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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, 2004
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 19, 2004, 15,738,442 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 consolidated balance sheets as of June 30, 2004 and
December 31, 2003 .........................................................2
Condensed consolidated statements of earnings for the three and six months
ended June 30, 2004 and 2003...............................................3
Condensed consolidated statements of cash flows for the six months
ended June 30, 2004 and 2003...............................................4
Notes to condensed consolidated financial statements ..........................5
ITEM 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations ...............................................11
ITEM 3 - Quantitative and Qualitative Disclosure about Market Risk ...........19
ITEM 4 - Controls and Procedures..............................................19
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1 - Legal Proceedings ...................................................21
ITEM 4 - Submission of Matters to a Vote of Security Holders .................21
ITEM 5 - Other Information....................................................22
ITEM 6 - Exhibits and Reports on Form 8-K ....................................22
SIGNATURES ...................................................................22
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MOSSIMO, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
UNAUDITED
JUNE 30, DECEMBER 31,
2004 2003
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ........................................ $ 8,697 $ 9,707
Restricted cash .................................................. -- 4,585
Accounts receivable .............................................. 4,467 2,007
Merchandising inventories ........................................ 407 --
Deferred income taxes ............................................ 2,455 3,071
Prepaid expenses and other current assets ........................ 561 282
--------- ---------
Total current assets ........................................... 16,587 19,652
Property and equipment, net ........................................ 1,056 480
Deferred income taxes .............................................. 5,202 6,037
Goodwill ........................................................... 324 --
Other assets ....................................................... 62 244
--------- ---------
$ 23,231 $ 26,413
========= =========
LIABILITIES AND STOCKHOLDERS' EQUTY
CURRENT LIABILITIES:
Accounts payable ................................................. 118 525
Accrued liabilities .............................................. 711 1,513
Accrued commissions .............................................. 526 5,251
Accrued bonuses .................................................. 667 112
--------- ---------
Total current liabilities ...................................... 2,022 7,401
--------- ---------
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 15,738,442 at June 30, 2004
and December 31, 2003 .......................................... 15 15
Additional paid-in capital ....................................... 39,763 39,763
Accumulated deficit .............................................. (18,569) (20,766)
--------- ---------
Stockholders' equity ........................................... 21,209 19,012
--------- ---------
$ 23,231 $ 26,413
========= =========
See accompanying notes to condensed consolidated financial statements.
2
MOSSIMO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
UNAUDITED
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2004 2003 2004 2003
--------- --------- --------- ---------
Revenue from license royalties and design
service fees ......................... $ 5,784 $ 6,858 $ 11,994 $ 12,726
Product Sales ............................. 424 -- 450 --
--------- --------- --------- ---------
Total revenues ............................ 6,208 6,858 12,444 12,726
Operating expenses:
Cost of product sales.................. 211 -- 224 --
Selling, general and administrative ... 4,330 3,774 8,543 7,300
--------- --------- --------- ---------
Operating earnings ........................ 1,667 3,084 3,677 5,426
Interest income (expense), net ............ 20 (9) 47 (23)
--------- --------- --------- ---------
Earnings before income taxes .............. 1,687 3,075 3,724 5,403
Provision for income taxes ................ 680 1,230 1,527 2,160
--------- --------- --------- ---------
Net earnings .............................. $ 1,007 $ 1,845 $ 2,197 $ 3,243
========= ========= ========= =========
Earnings per share:
Basic ................................. $ 0.06 $ 0.12 $ 0.14 $ 0.21
========= ========= ========= =========
Diluted ............................... $ 0.06 $ 0.12 $ 0.14 $ 0.21
========= ========= ========= =========
Shares used in computing earnings per share:
Basic ................................. 15,738 15,493 15,738 15,491
========= ========= ========= =========
Diluted ............................... 15,768 15,643 15,770 15,707
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
3
MOSSIMO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED
FOR THE SIX MONTHS
ENDED JUNE 30,
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings .............................................. $ 2,197 $ 3,243
Adjustment to reconcile net earnings to net
cash provided by (used in) operating activities:
Depreciation and amortization ......................... 141 150
Allowance for accounts receivable ..................... 22 --
Deferred income taxes ................................. 1,451 2,160
Changes in:
Restricted cash ................................... 4,585 (4,585)
Accounts receivable ............................... (2,470) (2,624)
Inventories ....................................... (394) --
Prepaid expenses and other current assets ......... (279) (311)
Other assets ...................................... 188 55
Accounts payable .................................. (407) (233)
Accrued liabilities ............................... (802) (436)
Accrued commissions ............................... (4,725) 1,694
Accrued bonuses ................................... 555 (27)
-------- --------
Net cash provided by (used in) operating activities 62 (914)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITITES:
Payment for acquisition of a business ..................... (375) --
Payments for acquisition of property and equipment ........ (697) (79)
-------- --------
Net cash used in investing activities ............. (1,072) (79)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of loan payable .................................. -- (1,066)
Proceeds from issuance of common stock .................... -- 27
-------- --------
Net cash used in financing activities .............. -- (1,039)
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS ................. (1,010) (2,032)
Cash and cash equivalents, beginning of period ............ 9,707 7,786
-------- --------
Cash and cash equivalents, end of period .................. $ 8,697 $ 5,754
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest .............. $ -- $ 10
======== ========
Cash paid during the period for income taxes ........... $ 58 $ --
======== ========
See accompanying notes to condensed consolidated financial statements.
4
MOSSIMO, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED
1. BASIS OF PRESENTATION
The condensed consolidated 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 presentation 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 consolidated balance sheet data presented
herein for December 31, 2003 was derived from the Company's audited financial
statements for the year then ended, but does not include all disclosures
required by accounting principles generally accepted in the United States of
America.
On January 16, 2004, Mossimo, Inc. acquired substantially all the assets
of Modern Amusement LLC through a wholly owned subsidiary, Modern Amusement,
Inc. ("Modern Amusement"). The accompanying condensed consolidated financial
statements include the account balances of Modern Amusement as of June 30, 2004
and the results of operations of Modern Amusement for the three months ended
June 30, 2004 and for the period from January 16, 2004 to June 30, 2004. All
intercompany accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America 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 accounting principles generally accepted
in the United States of America have been omitted pursuant to the Regulations of
the Securities and Exchange Commission. The Company believes the disclosures
included in the accompanying interim condensed consolidated 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, 2003.
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. 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 2003, (herein
after 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 payable in each of the contract years after
January 31, 2002. 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.
5
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. The next renewal option could be exercised by Target in or
before January 2005. This renewal option could extend the Target Agreement
through January 2008.
In addition to the Target Agreement, the Company also licenses its
trademarks and provides design services outside of the United States. The
Company 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. The Company
receives 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.
On January 16, 2004, the Company acquired substantially all the assets of
Modern Amusement LLC through a wholly owned subsidiary, Modern Amusement for
aggregate consideration of $375,000. Modern Amusement designs, merchandises,
sources, markets, sells and distributes wholesale apparel and related
accessories for young men and young women. The "Modern Amusement" registered
brand is principally focused on premium west coast-lifestyle apparel and related
accessories. The products are offered at moderate to upper price points through
traditional specialty store and higher-end department store distribution
channels. This line of business is expected to diversify the Company's current
design and licensing business of its Mossimo brand product through mass retail
distribution channels. The accompanying condensed consolidated financial
statements include the account balances of Modern Amusement as of June 30, 2004
and the results of operations of Modern Amusement for the three months ended
June 30, 2004 and for the period from January 16, 2004 to June 30, 2004. Pro
forma information is not presented for the three and six month periods ended
June 30, 2003 as the account balances and results of operations of Modern
Amusement are not considered material to the Company's results of operations for
those periods.
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 of 1% to 4% 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 fiscal year in
connection with the Target Agreement is significantly higher than in the third
and fourth quarters of the Company's fiscal year due to the declining rates in
the Target Agreement. Royalties from Target are receivable 30 days after the end
of Target's fiscal year quarters. Revenues from license royalties and design
service fees under license agreements other than the Target Agreement are
generally collected on a quarterly basis, and they range from 1% to 3% of sales,
as defined in the respective agreements.
Revenue from product sales is recognized when merchandise is sold to
customers. Reserves for returns and allowances are recorded at the time of sale.
6
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 $667,000 and
$875,000 under these agreements for the three month periods ended June 30, 2004
and 2003, respectively; and $1,274,000 and $1,446,000 for the six month periods
ended June 30, 2004 and 2003, respectively.
5. INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standard ("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 carry forward for income taxes
purposes.
The Company recorded a provision for income taxes of $680,000 and
$1,527,000 for the three and six month periods ended June 30, 2004,
respectively. Both provisions approximate the Company's combined statutory tax
rate for Federal and California state income taxes.
At June 30, 2004, the Company has recorded a total net deferred tax asset
of $7.7 million, with $2.5 million classified as current in the accompanying
condensed consolidated balance sheet, as a result of the extension of the Target
Agreement through January 31, 2006, management's discussions with Target prior
to the end of 2003 which resulted in management considering that it is more
likely than not that Target would extend the agreement through 2008, the
reevaluation of its forecasted operating results and resultant taxable income
during the extended term of the Target Agreement, and the consequent expected
utilization of available net operating losses during the extended term of the
Target Agreement. The Company has considered the projected taxable income from
the Target Agreement and other agreements in its estimate of deferred tax asset
recoverability and has recorded a valuation allowance for its net deferred tax
assets of $1.1 million.
As of December 31, 2003, the Company had approximately $22 million and
$18 million of federal and state income tax net operating loss carry forwards,
respectively, available to offset future taxable income which expire in various
years through 2022. The Company expects that future taxable income will be
offset in the near-term for the most part by its net operating tax loss
carryforwards.
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, however it is presently anticipated that in 2004, 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 2004 and the Company
intends to continue to take appropriate measures to avoid being classified as a
personal holding company at the end of 2004 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 2004 or in future
years.
7
6. BUSINESS ACQUISITION
On January 16, 2004, Mossimo, Inc. acquired substantially all the assets
of Modern Amusement LLC through a wholly owned subsidiary, Modern Amusement. The
acquisition was accounted for as a purchase whereby the purchase price was
allocated to the assets acquired based on fair values. The excess purchase price
over the amount allocated to the assets acquired has been recorded as goodwill
in the accompanying condensed consolidated balance sheet at June 30, 2004. The
following table summarizes the fair values of the assets acquired at the date of
acquisition. Proforma information is not presented as the impact of this
acquisition on the consolidated financial statements is not material.
Net current assets........................................ $ 25
Property and equipment.................................... 20
Goodwill.................................................. 324
Other assets.............................................. 6
-------
Assets acquired.................................. $ 375
-------
7. EARNINGS PER SHARE AND STOCK OPTION PLANS
Basic earnings per share is computed by dividing net earnings available
to common stockholders by the weighted average number of common shares
outstanding during the relevant period. Diluted earnings per share includes 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 441,000 and 614,000 for the three months
ended June 30, 2004 and 2003, respectively; and approximately 441,000 and
600,000 for the six months ended June 30, 2004 and 2003, respectively; as they
were antidilutive. There was no effect on net earnings available to common
stockholders for any period presented as a result of dilutive securities.
The reconciliation between net earnings and weighted average shares
outstanding for basic and diluted earnings per share is as follows (amounts in
thousands, except per share data):
Three Months Six Months
Ended June 30, Ended June 30,
-------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Net earnings .................................. $ 1,007 $ 1,845 $ 2,197 $ 3,243
Weighted average shares outstanding - Basic ... 15,738 15,493 15,738 15,491
Basic earnings per share ..................... $ 0.06 $ 0.12 $ 0.14 $ 0.21
Add: Dilutive effect of stock options ......... 30 150 32 216
Weighted average shares outstanding - Diluted.. 15,768 15,643 15,770 15,707
Diluted earnings per share ................... $ 0.06 $ 0.12 $ 0.14 $ 0.21
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 Company accounts for stock-based compensation in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees", and related interpretations. The Company follows the pro forma
disclosure requirements of SFAS No. 123, "Accounting for Stock-Based
Compensation", which require presentation of the pro forma effect of the fair
value based method on net earnings and earnings per share in the financial
statement footnotes.
8
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, 2004 and 2003, assuming risk-free interest rates in the range of
approximately 1.9 to 6.7 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 earnings per share would have resulted in the approximate pro forma
amounts indicated below for the three and six month periods ended June 30, 2004
and 2003 (in thousands, except per share data):
Three Months Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net earnings as reported .............................. $ 1,007 $ 1,845 $ 2,197 $ 3,243
Less: Total compensation as if the fair value method
was used, net of tax effect ...................... (73) (238) (147) (368)
---------- ---------- ---------- ----------
Pro forma net earnings ................................ $ 934 $ 1,607 $ 2,050 $ 2,875
========== ========== ========== ==========
Net earnings per share:
Basic - as reported .............................. $ 0.06 $ 0.12 $ 0.14 $ 0.21
Basic - pro forma ................................ $ 0.06 $ 0.10 $ 0.13 $ 0.19
Diluted - as reported ............................ $ 0.06 $ 0.12 $ 0.14 $ 0.21
Diluted - pro forma .............................. $ 0.06 $ 0.10 $ 0.13 $ 0.18
8. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the Financial Accounting Standards Board ("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
relating to certain mandatorily redeemable financial instruments, 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 FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities". In December 2003, the FASB issued
"Summary of Interpretation No. 46 (Revised December 2003)" ("FIN 46R") which
replaced FIN 46. FIN 46R clarifies the application of Accounting Research
Bulletin No. 51 "Consolidated Financial Statements", and requires companies to
evaluate variable interest entities for specific characteristics to determine
whether additional consolidation and disclosure requirements apply. Certain
special effective date provisions apply to companies that fully or partially
applied FIN 46 prior to the issuance of FIN 46R. Otherwise, application of FIN
46R is required in financial statements of public companies that have interests
in variable interest entities or potential variable interest entities, commonly
referred to as special-purpose entities, for periods ending after December 15,
2003. Application by public companies (other than small business issuers) for
all other types of entities is required in financial statements for periods
ending after March 15, 2004. Neither the initial adoption of FIN 46 nor the
adoption of FIN 46R had a material impact on the Company's financial position or
results of operations.
9
In December 2003, the SEC issued Staff Accounting Bulletin ("SAB") No.
104, "Revenue Recognition", which codifies, revises and rescinds certain
sections of SAB No. 101, "Revenue Recognition", in order to make this
interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. The changes noted in SAB No.
104 did not have a material effect on the Company's results of operations,
financial position or cash flows.
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 the
commissions owed, 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 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 demonstrated that the
finder's agreement between the Company and the third party was 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 $4,585,000 deposited with
the courts was classified as restricted cash on the Company's balance sheet as
of December 31, 2003. The deposit secured 150% of the judgment amount. In
January 2004 the appeal decision was rendered in favor of the third party, and
the Company proceeded with an appeal to the Supreme Court of the State of
California.
In March 2004, the California Supreme Court denied the Company's appeal.
The California Supreme Court's decision not to review the trial court judgment
reaffirms the validity of the original finder's agreement between the third
party and Mossimo and the third party 's right to be paid all amounts currently
due, including interest at the legal rate and all post-judgment amounts as well
as attorney's fees.
During the six months ended June 30, 2004 the Company paid all unpaid
commissions, legal fees and interest payable to the third party in connection
with this litigation. The Company had accrued for the full amount each quarter
under the original agreement with the third party, including estimated penalties
and interest.
10
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, 2003 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. 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 2003, (herein
after 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 payable in each of the contract years after
January 31, 2002. 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. The next renewal option could be exercised by Target in or
before January 2005. This renewal option could extend the Target Agreement
through January 2008.
In addition to the Target Agreement, the Company also licenses its
trademarks and provides design services outside of the United States. The
Company 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. The Company
receives 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.
On January 16, 2004, the Company acquired substantially all the assets of
Modern Amusement LLC through a wholly owned subsidiary, Modern Amusement for
aggregate consideration of $375,000. Modern Amusement designs, merchandises,
sources, markets, sells and distributes wholesale apparel and related
accessories for young men and young women. The "Modern Amusement" registered
brand is principally focused on premium west coast-lifestyle apparel and related
accessories. The products are offered at moderate to upper price points through
traditional specialty store and higher-end department store distribution
channels. This line of business is expected to diversify the Company's current
design and licensing business of its Mossimo brand product through mass retail
distribution channels.
11
THREE MONTHS ENDED JUNE 30, 2004 AND 2003
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. For the three months ended June 30, 2004, a substantial
amount of the Company's revenue from license royalties and design fees were
generated under the Target Agreement. The royalty rate under the Target
Agreement declines, as the contract year progresses and Target achieves certain
levels of retail sales, from 4% to 1%. The declining royalty rate is reset each
contract year beginning on February 1. Accordingly, revenue recognized in the
first and second quarters of the Company's fiscal year is significantly higher
than in the third and fourth quarters due to the declining rates in the Target
Agreement. Royalties from Target are receivable 30 days after the end of
Target's fiscal year quarters. Revenues from license royalties and design
service fees under license agreements other than the Target Agreement are
generally collected on a quarterly basis, and they range from 1% to 3% of sales,
as defined in the respective agreements.
Total revenue from license royalties and design service fees in the
second quarter of 2004 were $5.8 million compared to $6.9 million in the second
quarter of 2003.
Design service fees and royalties recognized under the Target Agreement
were $5.1 million in the second quarter of 2004 compared to $6.2 million in the
second quarter of 2003. The decrease is due to reduced consumer spending in the
second quarter of 2004 at Target stores. Royalties and design service fees from
customers other than Target decreased to $664,000 in the second quarter of 2004
from $685,000 in the second quarter of 2003. The decrease was primarily due to a
decrease in design service fees received from Zellers to $141,000 in the second
quarter of 2004 from $272,000 in the second quarter of 2003. Zellers performed
more of the design services for Mossimo branded products sold through Zellers
stores in Canada. This decrease was partially offset by an increase in royalty
fees to $250,000 in the second quarter of 2004 from $200,000 in the second
quarter of 2003 attributable to women's swimwear and body-wear sold in Target
stores under a separate agreement in the United States. The Company's revenues
generated under the Target Agreement are expected to increase modestly during
the remainder of 2004 as Target adds new stores, the Company continues to
maximize its opportunities with Target and consumer spending increases.
Modern Amusement realized product sales of $424,000 in the second
quarter of 2004.
OPERATING EXPENSES
Total operating expenses is comprised of the cost of product sales and
selling, general and administrative expenses. Selling, general and
administrative expenses increased to $4.3 million in the second quarter of 2004
from $3.8 million for the comparable period in 2003. Selling, general and
administrative expenses were approximately 75% of revenues from royalties and
design service fees in the second quarter of 2004, as compared to approximately
55% for the comparable period of 2003. This increase was primarily due to
$589,000 of selling, general and administrative expenses incurred in the second
quarter of 2004 by the operations of Modern Amusement. Operating expenses for
Mossimo, Inc., as a stand-alone operation, as a percent of revenues from
royalties and design service fees, increased to 65% for the second quarter of
2004 compared to 55% for the comparable period of 2003, primarily as a result of
the aforementioned decrease in design service fees and royalties received from
Target.
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 $765,000 in the second quarter of 2004 from $912,000 in the
second quarter of 2003, due to the decrease in design service fees and royalties
received from Target.
12
General and administrative expenses include payroll for the Company's
officers and its design staff, travel, facilities, insurance, legal and
professional fees, and other design related expenses for purchased services and
artwork used in the design process. Salaries and related costs for Mossimo, as a
stand alone operation increased to $1.3 million in the second quarter of 2004
from $1 million in the second quarter of 2003 as a result of an increase in
remuneration payable to the Company's then Vice-Chairman and President, Mr.
Edwin Lewis.
On July 30, 2004, the Board of Directors, upon the recommendation of
the Compensation Committee of the Board of Directors, approved an employment
agreement for Edwin Lewis. Under the agreement Mr. Lewis will have the title of
Chief Executive Officer-Operations and Finance. Additionally under his agreement
Mr. Lewis is entitled to an increased base salary of $900,000 per annum which is
effective from January 1, 2004.
Also included in general and administrative expenses are bonuses of
$667,000 in the second quarter of 2004, and $875,000 in the second quarter of
2003, which are due under bonus plans covering two executive officers of the
Company. Design, artwork and sample costs decreased to $134,000 in the second
quarter of 2004 from $223,000 in the second quarter of 2003 primarily due to
costs incurred in 2003 relating to the launch of the Company's product line with
Zellers. Travel expenses increased to $281,000 in the second quarter of 2004
from $182,000 in the second quarter of 2003 as a result of the increased amount
and costs of executive officers' travel.
Legal expenses in the second quarter of 2004 decreased to $82,000 from
$143,000 in the second quarter of 2003 as a result of $81,000 incurred in 2003
in connection with a legal dispute with the third party who assisted the Company
in connection with entering into the initial agreement with Target. The dispute
was resolved in the first quarter of 2004 and is further discussed in Part II,
Item I - Legal Proceedings in this quarterly report.
Selling, general and administrative expenses incurred by Modern
Amusement were $589,000 in the second quarter of 2004. These costs consisted
primarily of salary and related costs of $235,000, consulting and outsourcing
fees of $110,000, and tradeshow and samples costs of $66,000.
INTEREST INCOME (EXPENSE),NET
The Company earned $20,000 in interest income in the second quarter of
2004, compared to $22,000 in the second quarter of 2003. As a result of the
repayment of the Company's outstanding balance of a loan payable to a bank in
2003 no interest expense was incurred in the second quarter of 2004. The Company
incurred interest expense in the second quarter of 2003 of $31,000.
INCOME TAXES
The Company recorded a provision for income taxes of $680,000 in the
second quarter of 2004 compared to a provision for income taxes of $1,230,000 in
the second quarter of 2003. Both provisions approximate the Company's combined
statutory tax rate for Federal and California state income taxes.
At December 31, 2003, the Company had approximately $22 million and $18
million of federal and state income tax net operating loss carry forwards,
respectively, available to offset future taxable income which expire in various
years through 2022. The Company expects that future 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 second quarter of 2004 were $1.0
million, or $0.06 per diluted share, compared to net earnings of $1.8 million,
or $0.12 per diluted share for the second quarter of 2003 due to the factors
discussed above.
13
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
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. For the six months ended June 30, 2004, a substantial
amount of the Company's revenue from license royalties and design fees were
generated under the Target Agreement. The royalty rate under the Target
Agreement declines, as the contract year progresses and Target achieves certain
levels of retail sales, from 4% to 1%. The declining royalty rate is reset each
contract year beginning on February 1. Accordingly, revenue recognized in the
first and second quarters of the Company's fiscal year is significantly higher
than in the third and fourth quarters due to the declining rates in the Target
Agreement. Royalties from Target are receivable 30 days after the end of
Target's fiscal year quarters. Revenues from license royalties and design
service fees under license agreements other than the Target Agreement are
generally collected on a quarterly basis, and they range from 1% to 3% of sales,
as defined in the respective agreements.
Total revenue from license royalties and design service fees in the six
months ended June 30, 2004 were $12.0 million compared to $12.7 million in the
six months ended June 30, 2003.
Design service fees and royalties recognized under the Target Agreement
were $10.6 million in the six months ended June 30, 2004 compared to $11.4
million in the six months ended June 30, 2003. The decrease is due to reduced
consumer spending in the second quarter of 2004 at Target stores. Royalties and
design service fees from customers other than Target increased to $1.4 million
in the six months ended June 30, 2004 from $1.3 million in the six months ended
June 30, 2003. This increase was due to an increase in royalty fees to $582,000
for the six months ended June 30, 2004 from $447,000 in the six months ended
June 30, 2003 attributable to women's swimwear and body-wear sold in Target
stores under a separate agreement in the United States. This increase was
partially offset by a decrease in design service fees received from Zellers to
$301,000 in the six months ended June 30, 2004 from $378,000 in the six months
ended June 30, 2003. Zellers performed more of the design services in respect of
Mossimo branded products sold through Zellers stores in Canada. The Company's
revenues generated under the Target Agreement are expected to increase modestly
during the remainder of 2004 as Target adds new stores, the Company continues to
maximize its opportunities with Target and consumer spending increases.
Modern Amusement realized product sales of $450,000 in the six months
ended June 30, 2004.
OPERATING EXPENSES
Total operating expenses is comprised of the costs of product sales and
selling, general and administrative expenses. Selling, general and
administrative expenses increased to $8.5 million in the six months ended June
30, 2004, from $7.3 million for the comparable period in 2003. Selling, general
and administrative expenses were approximately 71% of revenues from royalties
and design service fees in the six months ended June 30, 2004, as compared to
approximately 57% for the comparable period of 2003. This increase was primarily
due to $1.1 million of selling, general and administrative expenses incurred in
the six months ended June 30, 2004 by the operations of Modern Amusement.
Operating expenses for Mossimo, Inc., as a stand-alone operation, as a percent
of revenues from royalties and design service fees, increased to 62% for the six
months ended June 30, 2004 compared to 57% for the comparable period of 2003,
primarily as a result of the decrease in design service fees and royalties
received from Target.
Selling expenses, comprised of commissions due to a third party who
assisted the Company in connection with entering into the initial agreement with
Target, increased to $1.8 million in the six months ended June 30, 2004 from
$1.7 million in the six months ended June 30, 2003. Despite the decrease in
design service fees and royalties received from Target in the six months ended
June 30, 2004 compared with the comparable period in 2003, commissions have
increased as a result of an adjustment in the interest owed on the unpaid
commissions to the third party that occurred in the first quarter of 2004.
14
General and administrative expenses include payroll for the Company's
officers and its design staff, travel, facilities, insurance, legal and
professional fees, and other design related expenses for purchased services and
artwork used in the design process. Salaries and related costs for Mossimo, as a
stand alone operation, increased to $2.2 million in the six months ended June
30, 2004 from $2.0 million in the six months ended June 30, 2003, primarily as a
result of an increase in remuneration payable to the Company's then
Vice-Chairman and President, Mr. Edwin Lewis.
On July 30, 2004, the Board of Directors, upon the recommendation of
the Compensation Committee of the Board of Directors, approved an employment
agreement for Edwin Lewis. Under the agreement Mr. Lewis will have the title of
Chief Executive Officer-Operations and Finance. Additionally under his agreement
Mr. Lewis is entitled to an increased base salary of $900,000 per annum which is
effective from January 1, 2004.
Also included in general and administrative expenses are bonuses of
$1.3 million in the six months ended June 30, 2004, and $1.4 million in the six
months ended June 30, 2003, which are due under bonus plans covering two
executive officers of the Company. Design, artwork and sample costs decreased to
$283,000 in the six months ended June 30, 2004, from $501,000 in the six months
ended June 30, 2003, primarily due to costs incurred in 2003 relating to the
launch of the Company's product line with Zellers. Travel expenses increased to
$509,000 in the six months ended June 30, 2004, from $405,000 in the six months
ended June 30, 2003, as a result of the increased amount and costs of executive
officers' travel.
Selling, general and administrative expenses incurred by Modern
Amusement were $1.1 million in the six months ended June 30, 2004. These costs
consisted primarily of salary and related costs of $424,000, consulting and
outsourcing fees of $194,000, and tradeshow and samples costs of $215,000.
INTEREST INCOME (EXPENSE),NET
The Company earned $47,000 in interest income in the six months ended
June 30, 2004, compared to $48,000 in the six months ended June 30, 2003. As a
result of the repayment of the Company's outstanding balance of a loan payable
to a bank in 2003 no interest expense was incurred in the six months ended June
30, 2004. The Company incurred interest expense in the six months ended June 30,
2003 of $71,000.
INCOME TAXES
The Company recorded a provision for income taxes of $1,527,000 in the
six months ended June 30, 2004 compared to a provision for income taxes of
$2,160,000 in the six months ended June 30, 2003. Both provisions approximate
the Company's combined statutory tax rate for Federal and California state
income taxes.
At December 31, 2003, the Company had approximately $22 million and $18
million of federal and state income tax net operating loss carry forwards,
respectively, available to offset future taxable income which expire in various
years through 2022. The Company expects that future 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 six months ended June 30, 2004 were
$2.2 million, or $0.14 per diluted share, compared to net earnings of $3.2
million, or $0.21 per diluted share for the six months ended June 30, 2003 due
to the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was approximately $62,000 for
the six months ended June 30, 2004. Cash provided by operating activities
primarily includes $2.2 million provided by net earnings, plus a decrease in
deferred income taxes of $1.5 million, partially offset by an increase in
accounts receivable of $2.5 million and decreases in accrued liabilities of
$802,000. Additionally during the six months ended June 30, 2004, a legal
15
dispute with a third party was resolved. Prior to June 30, 2004 the Company paid
all previously accrued and unpaid commissions, legal fees and interest payable
to the third party in connection with this matter. This resulted in a decrease
in restricted cash of $4.6 million which was offset by a decrease in accrued
commissions of $4.7 million. The dispute is further discussed in Part II, Item I
- - Legal Proceedings in this quarterly report.
Net cash used in investing activities was $1.1 million in the six
months ended June 30, 2004 and was comprised of the purchase price for the
business of Modern Amusement of $375,000 and purchase of additional property and
equipment of $697,000 primarily relating to additional property and equipment
for Modern Amusement.
As a result of the acquisition in January 2004, of the Modern
Amusement, we amended our facility lease to increase our space from
approximately 6,000 square feet to approximately 9,000 square feet, and extend
the lease term through July 2009. The future annual obligation under the amended
lease varies each year. It commences at approximately $290,000 in 2004 and
increases to $334,000 in 2008. The required cash and liquidity resources for
Modern Amusement are not expected to have a significant impact on our liquidity
and capital resources in 2004. Future cash and liquidity resources required
beyond 2004 will depend in part on our planned expansion of the Modern Amusement
business.
The Company is approached from time to time by parties seeking to sell
their brands and related trademarks. Should an established marketable brand
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 available cash.
The Company believes that its available cash balances at June 30, 2004,
and its expected net operating cash inflows from operations during 2004, will be
adequate to meet the Company's anticipated liquidity needs in 2004.
From time to time, the Company also considers a number of different
financing alternatives, including the issuance of equity securities, and debt
instruments as sources of liquidity or as consideration for potential
acquisitions. These financing sources may not be available on acceptable terms
to the Company.
CRITICAL ACCOUNTING POLICIES
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 of 1% to 4% 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 fiscal year in
connection with the Target Agreement is significantly higher than in the third
and fourth quarters of the Company's fiscal year due to the declining rates in
the Target Agreement. Royalties from Target are receivable 30 days after the end
of Target's fiscal year quarters. Revenues from license royalties and design
service fees under license agreements other than the Target Agreement are
generally collected on a quarterly basis, and they range from 1% to 3% of sales,
as defined in the respective agreements.
Revenue from product sales is recognized when merchandise is sold to
customers. Reserves for returns and allowances are recorded at the time of sale.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standard ("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 carry forward for income taxes
purposes.
16
The Company recorded a provision for income taxes of $680,000 and
$1,527,000 for the three and six month periods ended June 30, 2004,
respectively. Both provisions approximate the Company's combined statutory tax
rate for Federal and California state income taxes.
At June 30, 2004, the Company has recorded a total net deferred tax
asset of $7.7 million, with $2.5 million classified as current in the
accompanying condensed consolidated balance sheet, as a result of the extension
of the Target Agreement through January 31, 2006, management's discussions with
Target prior to June 30, 2004 which resulted in management considering that it
is more likely than not that Target would extend the agreement through 2008, the
reevaluation of its forecasted operating results and resultant taxable income
during the extended term of the Target Agreement, and the consequent expected
utilization of available net operating losses during the extended term of the
Target Agreement. The Company has considered the projected taxable income from
the Target Agreement and other agreements in its estimate of deferred tax asset
recoverability and has recorded a valuation allowance for its net deferred tax
assets of $1.1 million.
As of December 31, 2003, the Company had approximately $22 million and
$18 million of federal and state income tax net operating loss carry forwards,
respectively, available to offset future taxable income which expire in various
years through 2022. The Company expects that future taxable income will be
offset in the near-term, for the most part, by its net operating tax loss carry
forwards.
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, however it is presently anticipated that in 2004, 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 2004 and the Company
intends to continue to take appropriate measures to avoid being classified as a
personal holding company at the end of 2004 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 2004 or in future
years.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the Financial Accounting Standards Board ("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
relating to certain mandatorily redeemable financial instruments, 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 FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities". In December 2003, the FASB issued
"Summary of Interpretation No. 46 (Revised December 2003)" ("FIN 46R") which
replaced FIN 46. FIN 46R clarifies the application of Accounting Research
Bulletin No. 51 "Consolidated Financial Statements", and requires companies to
evaluate variable interest entities for specific characteristics to determine
whether additional consolidation and disclosure requirements apply. Certain
special effective date provisions apply to companies that fully or partially
applied FIN 46 prior to the issuance of FIN 46R. Otherwise, application of FIN
17
46R is required in financial statements of public companies that have interests
in variable interest entities or potential variable interest entities, commonly
referred to as special-purpose entities, for periods ending after December 15,
2003. Application by public companies (other than small business issuers) for
all other types of entities is required in financial statements for periods
ending after March 15, 2004. Neither the initial adoption of FIN 46 nor the
adoption of FIN 46R had a material impact on the Company's financial position or
results of operations.
In December 2003, the SEC issued Staff Accounting Bulletin ("SAB") No.
104, "Revenue Recognition", which codifies, revises and rescinds certain
sections of SAB No. 101, "Revenue Recognition", in order to make this
interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. The changes noted in SAB No.
104 did not have a material effect on the Company's results of operations,
financial position or cash flows.
CONTINGENCIES AND LITIGATION
Management evaluates contingent liabilities including pending or
threatened litigation in accordance with SFAS No. 5 "Accounting for
Contingencies", and records accruals when the outcome of these matters is deemed
probable and the amount of the liability is subject to reasonable estimate.
Management makes these assessments based on the facts and circumstances
available at the time, and in some instances based in part on the advice of
outside counsel.
INFLATION
The Company does not believe that the relatively moderate rates of
inflation experienced in the United States over the last three years have had a
significant effect on its operations. Since the Company's future revenues are
based on a percentage of sales of licensed products by licensees, the Company
does not anticipate that inflation will have a material impact on future
operations.
EXCHANGE RATES
The Company receives United States dollars for all its revenue from
license royalties and design service fees, other than from its business in
Canada, which began in 2003 and does not represent a substantial amount of
revenue at this time. During the last three fiscal years, exchange rate
fluctuations have not had a material impact on the Company's operating results.
The Company does not engage in hedging activities with respect to exchange rate
risk.
18
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. Further,
the Company does not face the risk of exposure to adverse movements in foreign
currency. The Company does not currently rely upon credit agreements for
financing, which could have an adverse impact upon the Company should interest
rates rise.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation as of June 30, 2004, our Chief Executive
Officer and Chief Financial Officer have concluded that our internal controls
and disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended) were
sufficiently effective to ensure that the information required to be disclosed
by us in this report on Form 10-Q was recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and instructions
for Form 10-Q.
There have not been any changes in our internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities
Exchange Act of 1934) during the periods covered by this report that have
materially affected, or are reasonably likely to materially affect our internal
controls over financial reporting.
Our management, including our Chief Executive Officer and Chief
Financial Officer, does not expect that our internal controls and disclosure
controls and procedures will prevent all errors and all fraud. A control system,
no matter how well conceived and operated, can provide only reasonable, not
absolute assurance that the objectives of the control system are met. Further,
the design of the control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
Certain information included in this Form 10-Q and other materials
filed or to be filed by us with the Securities and Exchange Commission (as well
as information included in oral or written statements made by us or on our
behalf), may contain forward-looking statements about our current and expected
performance trends, growth plans, business goals and other matters. These
statements may be contained in our filings with the Securities and Exchange
Commission, in our press releases, in other written communications, and in oral
statements made by or with the approval of one of our authorized officers. Words
or phrases such as "believe," "plan," "will likely result," "expect," "intend,"
"will continue," "is anticipated," "estimate," "project," "may," "could,"
"would," "should" and similar expressions are intended to identify
forward-looking statements. These statements, and any other statements that are
not historical facts, are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, as codified in Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, as amended from time to time (the "Act").
In connection with the "safe harbor" provisions of the Act, we are
filing the following summary to identify important factors, risks and
uncertainties that could cause our actual results to differ materially from
those projected in forward-looking statements made by us, or on our behalf.
These cautionary statements are to be used as a reference in connection with any
forward-looking statements. The factors, risks and uncertainties identified in
these cautionary statements are in addition to those contained in any other
cautionary statements, written or oral, which may be made or otherwise addressed
in connection with a forward-looking statement or contained in any of our
subsequent filings with the Securities and Exchange Commission. Because of these
19
factors, risks and uncertainties, we caution against placing undue reliance on
forward-looking statements. Although we believe that the assumptions underlying
forward-looking statements are reasonable, any of the assumptions could be
incorrect, and there can be no assurance that forward-looking statements will
prove to be accurate. Forward-looking statements speak only as of the date on
which they are made. We do not undertake any obligation to modify or revise any
forward-looking statement to take into account or otherwise reflect subsequent
events, or circumstances arising after the date that the forward-looking
statement was made.
The following risk factors may affect our operating results and the
environment within which we conduct our business. If our projections and
estimates regarding these factors differ materially from what actually occurs,
our actual results could vary significantly from any results expressed or
implied by forward-looking statements. These risk factors include, but are not
limited to, a termination or adverse modification of the Company's license
relationships with Target and others, the success of its licensing program with
Target and The Hudson Bay Company and other licensees, the integration of Modern
Amusement and its success in growing its business, 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 ended December 31, 2003.
20
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 the
commissions owed, 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 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 demonstrated that the
finder's agreement between the Company and the third party was 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 $4,585,000 deposited with
the courts was classified as restricted cash on the Company's balance sheet as
of December 31, 2003. The deposit secured 150% of the judgment amount. In
January 2004 the appeal decision was rendered in favor of the third party, and
the Company proceeded with an appeal to the Supreme Court of the State of
California.
In March 2004, the California Supreme Court denied the Company's
appeal. The California Supreme Court's decision not to review the trial court
judgment reaffirms the validity of the original finder's agreement between the
third party and Mossimo and the third party 's right to be paid all amounts
currently due, including interest at the legal rate and all post-judgment
amounts as well as attorney's fees.
During the six months ended June 30, 2004 the Company paid all unpaid
commissions, legal fees and interest payable to the third party in connection
with this litigation. The Company had accrued for the full amount each quarter
under the original agreement with the third party, including estimated penalties
and interest.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) Annual Meeting:
The 2004 Annual Meeting of stockholders of Mossimo, Inc. was
held on June 4, 2004.
(b) Brett White was elected as a director at the 2004 Annual
Meeting. The directors whose terms of office continued after
the 2004 Annual Meeting were Mossimo Giannulli, Edwin Lewis,
Robert Martini and William R. Halford.
(c) The following are the election results for the nominee to the
Board of Directors:
FOR WITHHELD
--- --------
Brett White 14,619,360 592,798
(d) Not applicable.
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ITEM 5 - OTHER INFORMATION
On July 30, 2004, the Board of Directors, upon the recommendation of
the Board of Directors' Compensation Committee, elected Mossimo Giannulli to the
position of Chairman of the Board and Chief Executive Officer-Design and
Strategic Planning and elected Edwin Lewis as Chief Executive Officer-Operations
and Finance. In addition, the Board of Directors, upon the recommendation of the
Board's Compensation Committee, approved an employment agreement for Edwin
Lewis. The employment agreement provides for a base salary of $900,000 per annum
which is effective from January 1 ,2004. All other terms of the employment
agreement are effective August 1 2004 and the agreement has a one year term that
is renewable by the Company and Mr. Lewis for subsequent one year terms.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
10.1 Employment Agreement between Edwin Lewis and Mossimo,
Inc.
31.1 Certification of Principal Executive Officer as
required by Rule 13a - 14(a) of the Securities
Exchange Act of 1934
31.2 Certification of Principal Financial Officer as
required by Rule 13a - 14(a) of the Securities
Exchange Act of 1934
32.1 Certification of Principal Executive Officer Pursuant
to 18 USC Section 1350 as adopted pursuant to Section
906 of the Sarbanes Oxley Act of 2002.
32.2 Certification of Principal Financial Officer Pursuant
to 18 USC 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 of its fiscal year ended December 31, 2004:
On May 12, 2004, the registrant filed a report on Form 8-K
announcing its financial results for the quarter ended March
31, 2004.
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 thirteenth day of August 2004.
MOSSIMO, INC.
/s/ MOSSIMO GIANNULLI
---------------------
Mossimo Giannulli
Chairman and Chief Executive Officer
Principal Executive Officer
/s/ EDWIN LEWIS
------------------
Edwin Lewis
President and Acting Chief Financial Officer
Principal Financial and Accounting Officer
22
Exhibit Index
10.1 Employment Agreement between Edwin Lewis and Mossimo, Inc.
31.1 Certification of Principal Executive Officer as required by
Rule 13a - 14(a) of the Securities Exchange Act of 1934
31.2 Certification of Principal Financial Officer as required by
Rule 13a - 14(a) of the Securities Exchange Act of 1934
32.1 Certification of Principal Executive Officer Pursuant to 18
USC Section 1350 as adopted pursuant to Section 906 of the
Sarbanes Oxley Act of 2002.
32.2 Certification of Principal Financial Officer Pursuant to 18
USC Section 1350 as adopted pursuant to Section 906 of the
Sarbanes Oxley Act of 2002.
23