lease payments		146
Less current portion		71
Noncurrent portion	$	75

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Share-Based Compensation (Details) (USD $) In Thousands, except Share data, unless otherwise specified	3 Months Ended
	Mar. 31, 2014
Stock Option Activity
Stock options outstanding, Beginning balance	3,090,801
Stock options, Shares, Granted	110,000
Stock options, Shares, Exercised	(120,000)
Stock options, Shares, Expired	(29,167)
Stock options, Shares, Forfeited
Stock options outstanding, Ending balance	3,051,634
Stock options exercisable	1,994,147
Weighted Average Exercise Price, Stock options outstanding, Beginning balance	$ 1.76
Stock options Granted, Weighted Average Exercise Price	$ 1.39
Stock options Exercised, Weighted Average Exercise Price	$ 0.81
Stock options Expired, Weighted Average Exercise Price	$ 1.07
Stock options Forfeited, Weighted Average Exercise Price
Weighted Average Exercise Price, Stock options outstanding, Ending balance	$ 1.79
Stock options Exercised, Weighted Average Exercise Price	$ 2.02
Stock options outstanding, Weighted Average Remaining Contractual Term	7 years 3 days
Stock options exercisable, Weighted Average Remaining Contractual Term	5 years 11 months 23 days
Stock options outstanding, Aggregate Intrinsic Value	$ 335
Stock options exercisable, Aggregate Intrinsic Value	$ 235

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Basis of Presentation and Recently Issued Accounting Principles (Policies)

3 Months Ended

Mar. 31, 2014

Accounting Policies [Abstract]

Basis of Presentation

Basis of Presentation

 The accompanying Consolidated Financial Statements of SPY Inc. and its wholly owned 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.  The Consolidated Financial Statements contained in this Form 10-Q should be read in conjunction with the Consolidated Financial Statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.

Recently Issued Accounting Principles

 Recently Issued Accounting Principles

 There are no recently issued accounting principles subsequent to the Company’s disclosure in the Annual Report on Form 10-K for the year ended December 31, 2013, which would have a significant impact on the Company’s Consolidated Financial Statements.