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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 JUNE 30, 2003
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: 1-14208
MOSSIMO, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 33-0684524
(State or other jurisdiction of (I.R.S. Employer ID No.)
incorporation or organization)
2016 BROADWAY
SANTA MONICA, CALIFORNIA 90404
(Address of principal (Zip Code)
executive offices)
(310) 460-0040
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for any 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 is an accelerated filer
(as determined by Exchange Act Rule 12b-2). Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
As of July 31, 2003, 15,503,442 shares of the Registrant's Common Stock,
$0.001 par value, were outstanding.
MOSSIMO, INC.
INDEX TO FORM 10-Q
Page
----
PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1 - Financial Statements (Unaudited):
Condensed balance sheets as of June 30, 2003 and December 31, 2002 ......... 2
Condensed statements of earnings for the three and six months
ended June 30, 2003 and 2002............................................ 3
Condensed statements of cash flows for the six months
ended June 30, 2003 and 2002............................................ 4
Notes to condensed financial statements .................................... 5
ITEM 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations ......................................... 10
ITEM 3 - Quantitative and Qualitative Disclosure about Market Risk ......... 17
ITEM 4 - Controls and Procedures............................................ 17
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1 - Legal Proceedings ................................................. 18
ITEM 4 - Submission of Matters to a Vote of Security Holders ............... 18
ITEM 6 - Exhibits and Reports on Form 8-K .................................. 19
SIGNATURES ................................................................. 20
INDEX TO EXHIBITS .......................................................... 21
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MOSSIMO, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
UNAUDITED
JUNE 30, DECEMBER 31,
2003 2002
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .................................... $ 5,754 $ 7,786
Restricted cash .............................................. 4,585 --
Accounts receivable .......................................... 4,550 1,926
Deferred income taxes ........................................ 3,000 3,000
Prepaid expenses and other current assets .................... 435 124
--------- ---------
Total current assets ....................................... 18,324 12,836
PROPERTY AND EQUIPMENT, net .................................... 537 608
DEFERRED INCOME TAXES .......................................... 4,840 7,000
OTHER ASSETS ................................................... 37 92
--------- ---------
$ 23,738 $ 20,536
========= =========
LIABILITIES AND STOCKHOLDERS' EQUTY
CURRENT LIABILITIES:
Loan payable ................................................. $ -- $ 1,066
Accounts payable ............................................. 699 741
Accrued liabilities .......................................... 896 1,332
Accrued commission ........................................... 4,355 2,661
Accrued bonuses .............................................. 1,038 1,065
--------- ---------
Total current liabilities ................................. 6,988 6,865
--------- ---------
LONG-TERM ACCOUNTS PAYABLE, net of current portion ............. -- 191
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.001; authorized shares 3,000,000;
no shares issued or outstanding ............................ -- --
Common stock, par value $.001; authorized shares 30,000,000;
issued and outstanding 15,493,442 - June 30, 2003
and 15,488,042 - December 31, 2002 ......................... 15 15
Additional paid-in capital ................................... 38,824 38,797
Accumulated deficit .......................................... (22,089) (25,332)
--------- ---------
Net stockholders' equity ................................... 16,750 13,480
--------- ---------
$ 23,738 $ 20,536
========= =========
See accompanying notes to condensed financial statements.
2
MOSSIMO, INC.
CONDENSED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
UNAUDITED
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ ------------------
2003 2002 2003 2002
-------- -------- -------- --------
REVENUE FROM LICENSE ROYALTIES
AND DESIGN SERVICE FEES ............... $ 6,858 $ 7,404 $12,726 $12,994
OPERATING EXPENSES:
Selling, general and administrative ... 3,774 3,652 7,300 6,079
-------- -------- -------- --------
Operating earnings ........................ 3,084 3,752 5,426 6,915
OTHER EXPENSE:
Interest expense, net ................. 9 98 23 219
-------- -------- -------- --------
Earnings before income taxes .............. 3,075 3,654 5,403 6,696
Provision for income taxes ................ 1,230 -- 2,160 --
-------- -------- -------- --------
Net earnings .............................. $ 1,845 $ 3,654 $ 3,243 $ 6,696
======== ======== ======== ========
Earnings per common share:
Basic ................................. $ 0.12 $ 0.24 $ 0.21 $ 0.44
======== ======== ======== ========
Diluted ............................... $ 0.12 $ 0.23 $ 0.21 $ 0.43
======== ======== ======== ========
Weighted average common shares outstanding:
Basic ................................. 15,493 15,380 15,491 15,360
======== ======== ======== ========
Diluted ............................... 15,643 15,743 15,707 15,655
======== ======== ======== ========
See accompanying notes to condensed financial statements.
3
MOSSIMO, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED
FOR THE SIX MONTHS
ENDED JUNE 30,
-------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings ................................................... $ 3,243 $ 6,696
Adjustment to reconcile net earnings to net
cash (used in) provided by operating activities:
Depreciation and amortization .............................. 150 105
Deferred income taxes ...................................... 2,160 --
Changes in:
Restricted cash ........................................ (4,585) --
Accounts receivable .................................... (2,624) (2,300)
Prepaid expenses and other current assets ................ (311) (244)
Other assets ........................................... 55 --
Accounts payable and long-term accounts payables ....... (233) (1,885)
Accrued liabilities .................................... (436) (314)
Accrued commission ..................................... 1,694 1,481
Accrued bonuses ........................................ (27) 841
-------- --------
Net cash (used in) provided by operating activities .... (914) 4,380
-------- --------
CASH FLOWS FROM INVESTING ACTIVITITES:
Payments for acquisition of property and equipment ............. (79) (33)
-------- --------
Net cash used in investing activities .................. (79) (33)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of loan payable ....................................... (1,066) (1,822)
Proceeds from issuance of common stock ......................... 27 356
-------- --------
Net cash used in financing activities ................... (1,039) (1,466)
-------- --------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ........... (2,032) 2,881
CASH AND CASH EQUIVALENTS, beginning of period ................. 7,786 3,182
-------- --------
CASH AND CASH EQUIVALENTS, end of period ....................... $ 5,754 $ 6,063
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest ................... $ 10 $ 377
======== ========
See accompanying notes to condensed financial statements.
4
MOSSIMO, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
UNAUDITED
1. BASIS OF PRESENTATION
The condensed financial statements presented herein have not been audited
by independent auditors, but include all material adjustments (consisting of
normal recurring adjustments), which are, in the opinion of management,
necessary for a fair statement of the financial condition, results of operations
and cash flows for the periods presented. However, these results are not
necessarily indicative of results for any other interim period or for the full
year. The condensed balance sheet data presented herein for December 31, 2002
was derived from the Company's audited financial statements for the year then
ended, but does not include all disclosures required by generally accepted
accounting principles.
The preparation of financial statements in accordance with generally
accepted accounting principles requires the Company to make certain estimates
and assumptions for the reporting periods covered by the financial statements.
These estimates and assumptions affect the reported amounts of assets,
liabilities, revenues and expenses. Actual amounts could differ from these
estimates.
Certain information and footnote disclosures normally included in annual
financial statements in accordance with generally accepted accounting principles
have been omitted pursuant to the Regulations of the Securities and Exchange
Commission. The Company believes the disclosures included in the accompanying
interim condensed financial statements and notes thereto are adequate to make
the information not misleading, but should be read in conjunction with the
financial statements and notes thereto included in our Form 10-K for the year
ended December 31, 2002.
2. DESCRIPTION OF BUSINESS
In 2000 the Company changed its business operating strategy from a
traditional apparel and related products wholesale company, to a designer and
licensor of apparel and related products. In connection therewith, the Company
entered into a multi-year licensing and design services agreement with Target
Corporation ("Target") in March 2000, subsequently amended in April 2002, and in
February and June 2003, hereinafter referred to as the "Target Agreement". Under
the terms of the Target Agreement, Target has the exclusive license, for
production and distribution through Target stores, of substantially all Mossimo
products sold in the United States, other than those covered under other
existing Mossimo licensing arrangements at the time the Company entered into the
Target Agreement.
Under the Target Agreement the Company provides design services and has
approval rights for product design, marketing and advertising materials. Target
collaborates on design and is responsible for product development, sourcing,
quality control and inventory management with respect to the Target licensed
product line. Target is obligated to pay the Company design service fees and
license royalty fees. Total fees payable by Target are based upon a percentage
of Target's net sales of Mossimo brand products, with minimum total guaranteed
fees of approximately $9.6 annually. Target fees are based on net sales achieved
multiplied by a rate, as defined in the Target Agreement. The Company pays a 15
percent commission, based on fees received from Target, to a third party who
assisted the Company in connection with entering into the initial agreement with
Target. The Target Agreement is subject to early termination under certain
circumstances. If Target is current with payments of its obligations under the
Target Agreement, Target has the right to renew the Target Agreement, on the
same terms and conditions, for additional terms of two years each. In January
2003, Target exercised its first renewal option extending the Target Agreement
through January 31, 2006.
5
In addition to the Target Agreement, the Company also licenses its
trademarks and provides design services outside of the United States, and also
licenses its trademarks for use in collections of eyewear and women's swimwear
and bodywear sold in Target stores in the United States.
In May 2002, the Company entered into an agreement with Hudson's Bay
Company whereby the Company provides product design services, and has licensed
the Mossimo trademark to Hudson's Bay Company exclusively in Canada, in return
for license royalties and design service fees. Hudson's Bay Company collaborates
on product design, and is responsible for manufacturing, importing, marketing,
advertising, selling and distributing merchandise bearing the Mossimo trademark.
The initial term of the agreement is three years beginning in May 2002, with a
five-year extension at the option of Hudson's Bay Company. Hudson's Bay Company
fully launched the Mossimo product in mid-March 2003 for distribution through
its Zellers stores in Canada.
3. REVENUE RECOGNITION
Revenue from license royalties and design service fees are recognized in
accordance with the terms of the underlying agreements, which is generally after
the design services are performed, and as the licensee achieves sales of the
Company's products. During the periods presented herein, a substantial amount of
the Company's revenue from license royalties and design fees were generated
under the Target Agreement under a rate that declines as the contract year
progresses and Target achieves certain levels of retail sales. Accordingly, the
Company's revenues from Target decrease as the year progresses. The declining
rate is reset each contract year beginning on February 1. Revenue recognized in
the first and second quarters of the Company's calendar year in connection with
the Target Agreement is significantly higher than in the third and fourth
quarters of the Company's calendar year due to the declining rates in the Target
Agreement. Revenue from license royalties and design service fees are generally
collected on a quarterly basis, and they range from one percent to seven percent
of sales, as defined in the respective agreements.
4. BONUS PLANS
The Company has bonus plans covering two executive officers which are
administered by the Compensation Committee of the Board of Directors, and that
provide for discretionary bonuses based on the Company's overall performance,
with the total amount of the bonuses not to exceed a percent (as defined) of the
excess over the minimum total guaranteed fees, if any, of license royalties paid
to the Company under the Target Agreement, and as defined in each of the
respective bonus plans. The Company has expensed approximately $875,000 and
$951,000 under these agreements for the three month periods ended June 30, 2003
and 2002, respectively; and $1,446,000 and $1,507,000 for the six month periods
ended June 30, 2003 and 2002, respectively.
5. LOAN PAYABLE
The Company had a loan payable to a bank that has been fully paid as of
June 30, 2003, and all security interests and guarantees in connection therewith
have been released.
6. INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". Deferred taxes result from the recognition of the
income tax benefit to be derived from the Company's net operating loss
carryforward for income taxes purposes. The Company has approximately $28
million and $18 million of federal and state income tax net operating loss
carryforwards, respectively, available to offset future taxable income beginning
in 2003, which expire in various years through 2020.
6
The Company recorded a provision for income taxes of $1,230,000 and
$2,160,000 for the three and six month periods ended June 30, 2003,
respectively; which approximates the Company's combined statutory tax rate for
federal taxes and California state taxes, and reduced its deferred tax asset
accordingly. At June 30, 2003, the total deferred tax asset was approximately
$7,840,000 million, with $3,000,000 million classified as current in the
accompanying balance sheet.
In addition to the Company's taxable income being subject to federal, state
and local income taxes, the Company may be classified as a "personal holding
company" from time to time. Personal holding company status results from more
than 50 percent of the value of outstanding stock being owned directly or
indirectly by five or fewer individuals, and more than 60 percent of the
Company's income, as defined, being derived from royalties. Personal holding
companies are subject to an additional federal tax at the highest personal
income tax rate on undistributed after tax earnings.
Over 50 percent of the value of the Company's outstanding stock is owned by
one stockholder, and it is anticipated that in 2003, no more than 60 percent of
the Company's income, as defined, would be derived from license royalties.
Accordingly, at this time the Company is not anticipated to be classified as a
personal holding company at the end of 2003. The Company intends to continue to
take appropriate measures to avoid being classified as a personal holding
company at the end of 2003 and beyond. However, there can be no assurance that
the Company will be successful in its efforts to avoid classification as a
personal holding company at the end of 2003 or in future years.
7. EARNINGS PER SHARE AND STOCK OPTION PLANS
The Company calculates net earnings per share in accordance with SFAS No.
128, "Earnings Per Share". This statement requires the presentation of both
basic and diluted net earnings per share. Basic net earnings per share is
computed by dividing net earnings available to common stockholders by the
weighted average number of common shares outstanding. Diluted net earnings per
share include the effect of potential shares outstanding, including dilutive
stock options, using the treasury stock method. Stock options excluded from
diluted weighted average shares outstanding were approximately 614,000 and
41,000 for the three months ended June 30, 2003 and 2002, respectively; and
approximately 600,000 and 67,000 for the six months ended June 30, 2003 and
2002, respectively; as they were antidilutive.
The reconciliation between net earnings and weighted average shares
outstanding for basic and diluted earnings per share is as follows (all amounts
in thousands, except per share data):
Three Months Six Months
Ended June 30, Ended June 30,
------------------ ------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net earnings .................................... $ 1,845 $ 3,654 $ 3,243 $ 6,696
Weighted average shares outstanding - Basic ..... 15,493 15,380 15,491 15,360
Basic earnings per share ........................ $ 0.12 $ 0.24 $ 0.21 $ 0.44
Add: Dilutive effect of stock options ........... 150 363 216 295
Weighted average shares outstanding - Diluted ... 15,643 15,743 15,707 15,655
Diluted earnings per share ...................... $ 0.12 $ 0.23 $ 0.21 $ 0.43
The Company adopted the Mossimo, Inc. 1995 Stock Option Plan (the "1995
Plan"), which provides for the grant of stock options, stock appreciation rights
and other stock awards to certain officers and key employees of the Company and
to certain advisors or consultants to the Company. In addition, the Company
adopted a Non-Employee Directors Stock Option Plan (the "Directors Plan") that
provides for the grant of stock options to non-employee directors.
7
The fair value of each option grant was estimated as of the grant date
using the Black-Scholes option-pricing model for the three and six month periods
ended June 30, 2003 and 2002, assuming risk-free interest rates in the range of
approximately 4.0 to 6.5 percent; volatility in the range of approximately 49 to
202 percent; zero dividend yield; and expected lives of five years. In
accordance with APB Opinion No. 25, no compensation expense has been recognized
related to stock options granted with an option price at or above the fair
market value of the Company's stock on the date of issuance.
If compensation expense was determined based on the fair value method
beginning with grants in the year ended December 31, 1996, the Company's net
earnings and net earnings per share would have resulted in the approximate pro
forma amounts indicated below for the three and six month periods ended June 30,
2003 and 2002 (in thousands, except per share data):
Three Months Six Months
Ended June 30, Ended June 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Actual net earnings .................................... $ 1,845 $ 3,654 $ 3,243 $ 6,696
Less: Total compensation as if the fair value method
was used, net of tax effect ....................... (238) (446) (368) (773)
---------- ---------- ---------- ----------
Pro forma net earnings ................................. $ 1,607 $ 3,208 $ 2,875 $ 5,923
========== ========== ========== ==========
Net earnings per share:
Basic - as reported ............................... $ 0.12 $ 0.24 $ 0.21 $ 0.44
Basic - pro forma ................................. $ 0.10 $ 0.21 $ 0.19 $ 0.39
Diluted - as reported ............................. $ 0.12 $ 0.23 $ 0.21 $ 0.43
Diluted - pro forma ............................... $ 0.10 $ 0.20 $ 0.18 $ 0.38
8. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments With Characteristics of Both Liabilities and Equity." SFAS
No. 150 changes the classification in the statement of financial position of
certain common financial instruments from either equity or mezzanine
presentation to liabilities and requires an issuer of those financial statements
to recognize changes in fair value or redemption amount, as applicable, in
earnings. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and with one exception, is effective at the
beginning of the first interim period beginning after June 15, 2003. The effect
of adopting SFAS No. 150 will be recognized as a cumulative effect of an
accounting change as of the beginning of the period of adoption. Restatement of
prior periods is not permitted. SFAS No. 150 is not expected to have any impact
on the Company's financial position or results of operations.
In January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities". This interpretation clarifies the application of Accounting Research
Bulletin No. 51 ("ARB 51"), "Consolidated Financial Statements", and requires
companies to evaluate variable interest entities for specific characteristics to
determine whether additional consolidation and disclosure requirements apply.
This interpretation is immediately applicable for variable interest entities
created after January 31, 2003, and applies to fiscal periods beginning after
June 15, 2003 for variable interest entities acquired prior to February 1, 2003.
This interpretation also requires extensive disclosures, including disclosures
that are applicable to December 31, 2002 financial statements. The Company does
not expect that the adoption of this interpretation will have a material impact
on its financial position or results of operations.
8
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". This interpretation clarifies
the requirements of a guarantor in accounting for and disclosing certain
guarantees issued and outstanding. The initial recognition and measurement
provisions of this interpretation are applicable on a prospective basis to
guarantees issued after December 31, 2002. The adoption of this interpretation
did not have a material impact on the Company's financial position or results of
operations.
On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends FASB
Statement No. 123, "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. Furthermore, this
statement amends the disclosure requirements of Statement No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. SFAS No. 148 is effective for financial
statements for fiscal years ending after December 15, 2002. The Company has
elected not to implement this voluntary change to the fair value method of
accounting, and has made the required disclosures of the pro-forma effect for
the periods presented herein.
In July 2001, the EITF issued EITF Issue No. 00-21 "Accounting for Revenue
Arrangements with Multiple Deliverables". EITF 00-21 provides guidance on how to
allocate revenue streams to multiple deliverables being provided by the Company.
The Company currently provides design and licensing services. This issue is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003, and management anticipates that its application
will not have a material impact on the Company's financial position and results
of operations.
9. LITIGATION
In May 2002, the Company made a demand for arbitration in connection with a
claim for overpayment of commissions paid to a third party who assisted the
Company in connection with entering into the initial agreement with Target. The
arbitration hearing was completed in October 2002. In November 2002, the
arbitration hearing panel issued a preliminary award in favor of the third
party, which became final in January 2003 and awarded the third party interest
on the amounts due which had been withheld by the Company, and the recovery of
the third party's legal fees. In January 2003, the Company deposited the total
amount of $2,934,688 due under the award into a separate Company bank account,
and filed a petition to vacate the award, including commissions, third party
legal fees, and interest, on the basis that the evidence received during the
arbitration hearing demonstrates that the finder's agreement between the Company
and the third party is illegal under certain applicable California law. In
January 2003 the third party filed a petition to confirm the award, including
commissions, the third party's legal fees, and interest. In June 2003, the award
was confirmed and a judgment entered in favor of the third party, and the third
party was awarded additional interest. In June 2003 the Company filed an appeal
to the judgment and in connection therewith deposited with the court
approximately $4,585,000. The deposit secures 150 percent of the judgment
amount. The Company could be liable for additional legal fees and interest
payable to the third party if the appeal is not successful. There can be no
assurance that the appeal will be successful. The Company continues to accrue
and withhold payment of estimated commissions and interest that may be payable
to the third party until this matter comes to a final resolution. At June 30,
2003, the Company had accrued approximately $5 million of unpaid commissions,
legal fees, and interest potentially payable to the third party in connection
with this matter. The $4,585,000 deposited with the courts was classified as
restricted cash on the Company's balance sheet as of June 30, 2003; and the
aggregate accruals of approximately $5 million were classified as accrued
commissions and accrued liabilities on the Company's balance sheet as of June
30, 2003. All expenses recognized to date have been classified with operating
expenses on the Company's statements of earnings.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion includes the operations of Mossimo, Inc. for each
of the periods discussed. This discussion and analysis should be read in
conjunction with the Company's financial statements for the year ended December
31, 2002 on Form 10-K.
RESULTS OF OPERATIONS
DESCRIPTION OF BUSINESS
In 2000 the Company changed its business operating strategy from a
traditional apparel and related products wholesale company, to a designer and
licensor of apparel and related products. In connection therewith, the Company
entered into a multi-year licensing and design services agreement with Target
Corporation ("Target") in March 2000, subsequently amended in April 2002 and in
February and June 2003, hereinafter referred to as the "Target Agreement". Under
the terms of the Target Agreement, Target has the exclusive license, for
production and distribution through Target stores, of substantially all Mossimo
products sold in the United States, other than those covered under other
existing Mossimo licensing arrangements at the time the Company entered into the
Target Agreement.
Under the Target Agreement the Company provides design services and has
approval rights for product design, marketing and advertising materials. Target
collaborates on design and is responsible for product development, sourcing,
quality control and inventory management with respect to the Target licensed
product line. Target is obligated to pay the Company design service fees and
license royalty fees. Total fees payable by Target are based upon a percentage
of Target's net sales of Mossimo brand products, with minimum total guaranteed
fees of approximately $9.6 annually. Target fees are based on net sales achieved
multiplied by a rate, as defined in the Target Agreement. The Company pays a 15
percent commission, based on fees received from Target, to a third party who
assisted the Company in connection with entering into the initial agreement with
Target. The Target Agreement is subject to early termination under certain
circumstances. If Target is current with payments of its obligations under the
Target Agreement, Target has the right to renew the Target Agreement, on the
same terms and conditions, for additional terms of two years each. In January
2003, Target exercised its first renewal option extending the Target Agreement
through January 31, 2006.
In addition to the Target Agreement, the Company also licenses its
trademarks and provides design services outside of the United States, and also
licenses its trademarks for use in collections of eyewear and women's swimwear
and bodywear sold in Target stores in the United States.
In May 2002, the Company entered into an agreement with Hudson's Bay
Company whereby the Company provides product design services, and has licensed
the Mossimo trademark to Hudson's Bay Company exclusively in Canada, in return
for license royalties and design service fees. Hudson's Bay Company collaborates
on product design, and is responsible for manufacturing, importing, marketing,
advertising, selling and distributing merchandise bearing the Mossimo trademark.
The initial term of the agreement is three years beginning in May 2002, with a
five-year extension at the option of Hudson's Bay Company. Hudson's Bay Company
fully launched the Mossimo product in mid-March 2003 for distribution through
its Zellers stores in Canada.
10
THREE MONTHS ENDED JUNE 30, 2003 AND 2002
REVENUES
Revenue from license royalties and design service fees are recognized in
accordance with the terms of the underlying agreements, which is generally after
the design services are performed, and as the licensee achieves sales of the
Company's products. During the period presented herein, a substantial amount of
the Company's revenue from license royalties and design fees were generated
under the Target Agreement under a rate that declines as the contract year
progresses and Target achieves certain levels of retail sales. Accordingly, the
Company's revenues from Target decrease as the year progresses. The declining
rate is reset each contract year beginning on February 1. Revenue recognized in
the first and second quarters of the Company's calendar year in connection with
the Target Agreement is significantly higher than in the third and fourth
quarters of the Company's calendar year due to the declining rates in the Target
Agreement. Revenue from license royalties and design service fees are generally
collected on a quarterly basis, and they range from one percent to seven percent
of sales, as defined in the respective agreements.
Total revenue from license royalties and design service fees in the second
quarter of 2003 were $6.9 million compared to $7.4 million in the second quarter
of 2002.
Design service fees and royalties recognized under the Target Agreement
were $6.2 million in the second quarter of 2003 compared to $6.9 million in the
second quarter of 2002, which included approximately $1.5 million of revenue
recognized in 2002 which had been deferred during the initial contract period
ended January 31, 2001 pending the results of a royalty audit, the
reconciliation and settlement of accounts between the Company and Target, and
the assessment of the underlying deferred revenue reserves, all of which was
completed during the second quarter of 2002. The provisions that resulted in the
deferral of revenue by the Company are not expected to recur. Exclusive of the
nonrecurring revenue recognized in 2002, revenue from Target increased
approximately $800,000 or 15 percent in 2003 as compared to 2002. Royalties and
design service fees from customers other than Target increased approximately
$217,000 or 47 percent in 2003 as compared to 2002. The increase was primarily
due to the full launch of the Mossimo product in Canada in mid-March 2003, under
the agreement with Hudson's Bay Company for distribution thru Zellers stores.
The Company's revenues generated under the Target Agreement are expected to
increase as Target adds new stores and the Company continues to maximize its
opportunities with Target, and the new Zellers business in Canada is also
expected to increase revenues as the Company begins to maximize its
opportunities with Zellers, having recently completed the full launch of its
product line.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative (S, G & A) expenses, increased to $3.8
million in the second quarter of 2003 from $3.7 million in the second quarter of
2002. S, G & A expenses were approximately 55 percent of total revenues in 2003,
as compared to approximately 49 percent of total revenues in 2002 (62 percent
based on 2002 recurring revenues). S, G & A expenses as a percent of revenues is
expected to decrease in the future, as the Company's revenues generated under
the Target Agreement are expected to increase as Target adds new stores and the
Company continues to maximize its opportunities with Target, and the new Zellers
business in Canada is also expected to increase revenues as the Company begins
to maximize its opportunities with Zellers, having recently completed the full
launch of its product line in mid-March 2003.
Selling expenses, comprised of commissions due to a third party who
assisted the Company in connection with entering into the initial agreement with
Target, were approximately $912,000 in the second quarter of 2003 and $1,036,000
in the second quarter of 2002, due to the differences in total revenue from
Target, as discussed above.
11
General and administrative expenses include payroll for the Company
officers and its design staff, travel, facilities, insurance, legal and
professional fees, and other design related expenses for free-lance artists and
purchased artwork used in the design process. The aggregate payroll costs
increased by approximately $125,000 in 2003, primarily due to increases in
design personnel. The aggregate payroll costs include accrued bonuses of
$875,000 in 2003, and $951,000 in 2002, which are payable under bonus plans
covering two executive officers of the Company. Facility expenses also increased
by approximately $49,000 to accommodate the additional personnel in 2003. At the
beginning of 2003, the Company had 21 employees, as compared to 8 employees at
approximately the same time in the previous year. The added personnel is
expected to better service the Target business, while also implementing the new
Zellers business in Canada, maximizing the potential of each of the respective
businesses, as well as strengthening the Company's infrastructure for the
future.
Expenses for travel, free-lance artists, and purchased artwork incurred in
connection with the design process increased by approximately $108,000 in 2003,
primarily due to increased activity in connection with the Target business, as
well as the implementation of the new Zellers business in Canada.
S, G & A expenses in 2003 also include approximately $107,000 of costs in
connection with a legal dispute pending final resolution. There were no expenses
incurred in connection with this legal dispute during second quarter of 2002. At
June 30, 2003, the Company has expensed and accrued, but has not paid all
commissions due under the agreement in dispute, as well as legal fees and
interest awarded to the third party in arbitration, plus additional interest
that might be due and payable on the past due amounts in the event the
arbitrators' award and the related amounts reach a final resolution in the
courts. The Company has also deposited with the court approximately $4.6 million
to secure 150 percent of the judgment amount, pending a final resolution of this
legal dispute which is further discussed in Part II, Item I - Legal Proceedings
in this quarterly report.
INTEREST EXPENSE, NET
The Company incurred net interest expense in 2003 of $9,000, compared to
$98,000 in 2002. The decrease was due to a reduction in the Company's
outstanding balance of a loan payable to a bank and increases in interest
income.
INCOME TAXES
The Company recorded no tax provision on its pre-tax earnings in the second
quarter of 2002, as any current tax component of the provision would have been
offset by an equal deferred tax benefit, pending the Company's reevaluation of
the allowance for its deferred tax asset. As of December 31, 2002, the Company
completed the reevaluation, and reported a total deferred tax asset of $10
million. In the second quarter of 2003, the Company recorded a provision for
income taxes of $1,230,000 which approximates the Company's combined statutory
tax rate for federal and California state taxes, and reduced its deferred tax
asset accordingly.
The Company has approximately $28 million and $18 million of federal and
state income tax net operating loss carryforwards, respectively, available to
offset taxable income beginning in 2003, which expire in various years through
2020. At June 30, 2003, the total deferred tax asset was approximately $7.8
million, with $3 million classified with current assets. The Company expects
that taxable income will be offset in the near-term, for the most part, by its
net operating tax loss carryforwards.
12
NET EARNINGS
The Company's net earnings for the second quarter of 2003 was $1.8 million,
or $0.12 per diluted share, compared to net earnings of $3.7 million, or $0.23
per diluted share for the second quarter of 2002 due to the factors discussed
above. In the second quarter of 2002, the Company recognized approximately $1.5
million of non-recurring revenue which had been previously deferred, as further
discussed above. The recognition of the deferred revenue resulted in an increase
of approximately $600,000 or $0.04 per diluted share to net earnings in the
second quarter of 2002. As further discussed above, the Company's effective tax
rate for the second quarter of 2002 was zero which is not comparable to the
effective tax rate of 40 percent in the second quarter of 2003. As a result, the
incremental tax expense recorded in the second quarter of 2003 was $1,230,000,
or $0.08 per diluted share. The Company's taxable income is expected to be
offset in the near-term, for the most part, by its net operating tax loss
carry-forwards. Comparable recurring pre-tax net earnings per diluted share were
$0.20 in 2003, and $0.19 in 2002.
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
REVENUES
Total revenue from license royalties and design service fees for the six
months ended June 30, 2003 were $12.7 million compared to $13.0 million in the
same period of 2002.
Design service fees and royalties recognized under the Target Agreement
were $11.4 million for the six months ended June 30, 2003 compared to $12.0
million in the same period of 2002, which included approximately $1.5 million of
revenue recognized in 2002 which had been deferred during the initial contract
period ended January 31, 2001 pending the results of a royalty audit, the
reconciliation and settlement of accounts between the Company and Target, and
the assessment of the underlying deferred revenue reserves, all of which was
completed during the second quarter of 2002. The provisions that resulted in the
deferral of revenue by the Company are not expected to recur. Exclusive of the
nonrecurring revenue recognized in 2002, revenue from Target increased
approximately $900,000 or 9 percent in 2003 as compared to 2002. Royalties and
design service fees from customers other than Target increased approximately
$427,000 or 48 percent in 2003 as compared to 2002. The increase was primarily
due to the full launch of the Mossimo product in Canada in mid-March 2003, under
the agreement with Hudson's Bay Company for distribution thru Zellers stores.
The Company's revenues generated under the Target Agreement are expected to
increase as Target adds new stores and the Company continues to maximize its
opportunities with Target, and the new Zellers business in Canada is also
expected to increase revenues as the Company begins to maximize its
opportunities with Zellers, having recently completed the full launch of its
product line.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
S, G & A expenses, increased to $7.3 million for the six months ended June
30, 2003 from $6.1 million in the same period of 2002. S, G & A expenses were
approximately 57 percent of total revenues in 2003, as compared to approximately
47 percent of total revenues in 2002 (53 percent based on 2002 recurring
revenues). S, G & A expenses as a percent of revenues is expected to decrease in
the future, as the Company's revenues generated under the Target Agreement are
expected to increase as Target adds new stores and the Company continues to
maximize its opportunities with Target, and the new Zellers business in Canada
is also expected to increase revenues as the Company begins to maximize its
opportunities with Zellers, having recently completed the full launch of its
product line in mid-March 2003.
Selling expenses, comprised of commissions due to a third party who
assisted the Company in connection with entering into the initial agreement with
13
Target, decreased to approximately $1,695,000 in 2003 from approximately
$1,805,000 in 2002, due to the differences in total revenue from Target, as
discussed above.
General and administrative expenses include payroll for the Company
officers and its design staff, travel, facilities, insurance, legal and
professional fees, and other design related expenses for free-lance artists and
purchased artwork used in the design process. The aggregate payroll costs
increased by approximately $667,000 in 2003, primarily due to increases in
design personnel. The aggregate payroll costs include accrued bonuses of
$1,446,000 in 2003, and $1,507,000 in 2002, which are payable under bonus plans
covering two executive officers of the Company. Facility expenses also increased
by approximately $93,000 to accommodate the additional personnel. At the
beginning of 2003 the Company had 21 employees, as compared to 8 employees at
approximately the same time in the previous year. The added personnel is
expected to better service the Target business, while also implementing the new
Zellers business in Canada, maximizing the potential of each of the respective
businesses, as well as strengthening the Company's infrastructure for the
future.
Expenses for travel, free-lance artists, and purchased artwork incurred in
connection with the design process increased by approximately $441,000 in 2003,
primarily due to increased activity in connection with the Target business, as
well as the implementation of the new Zellers business in Canada.
S, G & A expenses in 2003 also include approximately $181,000 of costs in
connection with a legal dispute pending final resolution. There were no expenses
incurred in connection with this legal dispute during the same period of 2002.
At June 30, 2003, the Company has expensed and accrued, but has not paid all
commissions due under the agreement in dispute, as well as legal fees and
interest awarded to the third party in arbitration, plus additional interest
that might be due and payable on the past due amounts in the event the
arbitrators' award and the related amounts reach a final resolution in the
courts. The Company has also deposited with the court approximately $4.6 million
to secure 150 percent of the judgment amount, pending a final resolution of this
legal dispute which is further discussed in Part II, Item I - Legal Proceedings
in this quarterly report.
INTEREST EXPENSE, NET
The Company incurred net interest expense in 2003 of $23,000, compared to
$219,000 in 2002. The decrease was due to a reduction in the Company's
outstanding balance of a loan payable to a bank and increases in interest
income.
INCOME TAXES
The Company recorded no tax provision on its pre-tax earnings for the six
month period ended June 30, 2002, as any current tax component of the provision
would have been offset by an equal deferred tax benefit, pending the Company's
reevaluation of the allowance for its deferred tax asset. As of December 31,
2002, the Company completed the reevaluation, and reported a total deferred tax
asset of $10 million. For the six months ended June 30, 2003, the Company
recorded a provision for income taxes of $2,160,000, which approximates the
Company's combined statutory tax rate for federal and California state taxes,
and reduced its deferred tax asset accordingly.
The Company has approximately $28 million and $18 million of federal and
state income tax net operating loss carryforwards, respectively, available to
offset taxable income beginning in 2003, which expire in various years through
2020. At June 30, 2003, the total deferred tax asset was approximately $7.8
million, with $3 million classified with current assets. The Company expects
that taxable income will be offset in the near-term, for the most part, by its
net operating tax loss carryforwards.
14
NET EARNINGS
The Company's net earnings for the six months ended June 30, 2003 was $3.2
million, or $0.21 per diluted share, compared to net earnings of $6.7 million,
or $0.43 per diluted share for the same period of 2002 due to the factors
discussed above. In the second quarter of 2002, the Company recognized
approximately $1.5 million of non-recurring revenue which had been previously
deferred, as further discussed above. The recognition of the deferred revenue
resulted in an increase of approximately $600,000 or $0.04 per diluted share to
net earnings for the six months ended June 30, 2002. As further discussed above,
the Company's effective tax rate for the six months ended June 30, 2002 was zero
which is not comparable to the effective tax rate of 40 percent for the same
period of 2003. As a result, the incremental tax expense recorded in the six
months ended June 30, 2003 was $2,160,000, or $0.14 per diluted share. The
Company's taxable income is expected to be offset in the near-term, for the most
part, by its net operating tax loss carry-forwards. Comparable recurring pre-tax
net earnings per diluted share were $0.34 in 2003, and $0.39 in 2002.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was approximately $914,000 for the
six months ended June 30, 2003. Cash used in operating activities primarily
includes $3.2 million provided by net earnings, plus deferred income taxes of
$2.2 million and increases in accrued commission of $1.7 million; net of
increases in restricted cash of $4.6 million, and accounts receivable of $2.6
million and net changes in various other assets and liabilities in an aggregate
amount of approximately $800,000. At June 30, 2003, the cash balance was
approximately $5.7 million, as compared to $7.8 million at December 31, 2002.
The decrease of approximately $2.1 million is primarily due to the normal lag in
the collection of accounts receivable, while the payment of operating expenses
is relatively fixed during the year. The restricted cash amount of $4.6 million
had no material impact on the Company's liquidity and capital resources because
similar amounts have been accrued but not paid pending a final resolution of a
legal dispute with a third party which is further discussed above and in Part
II, Item I - Legal Proceedings in this quarterly report. At June 30, 2003,
working capital was approximately $11.3 million, as compared to approximately
$6.0 million at December 31, 2002. The increase in working capital is primarily
due to the impact of pre-tax net earnings recognized in the six months ended
June 30, 2003.
Net cash used in investing activities was $79,000 in the six months ended
June 30, 2003, and was principally used to complete the facilities and equipment
to accommodate additional staff.
Net cash used in financing activities was approximately $1 million in the
six months ended June 30, 2003, and was primarily due to the final payments made
on the loan payable to a bank, partially offset by proceeds from the sale of
common stock upon the exercise of stock options. The Company has paid in full
the loan payable to a bank as of June 30, 2003, and has no debt outstanding
other than to the trade which is incurred in the normal course of business.
The Company is approached from time to time by parties seeking to sell
their brands and related trademarks, and at times their complete business.
Should an established marketable brand, trademark, or business become available
on favorable terms, the Company may be interested in pursuing such an
acquisition and may elect to fund such acquisition, in whole or in part, with a
combination of available cash, issuance of debt, or the sale of equity
securities.
In August, 2000, the Company entered into a lease agreement for its
principal facility in Santa Monica, California, which was subsequently amended
in June 2002. Future rent obligations under the lease agreement are
approximately $20,000 per month for a term of three years which expires in July
2005.
15
The Company believes that its available cash balances at June 30, 2003 and
its expected net operating cash flows from operations during 2003 will be
adequate to meet the Company's anticipated liquidity needs in 2003, including
settlement payments that may be required upon the final resolution of an award
for a claim of approximately $3 million, plus additional accrued commissions,
interest, and other costs, as further described under Part II, Item 1 - Legal
Proceedings in this quarterly report.
FORWARD LOOKING INFORMATION
This report on Form 10-Q contains certain forward-looking statements within
the meaning of the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995. Such forward-looking statements are based on the beliefs of
the Company's management as well as assumptions made by and information
currently available to the Company's management. The words "anticipate",
"believe", "may", "estimate", "plan", "expect", "future", "intend", "will",
"should", "continue" and similar expressions, variations of such terms or the
negative of such terms as they relate to the Company or its management when used
in this document, are intended to identify such forward-looking statements. Such
statements are based on management's current expectations and are subject to
certain risks, uncertainties and assumptions. Should one or more risks or
uncertainties materialize, or should underlying assumptions prove incorrect, the
Company's actual results, performance or achievements could differ materially
from those expressed in, or implied by such forward-looking statements. The
Company's future operations, financial performance, business and share price may
be affected by a number of factors, including a termination or adverse
modification of the Company's relationships under its licensing and design
service agreements, especially its relationship with Target and performance
under the Target licensing and design services agreement, changes in consumer
demands and preferences, competition from other lines, risks generally
associated with product introductions and shifting trends in the overall retail
and apparel retailing markets, and the other factors described in "Business-Risk
Factors." in the Company's Form 10-K filing for the year ending December 31,
2002. Accordingly, undue reliance should not be placed on these forward-looking
statements.
16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not use interest rate swaps, futures contracts or options
on futures, or other types of derivative financial instruments. The Company does
not believe that future market risks arising from holdings of its financial
instruments will have a material impact on its financial position or results of
operations.
ITEM 4. CONTROLS AND PROCEDURES
Based on an evaluation of the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Act
of 1934, as amended), our Chief Executive Officer and our Chief Financial
Officer have concluded that such controls and procedures were effective as of
the period covered by this report. In connection with such evaluation, no change
in the Company's internal control over financial reporting occurred during the
period covered by this report that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
17
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
In May 2002, the Company made a demand for arbitration in connection with a
claim for overpayment of commissions paid to a third party who assisted the
Company in connection with entering into the initial agreement with Target. The
arbitration hearing was completed in October 2002. In November 2002, the
arbitration hearing panel issued a preliminary award in favor of the third
party, which became final in January 2003 and awarded the third party interest
on the amounts due which had been withheld by the Company, and the recovery of
the third party's legal fees. In January 2003, the Company deposited the total
amount of $2,934,688 due under the award into a separate Company bank account,
and filed a petition to vacate the award, including commissions, third party
legal fees, and interest, on the basis that the evidence received during the
arbitration hearing demonstrates that the finder's agreement between the Company
and the third party is illegal under certain applicable California law. In
January 2003 the third party filed a petition to confirm the award, including
commissions, the third party's legal fees, and interest. In June 2003, the award
was confirmed and a judgment entered in favor of the third party, and the third
party was awarded additional interest. In June 2003 the Company filed an appeal
to the judgment and in connection therewith deposited with the court
approximately $4,585,000. The deposit secures 150 percent of the judgment
amount. The Company could be liable for additional legal fees and interest
payable to the third party if the appeal is not successful. There can be no
assurance that the appeal will be successful. The Company continues to accrue
and withhold payment of estimated commissions and interest that may be payable
to the third party until this matter comes to a final resolution. At June 30,
2003, the Company had accrued approximately $5 million of unpaid commissions,
legal fees, and interest potentially payable to the third party in connection
with this matter. The $4,585,000 deposited with the courts was classified as
restricted cash on the Company's balance sheet as of June 30, 2003; and the
aggregate accruals of approximately $5 million were classified as accrued
commissions and accrued liabilities on the Company's balance sheet as of June
30, 2003. All expenses recognized to date have been classified with operating
expenses on the Company's statements or earnings.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) Annual Meeting:
The 2003 Annual Meeting of stockholders of Mossimo, Inc. was held
on June 3, 2003.
(b) Not applicable.
(c) The following are the election results for the nominees to the
Board of Directors:
FOR WITHHELD
---------- ----------
Robert Martini 15,088,211 40,634
William R. Halford 15,086,111 42,734
(d) Not applicable.
18
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
Exhibit - 10.1 - Amendment No. 3 dated June 20, 2003, to the
License Agreement between Mossimo,
Inc. and Target Stores dated March 28, 2000.
Exhibit - 31.1 - Rule 13a - 14(a) Certification of Principal
Executive Officer
Exhibit - 31.2 - Rule 13a - 14(a) Certification of Principal
Financial Officer
Exhibit - 32.1 - Certification Pursuant To 18 U.S.C. Section 1350,
As Adopted Pursuant To Section 906 Of The
Sarbanes-Oxley Act Of 2002
Exhibit - 32.2 - Certification Pursuant To 18 U.S.C. Section 1350,
As Adopted Pursuant To Section 906 Of The
Sarbanes-Oxley Act Of 2002
(b) Reports on Form 8-K
The Company filed the following reports on Form 8-K during the
second quarter:
On May 14, 2003, the Company filed a current report on Form
8-K announcing the first quarter financial results.
19
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 on the 13th day of August 2003.
MOSSIMO, INC.
/s/ MOSSIMO GIANNULLI
-----------------------------------------
Mossimo Giannulli
President and Chief Executive Officer
/s/ Manuel Marrero
-----------------------------------------
Manuel Marrero
Chief Financial Officer
20
INDEX TO EXHIBITS
- --------------------------------------------------------------------------------
Exhibit - 10.1 - Amendment No. 3 dated June 20, 2003, to the
License Agreement between Mossimo, Inc. and
Target Stores dated March 28, 2000.
Exhibit - 31.1 - Rule 13a - 14(a) Certification of Principal
Executive Officer
Exhibit - 31.2 - Rule 13a - 14(a) Certification of Principal
Financial Officer
Exhibit - 32.1 - Certification Pursuant To 18 U.S.C. Section
1350, As Adopted Pursuant To Section 906 Of
The Sarbanes-Oxley Act Of 2002
Exhibit - 32.2 - Certification Pursuant To 18 U.S.C. Section
1350, As Adopted Pursuant To Section 906 Of
The Sarbanes-Oxley Act Of 2002
21