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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 September 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 Identification 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]
As of October 31, 2003, 15,557,904 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 September 30, 2003 and December 31, 2002 .. 2
Condensed statements of earnings for the three and nine months
ended September 30, 2003 and 2002..................................... 3
Condensed statements of cash flows for the nine months
ended September 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 ....... 16
ITEM 4 - Controls and Procedures.......................................... 16
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1 - Legal Proceedings ............................................... 17
ITEM 5 - Other Information ............................................... 17
ITEM 6 - Exhibits and Reports on Form 8-K ................................ 17
SIGNATURES ............................................................... 18
INDEX TO EXHIBITS ........................................................ 19
-1-
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MOSSIMO, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
UNAUDITED
SEPTEMBER 30, DECEMBER 31,
2003 2002
----------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................ $ 8,767 $ 7,786
Restricted cash.......................................................... 4,585 --
Accounts receivable...................................................... 2,068 1,926
Deferred income taxes.................................................... 3,000 3,000
Prepaid expenses and other current assets................................ 748 124
----------- -----------
Total current assets................................................... 19,168 12,836
PROPERTY AND EQUIPMENT, net................................................ 510 608
DEFERRED INCOME TAXES...................................................... 4,420 7,000
OTHER ASSETS............................................................... 244 92
----------- -----------
$ 24,342 $ 20,536
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Loan payable............................................................. $ -- $ 1,066
Accounts payable......................................................... 557 741
Accrued liabilities...................................................... 930 1,332
Accrued commissions...................................................... 4,896 2,661
Accrued bonuses.......................................................... 553 1,065
----------- -----------
Total current liabilities............................................. 6,936 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 15,503,442 - September 30, 2003
and 15,488,042 - December 31, 2002..................................... 15 15
Additional paid-in capital............................................... 38,849 38,797
Accumulated deficit...................................................... (21,458) (25,332)
----------- -----------
Net stockholders' equity............................................... 17,406 13,480
----------- -----------
$ 24,342 $ 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------- -------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenue from license royalties
and design service fees ............... $ 4,176 $ 4,287 $ 16,902 $ 17,281
Operating expenses:
Selling, general and administrative.... 3,144 2,797 10,444 8,890
--------- --------- --------- ---------
Operating earnings ........................ 1,032 1,490 6,458 8,391
Other (income) expense:
Other income, net ..................... -- -- -- (24)
Interest (income) expense, net ........ (18) 70 4 299
--------- --------- --------- ---------
Earnings before income taxes .............. 1,050 1,420 6,454 8,116
Income taxes expense (benefit) ............ 420 (195) 2,580 (195)
--------- --------- --------- ---------
Net earnings .............................. $ 630 $ 1,615 $ 3,874 $ 8,311
========= ========= ========= =========
Earnings per common share:
Basic ................................. $ 0.04 $ 0.10 $ 0.25 $ 0.54
========= ========= ========= =========
Diluted ............................... $ 0.04 $ 0.10 $ 0.25 $ 0.53
========= ========= ========= =========
Weighted average common shares outstanding:
Basic ................................. 15,500 15,450 15,495 15,403
========= ========= ========= =========
Diluted ............................... 15,782 15,666 15,734 15,619
========= ========= ========= =========
See accompanying notes to condensed financial statements.
-3-
MOSSIMO, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
------------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings ................................................ $ 3,874 $ 8,311
Adjustment to reconcile net earnings to net
cash provided by operating activities:
Depreciation and amortization ........................... 205 161
Deferred income taxes ................................... 2,580 --
Changes in:
Restricted cash ..................................... (4,585) --
Accounts receivable ................................. (142) (699)
Prepaid expenses and other current assets ........... (624) (177)
Other assets ........................................ (152) (11)
Accounts payable and long-term accounts payables..... (375) (2,475)
Accrued liabilities ................................. (402) (312)
Accrued bonuses ..................................... (512) 730
Accrued commissions ................................. 2,235 2,062
-------- --------
Net cash provided by operating activities ........... 2,102 7,590
-------- --------
CASH FLOWS FROM INVESTING ACTIVITITES:
Payments for acquisition of property and equipment .......... (107) (83)
-------- --------
Net cash used in investing activities ............... (107) (83)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of loan payable .................................... (1,066) (2,778)
Proceeds from issuance of common stock ...................... 52 449
-------- --------
Net cash used in financing activities ................ (1,014) (2,329)
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS ................... 981 5,178
CASH AND CASH EQUIVALENTS, beginning of period .............. 7,786 3,182
-------- --------
CASH AND CASH EQUIVALENTS, end of period .................... $ 8,767 $ 8,360
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest ................ $ 10 $ 39
======== ========
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.
Certain prior year balances have been reclassified to conform to the
current year presentation.
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 million 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 body-wear sold in Target stores in the United States.
-5-
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 $407,000 and
$509,000 under these agreements for the three month periods ended September 30,
2003 and 2002, respectively; and $1,870,000 and $2,016,000 for the nine month
periods ended September 30, 2003 and 2002, respectively.
5. LOAN PAYABLE
The Company had a loan payable to a bank that was fully paid in June
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.
The Company recorded a provision for income taxes of $420,000 and
$2,580,000 for the three and nine month periods ended September 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 September 30, 2003, the total deferred tax asset was
approximately $7.4 million, with $3.0 million classified as current in the
accompanying balance sheet. In the prior year periods, the Company recorded a
benefit of $195,000 related to the refund of prior year income taxes.
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
-6-
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 400,000 and
550,000 for the three months ended September 30, 2003 and 2002, respectively;
and approximately 550,000 for the nine months ended September 30, 2003 and 2002;
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 Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
2003 2002 2003 2002
---- ---- ---- ----
Net earnings .................................... $ 630 $ 1,615 $ 3,874 $ 8,311
Weighted average shares outstanding - Basic ..... 15,500 15,450 15,495 15,403
Basic earnings per share ........................ $ 0.04 $ 0.10 $ 0.25 $ 0.54
Add: Dilutive effect of stock options ........... 282 216 239 216
Weighted average shares outstanding - Diluted.... 15,782 15,666 15,734 15,619
Diluted earnings per share ...................... $ 0.04 $ 0.10 $ 0.25 $ 0.53
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.
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 nine month
periods ended September 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 nine month periods ended
September 30, 2003 and 2002 (in thousands, except per share data):
-7-
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------- --------------------------
2003 2002 2003 2002
--------- ---------- ---------- ----------
Actual net earnings .................................... $ 630 $ 1,615 $ 3,874 $ 8,311
Less: Total compensation as if the fair value method....
was used, net of tax effect ....................... (238) (446) (606) (1,219)
--------- ---------- ---------- ----------
Pro forma net earnings ................................. $ 392 $ 1,169 $ 3,268 $ 7,092
========= ========== ========== ==========
Net earnings per share:
Basic - as reported ............................... $ 0.04 $ 0.10 $ 0.25 $ 0.54
Basic - pro forma ................................. $ 0.03 $ 0.08 $ 0.21 $ 0.46
Diluted - as reported ............................. $ 0.04 $ 0.10 $ 0.25 $ 0.53
Diluted - pro forma ............................... $ 0.02 $ 0.07 $ 0.21 $ 0.45
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
implementation of SFAS No. 150 did not have an 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.
The provisions of FIN 46 for certain variable interest entities were delayed
until the fourth quarter of 2003. 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.
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 Company licenses its trademarks,
provides design services and has approval rights for product design, marketing
and advertising materials under licensing and design service agreements which
include certain provisions for indemnifying the licensee. As an element of its
standard commercial terms, the Company includes an indemnification clause in its
licensing and design services agreements that indemnifies the licensee against
liability and damages arising from any claims, suits, damages, or costs relating
to the breach of any warranty, representation, term or condition made or agreed
to by its licensees involving the manufacture, packaging, distribution,
promotion, sale, marketing, advertising or other use of the trademarks under
license. We believe that our policies and practices limit our exposure related
to the indemnification provisions of the license and design services agreements.
For several reasons, including the lack of prior indemnification claims and the
lack of monetary liability limit for certain infringement cases under the
license and design services agreements, we cannot determine the maximum amount
of potential future payments, if any, related to such indemnification
provisions.
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, the adoption of this issue did not have a
material impact on the Company's financial position or results of operations.
-8-
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 September
30, 2003, the Company had accrued approximately $5.6 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 September 30,
2003; and the aggregate accruals of approximately $5.6 million were classified
as accrued commissions and accrued liabilities on the Company's balance sheet as
of September 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 million 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 body-wear 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.
THREE MONTHS ENDED SEPTEMBER 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
-10-
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 third
quarter of 2003 were $4.2 million compared to $4.3 million in the third quarter
of 2002.
Design service fees and royalties recognized under the Target Agreement
were $3.7 million in the third quarter of 2003 compared to $3.9 million in the
third quarter of 2002. The decline in the comparable periods is because license
royalties and design fees generated under the Target Agreement are based on a
rate that declines as the contract year progresses and Target achieves higher
levels of retail sales. In the first and second quarter of 2003 Target achieved
higher levels of retail sales over the prior year, and the Company has generated
a 4 percent increase in year to date revenue from Target as of September 30,
2003, as further discussed below. Even though the business with Target has
continued to grow in 2003 as compared to 2002, the higher sales recognized
earlier in 2003 resulted in a lower fee applicable to 2003 third quarter sales
as compared to the same period in 2002.
Royalties and design service fees from customers other than Target
increased approximately $100,000 or 36 percent in the third quarter of 2003 as
compared to the same period in 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 through Zellers stores. The Company's
revenues generated under the Target Agreement are expected to increase in the
future 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
$3.1 million in the third quarter of 2003 from $2.8 million in the third quarter
of 2002. S, G & A expenses were approximately 75 percent of total revenues in
2003, as compared to approximately 65 percent of total revenues in 2002. S, G &
A expenses as a percent of revenues are expected to decrease in the future, as
the Company is better able to take advantage of the leverage resulting from
expected increase in revenues from Target as it adds new stores, and as the
Company continues to maximize its opportunities with Target, and the new Zellers
business in Canada.
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 $540,000 in the third quarter of 2003 and $580,000 in
the third quarter of 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 $132,000 in 2003, primarily due to increases in
design personnel. The aggregate payroll costs include accrued bonuses of
$407,000 in 2003, and $509,000 in 2002, which are payable under bonus plans
covering two executive officers of the Company. Facility expenses also increased
by approximately $42,000 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 $88,000 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.
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S, G & A expenses in 2003 also include approximately $83,000 of costs in
connection with a legal dispute pending final resolution. At September 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 (INCOME) EXPENSE, NET
The Company recognized interest income of $18,000 in 2003, compared to
interest expense of $70,000 in 2002. The decrease was due to a reduction in the
Company's outstanding balance of a loan payable to a bank which was fully paid
in June 2003, and increases in interest income.
INCOME TAXES
The Company recorded no tax provision on its pre-tax earnings in the
third 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 third quarter of 2003, the Company recorded a provision for
income taxes of $420,000 which approximates the Company's combined statutory tax
rate for federal and California state taxes, and reduced its deferred tax asset
accordingly. During the three months ended September 30, 2002, the Company
recorded an income tax benefit of $195,000 related to the refund of prior year
income taxes.
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 September 30, 2003, the total deferred tax asset was approximately $7.4
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 carry-forwards.
NET EARNINGS
The Company's net earnings for the third quarter of 2003 was $630,000, or
$0.04 per diluted share, compared to net earnings of $1.6 million, or $0.10 per
diluted share for the third quarter of 2002 due to the factors discussed above.
As further discussed above, the Company's effective tax rate for the third
quarter of 2002 was zero which is not comparable to the effective tax rate of 40
percent in the third quarter of 2003. As a result, the incremental tax expense
recorded in the third quarter of 2003 was $420,000, or $0.03 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 carryforwards. Comparable recurring
pre-tax net earnings per diluted share were $0.07 in 2003, and $0.09 in 2002.
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
REVENUES
Total revenue from license royalties and design service fees for the nine
months ended September 30, 2003 were $16.9 million compared to $17.3 million in
the same period of 2002.
Design service fees and royalties recognized under the Target Agreement
were $15.1 million for the nine months ended September 30, 2003 compared to
$16.0 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,
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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 $600,000 or 4 percent in 2003 as compared to 2002.
Royalties and design service fees from customers other than Target
increased approximately $500,000 or 38 percent in 2003 as compared to 2002. The
increase was primarily due to the full launch of the Mossimo product line in
Canada in mid-March 2003, under the agreement with Hudson's Bay Company for
distribution through 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 $10.4 million for the nine months ended
September 30, 2003 from $8.9 million in the same period of 2002. S, G & A
expenses were approximately 62 percent of total revenues in 2003, as compared to
approximately 51 percent of total revenues in 2002 (56 percent based on 2002
recurring revenues). S, G & A expenses as a percent of revenues are expected to
decrease in the future, as the Company is better able to take advantage of the
leverage resulting from expected increase in revenues from Target as it adds new
stores, and as the Company continues to maximize its opportunities with Target,
and the new Zellers business in Canada.
Selling expenses, comprised of commissions due to a third party who
assisted the Company in connection with entering into the initial agreement with
Target, decreased to approximately $2,234,000 in 2003 from approximately
$2,385,000 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 $809,000 in 2003, primarily due to increases in
design personnel. The aggregate payroll costs include accrued bonuses of
$1,870,000 in 2003, and $2,016,000 in 2002, which are payable under bonus plans
covering two executive officers of the Company. Facility expenses also increased
by approximately $135,000 to accommodate the additional personnel.
Expenses for travel, free-lance artists, and purchased artwork incurred
in connection with the design process increased by approximately $529,000 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 $264,000 of costs in
connection with a legal dispute pending final resolution. At September 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.
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INTEREST EXPENSE, NET
The Company incurred net interest expense in 2003 of $4,000, compared to
$299,000 in 2002. The decrease was due to a reduction in the Company's
outstanding balance of a loan payable to a bank fully paid in June 2003 and
increases in interest income.
INCOME TAXES
The Company recorded no tax provision on its pre-tax earnings for the
nine month period ended September 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 nine months ended September 30, 2003,
the Company recorded a provision for income taxes of $2,580,000, which
approximates the Company's combined statutory tax rate for federal and
California state taxes, and reduced its deferred tax asset accordingly. During
the nine months ended September 30, 2002, the Company recorded an income tax
benefit of $195,000 related to the refund of prior year income taxes.
NET EARNINGS
The Company's net earnings for the nine months ended September 30, 2003
was $3.9 million, or $0.25 per diluted share, compared to net earnings of $8.3
million, or $0.53 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 nine months ended September 30, 2002. As further discussed
above, the Company's effective tax rate for the nine months ended September 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 nine months ended September 30, 2003 was $2,580,000, or $0.16 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 carryforwards. Comparable
recurring pre-tax net earnings per diluted share were $0.41 in 2003, and $0.48
in 2002.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was approximately $2.1 million
for the nine months ended September 30, 2003. Cash provided by operating
activities primarily includes $3.9 million provided by net earnings, plus
deferred income taxes of $2.6 million and increases in accrued commission of
$2.2 million; net of increases in restricted cash of $4.6 million, and net
changes in various other assets and liabilities in an aggregate amount of
approximately $2.0 million. At September 30, 2003, the cash balance was
approximately $8.8 million, as compared to $7.8 million at December 31, 2002.
The increase of approximately $1.0 million is primarily the result of cash from
operating activities of approximately $2 million, net of approximately $1.0
million in principal payments of bank debt. 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
September 30, 2003, working capital was approximately $12.2 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
nine months ended September 30, 2003.
Net cash used in investing activities was $107,000 in the nine months
ended September 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
nine months ended September 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 fully
paid the loan payable to a bank in June 2003, and as of September 30, 2003 has
no debt outstanding other than to the trade which is incurred in the normal
course of business.
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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.
The Company believes that its available cash balances at September 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.
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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.
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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 September
30, 2003, the Company had accrued approximately $5.6 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 September 30,
2003; and the aggregate accruals of approximately $5.6 million were classified
as accrued commissions and accrued liabilities on the Company's balance sheet as
of September 30, 2003. All expenses recognized to date have been classified with
operating expenses on the Company's statements or earnings.
ITEM 5 - OTHER INFORMATION
In October 2003, Gia Castrogiovanni, the Company's Chief Operating
Officer, resigned to pursue other opportunities. Her responsibilities have been
divided among the Company's existing executives and senior staff.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
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
third quarter:
On November 6, 2003, the Company filed a current report on
Form 8-K announcing the third quarter financial results.
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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 on the 7th day of November 2003.
MOSSIMO, INC.
/s/ MOSSIMO GIANNULLI
-----------------------------------------------
Mossimo Giannulli
President and Chief Executive Officer
/s/ Manuel Marrero
-----------------------------------------------
Manuel Marrero
Chief Financial Officer
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INDEX TO EXHIBITS
- --------------------------------------------------------------------------------
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
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