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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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
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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)
9 PASTEUR
IRVINE, CALIFORNIA 92618-2215
(Address of principal executive (Zip Code)
offices)
(714) 789-0200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Common stock,
par value $.001 per share
Securities registered pursuant to Section 12(g) of the Act: None
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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 such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference and Part III of this Form 10-K or any amendment to
this Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of the
registrant at March 31, 1998 was approximately $25,768,000.
The registrant had 15,008,592 shares of common stock, par value $.001 per
share outstanding at March 31, 1998.
Documents Incorporated by Reference (To the Extent Indicated Herein):
Portions of the Definitive Proxy Statement for the 1998 Annual Meeting (in Part
III)
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ITEM 1--BUSINESS
GENERAL
Mossimo, Inc. ("Mossimo" or the "Company") designs, sources and markets a
lifestyle collection of designer men's and women's sportswear and activewear
bearing Mossimo-Registered Trademark- trademarks that project the Company's
image of a contemporary and youthful lifestyle. The Company's apparel offerings
include men's and women's denim products, knit and woven shirts, men's
tee-shirts, shorts, sweatshirts and outerwear. The Company also designs, sources
and markets men's and women's eyewear, and licenses its trademarks for use in
collections of women's swimwear and bodywear, men's tailored clothing, men's
neckwear, and men's and women's accessories. Mossimo products are characterized
by quality workmanship and are targeted towards the culturally conscious,
youthful-minded consumer generally age 35 or under.
One of the Company's primary sales strategies is to increase sales to
existing accounts by expanding its in-store shop program whereby participating
retailers set aside exclusive floor space, highlighted by signature Mossimo
fixtures, to sell the Company's products. This program is designed to enable
retailers to create an environment consistent with the Mossimo image and to
display, stock and sell greater volumes of the Company's products. The Company
believes that these in-store shops will help build retailer commitment and
consumer recognition of the Mossimo brand name. As of December 31, 1997, the
Company had 155 in-store shops as compared with 100 at the end of 1996. The
Company plans to continue the expansion of its in-store shop concept in 1998,
although the rate of such expansion is dependent, in part, on consumers'
acceptance of the Company's products.
Mossimo is a Delaware corporation formed in November 1995 to succeed to the
assets and liabilities of Mossimo, Inc., a California corporation, which was
organized in 1988 to continue the business founded by Mossimo Giannulli in 1987
as a sole proprietorship.
References herein to the "Company" and "Mossimo" refer to Mossimo, Inc. and,
unless the context otherwise indicates, its subsidiaries and predecessors.
PRODUCT DESIGN
The cornerstone of the Company's business is its ability to design products
which embody the Mossimo image of a contemporary and youthful lifestyle. The
Company's designs are inspired by subtle changes in culture and society
including such areas as music, television, cinema, architecture and other forms
of artistic expression, and appeal to the youthful-minded consumer. Mossimo
Giannulli, the Company's founder, Visionary and principal designer, provides
leadership and direction for all aspects of the design process and oversees a
design staff of five people. The design staff reflects the Company's culturally
conscious, youthful-minded target consumer as they consistently monitor changes
in fashion, style, culture and society. Mr. Giannulli's active participation in,
and oversight of, the design process for all Mossimo products is intended to
ensure consistency of the quality and style of such products and their adherence
to the Company's distinctive image.
PRODUCTS
The Company's products include men's and women's sportswear, including knit
and woven tops and denim and related products, men's activewear, such as
tee-shirts and shorts, and men's and women's eyewear. The Company also licenses
Mossimo trademarks to third-party licensees who manufacture and distribute
women's swimwear and bodywear, men's tailored clothing, men's neckwear and men's
and
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women's apparel-related accessories utilizing designs approved by the Company.
The following table sets forth the components of the Company's net sales by
product for the periods indicated:
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------
1997 1996 1995
------------------------ ----------------------- ------------------------
NET SALES % NET SALES % NET SALES %
----------- ----------- ---------- ----------- ----------- -----------
(NET SALES IN THOUSANDS)
Men's Apparel:
Sportswear................................... $ 27,370 38.6% $ 41,678 38.4% $ 24,427 33.9%
Activewear................................... 19,541 27.5 42,335 39.0 43,288 60.2
Women's Sportswear............................. 20,511 28.9 19,874 18.3 731 1.0
Eyewear........................................ 2,883 4.1 2,842 2.6 2,295 3.2
Other (1)...................................... 631 0.9 1,945 1.7 1,220 1.7
----------- ----- ---------- ----- ----------- -----
Total.......................................... $ 70,936 100.0% $ 108,674 100.0% $ 71,961 100.0%
----------- ----- ---------- ----- ----------- -----
----------- ----- ---------- ----- ----------- -----
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(1) Other is comprised primarily of sales of the Company's Time collection of
watches (which was discontinued in 1997), sales of fabric, trim,
merchandising supplies and fixtures to certain of the Company's licensees,
less unallocated discounts and allowances.
APPAREL
MEN'S SPORTSWEAR. Mossimo's men's sportswear encompasses a variety of
products including: knit and woven tops, including polo shirts and collared,
button shirts; denim and related products, such as jeans, shirts and jackets;
and outerwear, including sweaters and jackets. Mossimo's contemporary designer
men's sportswear products compete with other designer men's sportswear lines
such as Tommy Hilfiger, Calvin Klein, Polo/Ralph Lauren, Nautica, Liz Claiborne,
Perry Ellis and Guess?. The Company's sportswear products generally retail for
between $18 to $228, which is generally lower than such competitors' products.
While the Company's sportswear line includes basic styles of jeans and other
products that recur with only minor variation from season to season and year to
year, most of the Company's sportswear products, while having certain consistent
design elements, offer a variety of silhouettes, fabrics, colors and patterns
and are seasonal in nature. The Company also offers generally higher priced
products such as leather jackets and certain sweaters and trousers, which are
more seasonal and fashion-oriented. Although these products are an important
component of the Mossimo designer label, they historically constitute less than
one percent of net sales. The Company expects that such products will continue
to represent a relatively small percentage of its overall net sales.
MEN'S ACTIVEWEAR. Mossimo's activewear products are targeted toward younger
designer-oriented consumers. The Company offers both screenprinted and
embroidered tee-shirts and sweatshirts, in a variety of styles and colors,
prominently displaying the Company's name. In addition, the Company's volley and
walk shorts are offered in a variety of styles, fabrics and colors and are
designed for athletic use or casual wear. During the fourth quarter of 1997, the
Company introduced its Moss line of value-priced activewear. The Company
believes that its activewear products are characterized by the quality of
fabrics and construction and are distinguished from other activewear lines by
the Mossimo name. Beginning in 1996, the Company began focusing its efforts more
towards the sportswear market, as it believes that its long-term future growth
and diversity will be in sportswear. The Company's activewear products compete
with other activewear designers such as Quiksilver, Billabong, Rusty and Redsand
and are generally priced between $18 and $48.
WOMEN'S SPORTSWEAR. The Company formally launched its designer young
women's sportswear line in July 1996. The women's sportswear line is being
distributed primarily to the Company's better department store and specialty
store accounts, including the Company's in-store shops, and must compete with
other
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designer young women's sportswear lines such as Calvin Klein, Polo/Ralph Lauren,
Guess? and Esprit. The line consists of denim products, including tops, pants
and jackets, knit tops, dresses, shorts and outerwear, such as sweaters and
leather jackets, and is characterized by distinctive fabrics and contemporary
styling. The women's sportswear products generally retail for between $18 and
$198 and are targeted toward young women between the ages of 13 and 25.
EYEWEAR
The Company's eyewear line features three primary categories of high quality
men's and women's eyeglasses manufactured to Mossimo's design specifications.
The eyewear features either glass or polycarbonate lenses and highly stylized
frames which are sold primarily in better department stores and optical
specialty stores. The eyewear collections include:
MOSSIMO OPTICS--Mossimo's original contemporary eyewear featuring glass
lenses and highly stylized Italian frames at retail price points ranging
from $138 to $200.
MOSS--A sunwear collection developed to appeal to younger Mossimo customers
featuring polycarbonate lenses and a combination of nylon, nickel and monel
frames. The Moss collection has retail price points ranging from $75 to
$100.
MOSSIMO GIANNULLI--A signature collection developed exclusively for high-end
optical retailers and specialty department stores. The signature collection
has retail price points upwards of $300.
LICENSED PRODUCTS
WOMEN'S SWIMWEAR AND BODYWEAR. The Mossimo line of women's swimwear and
bodywear is manufactured and distributed in the United States through a license
agreement with Lunada Bay which utilizes designs approved by the Company bearing
Mossimo trademarks. The swimwear products include both one-piece and two-piece
swimsuits which are fashion-oriented and targeted towards young, body conscious
women. The Mossimo swimwear line has been featured in several magazines,
including the SPORTS ILLUSTRATED swimsuit issue. The women's bodywear line is a
collection of fashionable aerobic activewear which prominently bears the Mossimo
trademarks and is designed using materials such as lycra that stretch and
compensate for body movements during strenuous exercise.
ACCESSORIES. Accessories bearing the Company's trademarks, are manufactured
and distributed in the United States through a license agreement with Aquarius
which utilizes designs approved by the Company bearing Mossimo trademarks. Such
accessories are consistent with Mossimo's contemporary and youthful image and
are intended to complement the Company's other lines through related styles,
colors or fabrics.
NECKWEAR. The Mossimo line of neckwear is manufactured and distributed
through a license agreement with Superba, which produces a collection of men's
better ties and neckwear under the Mossimo label.
MEN'S TAILORED CLOTHING. In 1997, the Company increased its men's apparel
line to include tailored suits and dress shirts. In July 1997, the Company
signed a license agreement with GFT Apparel Corporation to produce these
products under the Mossimo and Mossimo Giannulli brand names. This collection is
planned to be available at retail for the Fall 1998 season.
MEN'S HOSIERY. In 1997, the Company signed a license agreement with
Mountain High Hosiery Ltd. to produce a hosiery product line which will include
a variety of socks and hosiery to accommodate each of Mossimo's men's divisions.
This collection is planned to be available at retail for the Holiday 1998
season.
FRAGRANCES. In 1997, the Company signed a license agreement with Giorgio
Beverly Hills, Inc. ("Giorgio") to create and produce a line of fine fragrance
products under the Mossimo brand name. The agreement provided for a "trial
period" in which the parties could evaluate the product and determine
5
whether to continue the relationship. In March 1998, the license agreement was
terminated by Giorgio. The Company currently intends to pursue other licensing
opportunities to produce fine fragrance products.
SOURCING AND MANUFACTURING
The Company sources each of its product lines separately based on the
individual design, styling and quality specifications of such products through
independently owned contractors with manufacturing facilities primarily in the
United States, China, India, Korea and Peru. The Company believes that
outsourcing the substantial majority of its production allows it to enhance
production flexibility and capacity while substantially reducing capital
expenditures and avoiding the costs of managing a large production work force.
In addition, outsourcing provides the Company with expertise in fabric selection
and manufacturing processes.
Mossimo contracts for the manufacture and sewing of its products with
approximately 17 domestic factories and mills and 48 overseas factories and
mills. During 1997, approximately 40% of the Company's products were
manufactured offshore. The balance of the Company's finished goods were
manufactured by domestic suppliers. The Company anticipates that the importation
of its products will increase primarily due to its increased focus on sportswear
sales.
Other than a screenprinting facility operated by Giannico, Inc.
("Giannico"), a wholly-owned subsidiary of the Company, the Company does not own
or operate any manufacturing facilities. Therefore, the Company is dependent on
independent contractors for the manufacture of its products. There are no formal
arrangements between the Company and any of its contractors or suppliers. The
Company's products are manufactured to its specifications by both domestic and
international manufacturers. The inability of a manufacturer to ship the
Company's products in a timely manner or to meet the Company's quality standards
could adversely effect the Company's ability to deliver products to its
customers in a timely manner. Delays in delivery could have an adverse effect on
the Company's financial condition and results of operation due to resultant
cancellations of orders by retailers, discounts in the prices paid by retailers
or missing certain retailing seasons. The Company has experienced production
delays from certain of its manufacturing sources in the past, including a delay
in the production of knit tops in the first quarter of fiscal 1997, and there
can be no assurance that production delays will not occur in the future.
The Company utilizes international sourcing agents who assist the Company in
selecting and overseeing third party contractors, sourcing fabric and monitoring
quotas and other trade regulations. The Company's production staff and
independent sourcing agents oversee all aspects of apparel manufacturing and
production. The Company and its sourcing agents separately negotiate with
suppliers for the purchase of fabrics which are then purchased either by the
Company or by its contractors.
The Company arranges for the production of some of its products based on
orders received. While the Company traditionally receives a portion of its
customer orders prior to placement of its initial manufacturing orders, many of
these customer orders may change with respect to colors, sizes, allotments or
assortments prior to the delivery date. The Company utilizes customer orders
received and its historical experience to estimate production requirements in
order to secure necessary fabrics and manufacturing capacity. Because the
Company's foreign manufacturers are located at greater geographic distances from
the Company than its domestic manufacturers, the Company is generally required
to allow greater lead time for foreign manufacturing orders.
The Company's quality control program is designed to ensure that all goods
bearing Mossimo trademarks meet the Company's standards. With respect to its
products, the Company develops and inspects prototypes of each product prior to
cutting by the contractors, establishes fittings based on the prototype,
inspects samples and, through its employees or sourcing agents, inspects fabric
prior to cutting. The Company or its sourcing agents inspect the final product
prior to shipment to the Company's Irvine, California warehouse. With respect to
licensed products, the Company oversees the quality control programs of its
licensees and regularly inspects samples of their products.
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In June 1996, the Company formed its wholly-owned subsidiary, Giannico,
which is engaged exclusively in the screenprinting of tee-shirts. Giannico
commenced operations in a 53,000 square foot facility in October 1996.
MARKETING AND ADVERTISING
In marketing its men's and women's apparel products in the United States,
the Company utilizes a total of ten in-house sales representatives who are
salaried employees. The Company's eyewear products are marketed through a sales
force of 12 independent sales representatives who work on a commission basis.
The Company maintains showrooms at its headquarters in Irvine, California, and
in New York City, Dallas and Chicago to display various portions of its product
line. The Company's products are presented at a number of trade shows, including
the semi-annual MAGIC Show where the Company's products appear in the designer
pavilion.
The Company strives to maintain a consistent image through the coordination
of merchandising, advertising and promotion. The Company advertises in magazines
such as GQ, DETAILS, DETOUR, ELLE and VANITY FAIR. The Company develops its
advertising program in-house which provides the Company with a greater degree of
creative control. The goal of the Company's print campaign is to present a
distinctive image of a contemporary and youthful lifestyle which consumers will
associate with the Company's products. This image is carried forward in hangtags
and in the design of the Company's in-store shops and displays and its two
Southern California signature retail stores. The Company also uses personal
appearances by Mossimo Giannulli to promote its products to the consumer and to
enhance its relationships with its accounts.
DISTRIBUTION
Distribution of all Mossimo non-licensed products is centralized in the
Company's Irvine facility. Upon receipt from the manufacturers, the Company's
products are inspected, sorted, packed and shipped to retail accounts in the
United States. The Company's licensees are responsible for the distribution of
licensed products. The Company maintains an open stock program for certain of
its denim products to facilitate reorders by its customers.
Mossimo has an electronic data interchange ("EDI") system through which
certain orders are automatically placed by the retailer with the Company. In
addition, the Company's sales representatives can transmit orders directly to
the Company's system from the field, further expediting order processing.
During 1997, the Company's products were sold in over 2,600 department and
specialty retail store locations throughout the United States. The Company's
five largest customers accounted for approximately 40.4% and 37.8% of net sales
in 1997 and 1996, respectively. A decision by the controlling owner of a group
of department stores, or any other significant customer, to decrease the amount
purchased from the Company or to cease carrying the Company's products could
have a material adverse effect on the Company's financial condition and results
of operations. The Company's largest customer, Dillards, accounted for
approximately 12.8% of net sales in 1997. Due to losses incurred in connection
with its sales to Dillards in 1997, the Company intends to reduce the level of
its sales to Dillards in 1998.
The Company seeks to enhance brand image by controlling the distribution
channels for its products based on criteria which include the image of the
store, availability of a desirable location within the store and the store's
ability to effectively display and promote the Company's products.
A significant component of this strategy is the Company's in-store shops
program in department and selected specialty retail stores. This program enables
Mossimo to design a retail space consistent with the Company's image and is
intended to enable the retailers to display, stock and sell a greater volume of
the
7
Company's products. The Company believes that these in-store shops build
longer-term retailer commitment to the Company's products and consumer
recognition of the Mossimo brand name. As of December 31, 1997, the Company had
installed 155 in-store shops in department and specialty retail store chains,
including Macy's, Bloomingdales, Bon Marche and Dayton Hudson, and currently
plans to install approximately 30 men's and women's in-store shops in 1998. The
installation of additional in-store shops is dependent, in part, on consumers'
acceptance of the Company's products. The costs of the shops to date have
generally been shared between the retailer and the Company.
RETAIL STORES
The Company operates two signature retail stores located in South Coast
Plaza, Orange County, California (established in 1993) and Old Towne, Pasadena,
California (established in 1994). These stores incorporate contemporary
architectural designs, which are consistent with the Company's in-store shop
environment and the Company's image. The Company currently intends to close its
Pasadena store in 1998.
Additionally, the Company operates one outlet store, which provides a
location to sell prior season and overstocked goods. The store is located in
Ontario Mills Plaza, Ontario, California (established in 1997).
LICENSING
The Company enters into licensing agreements for certain products and
geographical territories if the Company believes such arrangements will provide
more effective manufacturing, distribution or marketing of such products than
could otherwise be achieved in-house. In addition, the Company believes that
selective licensing of the Mossimo name and trademarks provides an opportunity
to promote the Mossimo brand name while significantly reducing capital outlays
and operating expenses. In evaluating a licensing decision, the Company
considers various factors including potential profit and capital and management
resources available to the Company at such time. The Company maintains
substantial control over the design, manufacturing specifications, advertising
and distribution of its licensed products and maintains a policy of evaluating
its licensing arrangements to ensure consistent presentation of the Mossimo
image.
The Company has licensed the exclusive right to manufacture and distribute
women's swimwear and bodywear bearing its trademarks in the United States
pursuant to a license agreement with The Lunada Bay Corporation that expires in
September 1999, subject to renewal upon negotiation. Mossimo currently licenses
to Aquarius, Ltd. the exclusive right to manufacture and distribute men's and
women's accessories in the United States. This license agreement expires in
December 1999. In addition in 1996, the Company licensed to Superba the
exclusive right to manufacture and distribute finer men's neckwear in the United
States. This license currently expires in March 2000, subject to renewal by the
licensee for an additional three-year term, if minimum sales and royalty
requirements are met. Under all license agreements, Mossimo retains approval
rights with respect to the design of products. Royalty payments are due on a
monthly or quarterly basis and range from 4% to 12% of the licensee's net sales.
Currently, Mossimo has seven additional license agreements pursuant to which
third-party licensees have the exclusive right to manufacture and sell certain
products under the Company's trademarks according to designs furnished or
approved by the Company in specified territories including Japan, Canada,
Australia and New Zealand, Mexico, Chile, South Africa and Southeast Asia. The
present terms of these agreements (exclusive of renewal terms) expire at various
dates ranging from July 1998 through December 2000. Royalty payments under these
license agreements are due on a monthly or quarterly basis and range from 4% to
7% of the licensee's net sales.
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TRADEMARKS
The Company utilizes a variety of trademarks which it owns, including the
script Mossimo trademark. Currently, the Company has 10 registrations and 10
pending applications for its trademarks in the United States, and approximately
270 trademark registrations and applications in over 60 other countries. The
Company regards its trademarks and other proprietary rights as valuable assets
and believes they have significant value in the marketing of its products. The
Company vigorously protects its trademarks against infringement, by using, among
other things, cease-and-desist letters, administrative proceedings and lawsuits.
COMPETITION
The men's sportswear and activewear segments of the apparel industry are
highly competitive. The Company encounters substantial competition in the men's
and women's designer sportswear business, including Tommy Hilfiger, Calvin
Klein, Polo/Ralph Lauren, Nautica, Liz Claiborne, Perry Ellis and Guess?, as
well as certain other designer and non-designer lines. With respect to its men's
activewear products, the Company encounters substantial competition from other
activewear and beachwear lines. Additionally, the Company encounters substantial
competition from department stores, including some of the Company's major retail
customers, which have increased in recent years the amount of sportswear and
activewear manufactured specifically for them and sold under their own labels.
Mossimo's eyewear, licensed accessories and women's swimwear and bodywear also
compete with a substantial number of designer and non-designer lines. Many of
the Company's competitors are significantly larger and more diversified than the
Company, have substantially greater financial, distribution, marketing and other
resources and have achieved greater recognition for their brand names than the
Company. The Company competes primarily on the basis of fashion, image, price,
quality and service. The Company believes its competitive position depends upon
its ability to anticipate and respond effectively to changing consumer demands
and to offer fashion-conscious customers a wide variety of high quality apparel
at competitive prices.
BACKLOG
The Company generally receives the bulk of the orders for each of the
Spring, Summer, Fall and Holiday seasons a minimum of three months prior to the
date the products are shipped to stores. Such orders are cancelable by the
retailer up to 30 days prior to the shipments start date. At December 31, 1997,
the Company's backlog of orders for delivery primarily in the first quarter was
approximately $8.5 million, as compared with backlog of approximately $22.7
million at December 31, 1996. Historically, the Company has shipped less than
all orders in its backlog. The Company's backlog depends upon a number of
factors, including the timing of trade shows during which a significant
percentage of the Company's orders are received, the timing of shipments,
product mix of customer orders and the amount of in-season orders. Accordingly,
a comparison of backlog from period to period is not necessarily meaningful and
may not be indicative of actual shipments.
EMPLOYEES
At March 31, 1998, the Company had approximately 250 full-time employees,
down from 330 at the same time last year. The Company began Company-wide staff
reductions in April 1997 due to the downturn in the Company's sales. None of the
Company's employees are covered by collective bargaining agreements. The Company
considers its relations with its employees to be good.
9
RISK FACTORS
In addition to the matters set forth in the foregoing discussion of the
Company's business, the operations and financial results of the Company are
subject to the risks described below.
DECLINING FINANCIAL CONDITION
During the year ended December 31, 1997, the Company experienced a
significant decline in revenues and an increase in operating costs. As a result,
the Company reported an operating loss and negative cash flow in fiscal 1997. At
December 31, 1997, the Company was in violation of certain covenants of its
revolving credit facility that is used to fund operations. The Company
subsequently received a waiver for such violations and the bank amended the
existing covenants and extended the arrangement through January 1, 1999.
In response to these declining financial conditions, in late fiscal 1997 the
Company began cost cutting measures to align its expense level with its
declining sales. Accordingly, the Company has reduced staffing levels, reduced
compensation to existing staff and is reviewing other cost cutting measures
which are planned to reduce operating expenses over the next fiscal year and is
pursuing equity investments. Although management believes that the Company will
be in compliance with its amended credit facility, management anticipates that
the Company will continue to experience operating losses and negative cash flows
throughout fiscal 1998. Should such losses exceed management's plans, the
Company may experience future violations of its new loan covenants and
additional funds may not be available pursuant to the Company's revolving credit
facility. In such event, management would execute additional cost cutting
measures and explore alternative financing with third party lenders.
TRANSITION TO SPORTSWEAR FOCUS; REVENUE DECLINES
The Company believes that its greatest future growth opportunity lies within
the status sportswear section of department stores and has undertaken to
transition its business in that direction. This transition from a predominantly
activewear-based resource to a supplier of finer men's and women's sportswear
has been a complex process that is taking longer than the Company originally
anticipated. The Company anticipates that the recent softness in men's
activewear and men's and women's sportswear sales will continue in the near
term. As a result, the Company currently believes it will continue to experience
revenue declines over the short term as it works to further establish itself as
a finer sportswear label and to reinvigorate men's activewear sales.
CHANGES IN FASHION TRENDS
The apparel industry is subject to rapidly changing consumer demands and
preferences, which may adversely affect companies that misjudge such demands and
preferences. The Company believes that its success depends on its ability to
anticipate, gauge and respond in a timely manner to changing consumer demands
and fashion trends. There can be no assurance that the Company will be
successful in this regard. If fashion trends shift away from the Company's
products, or if the Company otherwise misjudges the market for its product
lines, it may be faced with a significant amount of unsold finished goods
inventory or other conditions which could have a material adverse effect on the
Company's financial condition and results of operations. Decisions with respect
to product designs often need to be made several months in advance of the time
when consumer acceptance of such products is known. In addition, any failure by
the Company to identify and respond to changing demands and trends could
adversely affect consumer acceptance of the Mossimo brand name, which may have
an adverse effect on the Company's business and prospects.
SUBSTANTIAL COMPETITION
The men's sportswear and activewear segments of the apparel industry are
highly competitive. The Company's men's designer sportswear line encounters
substantial competition from Tommy Hilfiger, Calvin Klein, Polo/Ralph Lauren,
Nautica, Liz Claiborne, Perry Ellis and Guess?, as well as from certain
10
other designer and non-designer lines. With respect to its men's activewear
products, the Company encounters substantial competition from other activewear
and beachwear lines. Additionally, the Company encounters substantial
competition from department stores, including some of the Company's major retail
customers, which have increased in recent years the amount of sportswear and
activewear manufactured specifically for them and sold under their own labels.
Mossimo's eyewear line and its licensed accessories and women's swimwear and
bodywear lines also compete with a substantial number of designer and non-
designer lines. The Company's women's sportswear line also encounters
substantial competition from Calvin Klein, Polo/Ralph Lauren, Guess? and Esprit.
Many of the Company's competitors are significantly larger and more diversified
and have substantially greater financial, distribution, marketing and other
resources and have achieved greater recognition for their brand names than the
Company. Increased competition by existing and future competitors could result
in reductions in sales or prices of Mossimo products that could have a material
adverse effect on the Company's financial condition and results of operations.
NEW PRODUCT INTRODUCTIONS
The Company's success is dependent upon its ability to design and deliver
new products and new product lines. As is typical with new products, demand for
and market acceptance of new products introduced by the Company are subject to
uncertainty. Achieving market acceptance for new products may require
substantial marketing and other efforts and the expenditure of significant funds
to create customer demand. There can be no assurance that the Company's efforts
will be successful. Lack of demand for, or market acceptance of, the Company's
products may result in reductions in the purchase price for such products and,
in some cases, an increase in obsolete inventory. In addition, the failure of
new products or new product lines to gain sufficient market acceptance could
adversely affect the image of the Mossimo brand name and retailers' demand for
other Mossimo products.
DEPENDENCE ON KEY PERSONNEL
The success of the Company is largely dependent on the personal efforts and
abilities of Mossimo Giannulli, who founded the Company and continues to be its
lead designer. In addition, the Company is dependent on the personal efforts and
abilities of a small group of key management executives. In January 1996, Mr.
Giannulli entered into a three-year employment contract with the Company, which
expires December 31, 1998. Such agreement contains a non-competition provision
effective through the term and for two additional years thereafter during which
Mr. Giannulli will render consulting services to the Company.
UNCERTAINTIES IN APPAREL RETAILING; GENERAL ECONOMIC CONDITIONS
The apparel industry historically has been subject to substantial cyclical
variations. During recessionary periods, when disposable income is low, purchase
of apparel and related goods tend to decline. Accordingly, a recession in the
general economy or uncertainties regarding future economic prospects that affect
consumer spending habits could have a material adverse effect on the Company's
results of operations. Additionally, the retail industry has experienced
significant changes and difficulties over the past several years, including
consolidation of ownership, increased centralization of buying decisions,
restructurings, bankruptcies and liquidations. While various retailers,
including some of the Company's customers, experienced financial difficulties in
the past few years which increased the risk of extending credit to such
retailers, the Company's bad debt experience has been limited. Financial
problems of a retailer could cause the Company's factor to limit the amount of
receivables of such retailer that the factor would approve, which could cause
the Company to curtail business with such retailer or require the Company to
assume more credit risk relating to such customer's receivables. The Company
cannot predict what effect, if any, continued changes within the retail industry
will have on the Company's business.
11
DEPENDENCE ON FACTORING OF ACCOUNTS RECEIVABLE
Historically, the Company has sold a substantial portion of its trade
accounts receivable to a factor, which assumes the credit risk with respect to
collection of nonrecourse accounts receivable in exchange for a fee. The factor
approves the credit of the Company's customers prior to sale. If the factor
disapproves of a sale to a customer and the Company decides to proceed with the
sale, the Company bears the credit risk. Prior to July 1997, the factoring
agreement provided that the Company could request advances against a percentage
of qualifying accounts receivable. In conjunction with the Company's credit
facility, the advance facility associated with the factoring agreement was
terminated. The factoring agreement is in force until June 1, 2000. The
agreement may be terminated by the factor at any time with 180 days prior
notice. Such termination could have a material adverse effect on the Company's
financial condition and results of operations if the Company could not replace
the factoring agreement within such period. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity."
DEPENDENCE ON CERTAIN CUSTOMERS
The Company's department store customers include major United States
retailers. The Company's five largest customers accounted for approximately
40.4% and 37.8% of net sales in 1997 and 1996, respectively. Purchases by
Dillards in its various regions accounted for approximately 12.8% of net sales
in 1997. Although several of the Company's department store customers are under
common ownership, no other single customer, or group of related customers,
accounted for more than 10% of the Company's net sales in those periods. While
the Company believes that purchasing decisions in many cases are made
independently by each department store customer, the trend may be toward more
centralized purchasing decisions. A decision by the controlling owner of a group
of department stores or a significant customer, to decrease the amount purchased
from the Company or to cease carrying the Company's products could have a
material adverse effect on the Company's financial condition and results of
operations.
DEPENDENCE ON UNAFFILIATED MANUFACTURERS
Other than the screenprinting facility operated by Giannico, the Company
does not own or operate any manufacturing facilities and is therefore dependent
on independent contractors for the manufacture of its products. There are no
formal arrangements between the Company and any of its contractors or suppliers.
The Company's products are manufactured to its specifications by both domestic
and international manufacturers. The inability of a manufacturer to ship the
Company's products in a timely manner or to meet the Company's quality standards
could adversely affect the Company's ability to deliver products to its
customers in a timely manner. Delays in delivery could have an adverse effect on
the Company's financial condition and results of operation due to resultant
cancellation of orders by retailers, discounts in the prices paid by retailers
or missing certain retailing seasons. The Company has experienced production
delays from certain of its manufacturing sources in the past, including a delay
in the production of knit tops in the first quarter of 1997, and there can be no
assurance that production delays will not occur in the future.
FOREIGN OPERATIONS
During 1997, approximately 60% of the Company's products were manufactured
in the United States and approximately 40% were manufactured in other parts of
the world, primarily Asia. The Company anticipates that the importation of its
products will increase primarily due to its increased focus on sportswear sales.
The current economic conditions in Asia have made it more difficult for Asian
manufacturers to gain access to working capital and there is a risk that these
manufacturers could encounter financial problems which could affect their
ability to manufacture the Company's products. Generally, the Company's
operations may be adversely affected by political instability resulting in
disruption of trade from foreign countries in which the Company's contractors
and suppliers are located, the imposition of additional regulations related to
imports or duties, taxes and other charges on imports,
12
any significant fluctuation in the value of the dollar against foreign
currencies and restrictions on the transfer of funds. In addition, the Company's
import operations are subject to constraints imposed by bilateral textile
agreements between the United States and a number of foreign countries. These
agreements impose quotas on the amount and type of goods which can be imported
into the United States from these countries and can limit or prohibit
importation of products on very short notice. The Company's imported products
are also subject to United States customs duties which are a material portion of
the Company's cost of imported goods. A substantial increase in customs duties
or a substantial reduction in quota limits applicable to the Company's imports
could have a material adverse effect on the Company's financial condition and
results of operations.
A significant portion of the Company's products purchased overseas are
manufactured by independent contractors headquartered in Hong Kong and Macao
with manufacturing facilities in China and Macao. In July 1997 China resumed
sovereignty over Hong Kong, and in December 1999, China will resume sovereignty
over Macao. The Company cannot predict the effect, if any, these events will
have on its contractors in Hong Kong and Macao and there can be no assurance
that Hong Kong and Macao will not experience political, economic or social
disruption as a result of the resumption of Chinese sovereignty. In addition,
there have been a number of recent trade disputes between China and the United
States during which the United States has threatened to impose tariffs and
duties on some products imported from China and to withdraw China's "most
favored nation" trade status. The loss of most favored nation trade status for
China, changes in current tariff structures or the adoption by the United States
of trade policies or sanctions adverse to China could have a material adverse
effect on the Company's financial condition and results of operations.
Because the Company's foreign manufacturers are located at greater
geographic distances from the Company than its domestic manufacturers, the
Company is generally required to allow greater lead time for foreign orders.
This reduces the Company's manufacturing flexibility which increases the risk
that the Company would be required to mark-down unsold inventory as a result of
misjudging the demand for a foreign manufactured product.
PROTECTION OF TRADEMARKS
The Company believes that its trademarks and other proprietary rights are
important to its success and its competitive position. Accordingly, the Company
devotes substantial resources (including time and attention by its executive
officers) to the establishment and protection of its trademarks on a worldwide
basis. Nevertheless, there can be no assurance that the actions taken by the
Company to establish and protect its trademarks and other proprietary rights
will be adequate to prevent imitation of its products by others or to prevent
others from seeking to block sales of the Company's products as violative of the
trademarks and proprietary rights of others. No assurance can be given that
others will not assert rights in, and ownership of, trademarks and other
proprietary rights of the Company. In addition, the laws of certain foreign
countries do not protect proprietary rights to the same extent as do the laws of
the United States.
CONTROL BY PRINCIPAL STOCKHOLDER
Mossimo Giannulli has majority control of the Company and the ability to
control the election of directors and the results of other matters submitted to
a vote of stockholders. Such concentration of ownership, together with the
anti-takeover effects of certain provisions in the Delaware General Corporation
Law and in the Company's Certificate of Incorporation and Bylaws, may have the
effect of delaying or preventing a change in control of the Company.
SEASONALITY
The Company's business is impacted by general seasonal trends that are
characteristic of many companies in the apparel industry. However, due primarily
to the significant growth that the Company
13
experienced during 1996 and the declining sales experienced in 1997, past
quarterly sales and profit trends have not reflected normal apparel industry
seasonality. In future years, the Company expects that its sales may reflect
greater seasonal trends.
ITEM 2--PROPERTIES
The Company's current corporate headquarters, distribution facility and
screenprinting operation are located in Irvine, California and consist of three
leased buildings totaling approximately 261,000 square feet of space. In
addition, the Company leases showrooms in New York City, Dallas and Chicago as
well as three retail stores in Costa Mesa, Pasadena and Ontario California.
ITEM 3--LEGAL PROCEEDINGS
On January 23, 1997, plaintiff Chaile Steinberg filed a purported class
action against the Company and certain other defendants on behalf of individuals
who purchased the Company's common stock in the initial public offering pursuant
to the Registration Statement and Prospectus ("Prospectus"), dated February 22,
1996, and on the open market from February 22, 1996 through January 14, 1997
(the "Class Period"). In addition to naming the Company, the plaintiffs Igor
Glaudnikov, Cara Debra Marks and Lois Burke filed a second related action
against the same defendants. The two cases were subsequently consolidated by
court order, dated May 19, 1997. Both Steinberg and Glaudnikov (collectively,
the "State Actions") contain identical factual allegations, and only differ in
the number of shares purchased by plaintiffs and the California residence of two
of the plaintiffs in the Glaudnikov action.
The State Actions allege that defendants made false and misleading
statements and intentionally concealed material negative information in the
Prospectus and afterward during the Class Period, which artificially inflated
prices for the Company's common stock. Plaintiffs contend that the class was
damaged in an unspecified amount as a result of this artificial inflation of the
Company's stock price.
On September 23, 1997, a federal class action complaint was filed on behalf
of plaintiff James Frenkil by the same law firm that represents the plaintiffs
in the State Actions. One of the named plaintiffs in the federal action is a
plaintiff in the State Actions. The class period and precipitating events are
the same as in the State Actions, but the federal complaint purports to allege
violations of certain federal securities laws. On October 17, 1997, the judge
stayed the federal action pending resolution of the State Actions.
Defendants filed demurrers in the State Actions, challenging the legal
sufficiency of the complaints. On June 26, 1997, the judge sustained the
defendant's general demurrer to the complaints in the State Actions, finding
that neither complaint pleaded facts sufficient to constitute causes of action
against the defendants. The judge sustained the demurrer as to four of the
causes of action with leave to amend, and as to the fifth cause of action for
unlawful, unfair or fraudulent business practices and false or misleading
advertising without leave to amend. Since that time, no amended complaint nor
motion for class certification has been filed by the plaintiffs.
Although the outcome of the litigation cannot be predicted with certainty,
management believes that the Company has meritorious defenses to the claims
alleged and intends to defend this action with vigor.
The Company is involved in certain other legal and administrative
proceedings and threatened legal and administrative proceedings arising in the
normal course of its business. While the outcome of such proceedings and
threatened proceedings cannot be predicted with certainty, in the opinion of
management, the ultimate resolution of these matters individually or in the
aggregate will not have a material adverse effect on the Company.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
14
ITEM 5-- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock, par value $.001 per share (Common Stock), began
trading February 23, 1996 on the New York Stock Exchange upon completion of the
Company's initial public offering (trading symbol "MGX"). As of March 31, 1998,
there were approximately 5,200 stockholders of record. The following table sets
forth the high and low sales prices for the Common Stock for each quarterly
period as reported on the New York Stock Exchange Composite Tape:
1996
------------------
HIGH LOW
------- -------
First Quarter (from February 23, 1996)................. $34 1/4 $23 3/4
Second Quarter......................................... $50 1/8 $27 4/3
Third Quarter.......................................... $49 3/4 $26 1/4
Fourth Quarter......................................... $31 7/8 $11 7/8
1997
--------------------
HIGH LOW
--------- -------
First Quarter............................................... $13 $ 7 1/4
Second Quarter.............................................. $11 1/2 $ 5 7/8
Third Quarter............................................... $11 3/4 $ 6 1/2
Fourth Quarter.............................................. $10 13/16 $ 3
Any future determination as to the payment of dividends will be at the
discretion of the Company's Board of Directors, subject to the consent of the
lender under the Company's credit facility, and will depend upon the Company's
results of operations, financial condition, contractual restrictions and other
factors deemed relevant by the Board of Directors.
Since its initial public offering, the Company has not paid a dividend on
its Common Stock. For certain information regarding distributions made by the
Company in 1995 and 1996 (prior to its initial public offering in February
1996), see "Item 7--Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
15
ITEM 6--SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data regarding the
Company which is qualified by reference to, and should be read in conjunction
with, the consolidated financial statements and notes thereto (see "Index to
Consolidated Financial Statements") and "Item 7--Management's Discussion and
Analysis of Financial Condition and Results of Operations." The income statement
and balance sheet data presented below have been derived from the Company's
consolidated financial statements. The selected pro forma income statement data
set forth below is for informational purposes only and may not necessarily be
indicative of the Company's results of operations in the future.
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Net sales................................................... $ 70,936 $ 108,674 $ 71,961 $ 44,333 $ 22,134
Cost of sales............................................... 63,963 69,364 41,210 26,027 14,516
--------- --------- --------- --------- ---------
Gross profit................................................ 6,973 39,310 30,751 18,306 7,618
Royalty income, net......................................... 3,798 3,919 3,413 2,375 1,051
Operating expenses.......................................... 32,802 25,283 14,586 9,380 5,954
--------- --------- --------- --------- ---------
Operating (loss) income..................................... (22,031) 17,946 19,578 11,301 2,715
Other (expense) income, net................................. (362) 19 114 87 (4)
Interest (expense) income, net.............................. (278) 191 (233) (148) (216)
--------- --------- --------- --------- ---------
(Loss) income before income taxes........................... (22,671) 18,156 19,459 11,240 2,495
(Benefit) provision for income taxes (1).................... (3,935) 5,526 297 176 70
--------- --------- --------- --------- ---------
Net (loss) income........................................... $ (18,736) $ 12,630 $ 19,162 $ 11,064 $ 2,425
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net (loss) income per share:
Basic and diluted........................................... $ (1.25) $ .84 $ 1.47 $ .85 $ .19
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
PRO FORMA DATA (2):
Historical income before income taxes....................... $ 18,156 $ 19,459 $ 11,240 $ 2,495
Pro forma provision for income taxes........................ 7,374 7,946 4,663 1,026
--------- --------- --------- ---------
Pro forma net income........................................ $ 10,782 $ 11,513 $ 6,577 $ 1,469
--------- --------- --------- ---------
--------- --------- --------- ---------
Pro forma net income per share.............................. $ .73
---------
---------
Pro forma weighted average common shares outstanding........ 14,853
---------
---------
DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital............................................. $ 13,487 $ 36,152 $ 12,621 $ 9,880 $ 1,932
Total assets................................................ 36,824 50,754 17,162 14,635 5,326
Long-term debt.............................................. 31 85 30 64 72
Stockholders' equity........................................ 22,395 41,131 14,035 10,987 2,459
- ------------------------
(1) Represents California state franchise taxes for periods prior to the
Company's conversion to C corporation status.
(2) Amounts reflect adjustment for Federal and state income taxes as if the
Company had been taxed as a C corporation rather than an S corporation.
16
ITEM 7-- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's discussion and analysis should be read in conjunction with the
Company's consolidated financial statements and the notes thereto set forth in
this Form 10-K commencing on page F-1.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net sales decreased $37.8 million, or 34.8%, to $70.9 million in 1997 from
$108.7 million in 1996. This decrease was primarily a result of a decrease of
$37.1 million in sales of the men's activewear and sportswear lines due to a
reduced demand for the Company's products. Net sales of the men's activewear
line, which represented 27.5% of the Company's net sales in 1997, decreased to
$19.5 million from $42.3 million in 1996 primarily due to decreased sales of
screenprinted tee-shirts and fleece. Net sales of the men's sportswear line,
which represented 38.6% of the Company's net sales in 1997, decreased to $27.4
million from $41.7 million in 1996 primarily due to decreased sales of knits,
denim and wovens. Net sales of the women's sportswear line, which was introduced
in June 1996, represented 28.9% of the Company's net sales in 1997, and
increased to $20.5 million in 1997 from $19.9 million in the six months of 1996
in which there were sales. Net sales of the eyewear line, which represented 4.1%
of the Company's net sales in 1997, increased to $2.9 million in 1997 from $2.8
million in 1996.
Gross profit decreased to $7.0 million in 1997 from $39.3 million in 1996.
Gross profit as a percentage of net sales decreased to 9.9% in 1997 from 36.2%
in 1996. This decrease resulted primarily from inventory writedowns necessitated
by lower than expected sales levels and price resistance within discount
channels used to absorb the Company's prior season merchandise. To a lesser
extent, gross profit margins for the year ended December 31, 1997 were impacted
by; a decrease in sales of higher margin men's activewear; allowances to the
Company's retail customers due to late product deliveries, product fit problems
and lower than anticipated sales at retail; higher than planned production
development costs; and, higher than planned warehouse costs due to startup costs
associated with the Company's new facilities.
Net royalty income remained relatively stable at $3.8 million, or 5.4% of
net sales, in 1997 as compared to $3.9 million, or 3.6% of net sales, in 1996.
Operating expenses increased in nearly all categories to total $32.8 million
in 1997 from $25.3 million in 1996. General and administrative expense increased
to $13.4 million in 1997 compared to $9.4 million in 1996 primarily as a result
of higher average staffing levels due to significant staffing increases at the
end of 1996 and early 1997, increased rent expense due to the Company occupying
its new headquarters in July 1997 and increased depreciation due to the buildout
of the Company's new headquarters. Selling expense decreased to $8.5 million in
1997 from $9.3 million in 1996 primarily due to decreased commission expense as
a result of the decline in sales. Marketing expense increased to $7.0 million in
1997 from $4.2 million in 1996 primarily due to increased advertising expenses
and depreciation. Design expense increased to $3.9 million in 1997 from $2.4
million in 1996 primarily as a result of higher average staffing levels
necessary to support the expansion of the Company's product offerings and
increases in sales samples. Operating expenses as a percentage of net sales
increased to 46.3% in 1997 from 23.3% in 1996. In 1997 the Company began cost
cutting measures to more align its expense level with its declining sales.
Accordingly, the Company has reduced staffing levels, reduced compensation to
existing staff and is reviewing other cost cutting measures which are planned to
reduce operating expenses in fiscal 1998.
The Company had other expense of $362,000 in 1997 compared to none in 1996
primarily due to losses on disposals of fixed assets.
The Company had interest expense of $278,000 in 1997 compared to interest
income of $191,000 in 1996 primarily due to an increase in overall expenses
which resulted in an increase in borrowings on the Company's credit facility.
17
The Company had an income tax benefit of $3,935,000 in 1997 compared to a
proforma income tax provision of $7,374,000 in 1996. Losses for 1997 were
benefited only to the extent the Company could apply for carryback claims in its
income tax returns.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Net sales increased $36.7 million, or 51.0%, to $108.7 million in 1996 from
$72.0 million in 1995. This increase was primarily the result of the successful
launch of the women's sportswear line in department and specialty stores and
increased sales of men's sportswear to new and existing wholesale customers as
they expanded their purchases to include a more complete line of Mossimo
products. Net sales of the women's sportswear line, which represented 18.3% of
the Company's net sales in 1996, increased to $19.9 from $731,000 in 1995. Net
sales of the men's activewear line, which represented 39.0% of the Company's net
sales in 1996, decreased 2.2% from 1995 primarily as a result of decreased sales
of screenprinted tee-shirts. Net sales of the men's sportswear line, which
represented 38.4% of the Company's net sales in 1996, increased 70.6% from 1995
primarily as a result of increased sales of knit shirts, woven shirts and denim.
Net sales of the eyewear line increased 23.8% to $2.8 million in 1996 from $2.3
million in 1995.
Gross profit increased to $39.3 million in 1996 from $30.8 million in 1995.
Gross profit as a percentage of net sales decreased to 36.2% in 1996 from 42.7%
in 1995. This decrease resulted primarily from higher than planned production
development costs of approximately $2.6 million and late product deliveries
which necessitated approximately $1.2 million in year-end allowances to the
Company's retail customers. The higher development costs are the result of
increased product sampling costs related to an expanded number of men's
sportswear offerings and the launch of the women's sportswear line, compounded
by certain inefficiencies in sourcing such product samples through new agents
and factories. To a lesser extent, gross margins for the year ended December 31,
1996 were impacted by a physical inventory shortage, off-price sales of certain
out-of-season merchandise and change in sales mix, with men's and women's
sportswear representing a substantially higher portion of sales (56.7% in 1996
compared to 35.0% in 1995).
Net royalty income increased 14.3% to $3.9 million in 1996 from $3.4 million
in 1995 primarily due to increased sales by the Company's women's swimwear and
bodywear licensee and increased sales by certain of the Company's international
licensees.
Operating expenses increased in all categories to $25.3 million in 1996 from
$14.6 million in 1995. General and administrative expense increased to $9.4
million in 1996 compared to $5.7 million in 1995 primarily as a result of
increases in staffing levels necessary to manage higher levels of net sales,
increased costs of protecting the Company's trademarks globally and certain
increased costs customary to the Company's change in status from a privately
held to a publicly traded company. Selling expense increased to $9.3 million in
1996 from $5.8 million in 1995 primarily as a result of commissions on higher
levels of sales and increases in staffing levels, including the addition of
women's sales representatives who are salaried rather than commissioned.
Marketing expense increased to $4.2 million in 1996 from $2.1 million in 1995
primarily due to increased advertising expenses, including the cost of photo
shoots related to the Company's advertising campaign. Design expense increased
to $2.4 million in 1996 from $1.0 million in 1995, primarily as a result of
increases in staffing levels necessary to support the expansion of the Company's
product offerings. Operating expenses as a percentage of net sales increased to
23.3% in 1996 from 20.2% in 1995.
The Company had interest income of $191,000 in 1996 compared to interest
expense of $233,000 in 1995 primarily due to interest earned on the investment
of net cash proceeds from the Company's initial public offering.
Due to the Company's conversion to a C corporation in 1996, the provision
for income taxes increased from $297,000 in the 1995 period to $7.4 million (on
a pro forma basis) in 1996.
18
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary cash requirements are to fund the Company's working
capital needs, primarily inventories and accounts receivable, and to purchase
property and equipment. Net cash used in operating activities totaled $6.9
million during 1997. At December 31, 1997, working capital was approximately
$13.5 million as compared to $36.2 million at December 31, 1996 due primarily to
the loss sustained by the Company in fiscal 1997. Working capital may vary from
time to time as a result of seasonality, new product introductions, capital
expenditures and changes in inventory levels. To supplement cash flow from
operations the Company maintains a $20.0 million revolving credit facility with
a factor to be used for general working capital purposes. All obligations under
the credit agreement, which includes a letter of credit facility, are
collateralized by the Company's inventory and receivables. The Company's
borrowings are limited to 50% of eligible inventory and 85% of eligible
receivables. The credit agreement contains various restrictive covenants with
respect to the conduct of the Company's business and requires the maintenance of
various financial levels and ratios. As of December 31, 1997, the Company was in
violation of certain covenants, however, the Company subsequently received a
waiver from its factor for the violations. The Company had borrowings of $7.0
million outstanding on the line of credit as of December 31, 1997.
In April 1998, the credit facility was amended to a $15.0 million revolving
credit line which is collateralized by inventory, receivables, machinery and
equipment and tradenames. The covenants in the credit agreement under which the
Company was in violation at December 31, 1997 were modified in the amended
agreement. The Company's borrowings under the amended agreement are limited to
eligible inventory and receivables. Advances under the amended agreement bear
interest at the prime rate plus 0.5%. Whereas the Company's factoring and
finance agreements run through June 1, 2000, the revolving line is committed
through January 1, 1999 with an extension through March 31, 1999, subject to
certain conditions. The agreement provides for early termination penalties
during the first three years.
Historically, the Company has sold a substantial portion of its trade
accounts receivable to a factor, which assumes the credit risk with respect to
collection of nonrecourse accounts receivable in exchange for a fee. The factor
approves the credit of the Company's customers prior to sale. If the factor
disapproves of a sale to a customer and the Company decides to proceed with the
sale, the Company bears the credit risk. Prior to July 1997, the factoring
agreement provided that the Company could request advances against a percentage
of qualifying accounts receivable. In conjunction with the Company's credit
facility, the advance facility associated with the factoring agreement was
terminated. The factoring agreement is in force until June 1, 2000.
Cash flows used in investing activities totaled $6.3 million for 1997 and
was comprised of capital expenditures related primarily to the costs to
construct tenant improvements and equip the Company's new corporate headquarters
and construction of in-store shops. In May 1996, the Company entered into a
10-year lease for its new headquarters and distribution facility in Irvine,
California, which it occupied in July 1997.
By reason of the Company's treatment as an S corporation for Federal and
state income tax purposes, the Company, since inception through its initial
public offering, provided to its sole stockholder funds for the payment of
income taxes on the earnings of the Company through the termination of S
corporation status. In addition, the Company historically paid dividends to its
sole stockholder to provide a return on investment. In connection with its
initial public offering, the Company's S Corporation status was terminated and
the Company declared the final S Corporation distribution of its previously
undistributed earnings. For the year ended December 31, 1996 the Company paid
dividends, including amounts attributable to the payment of taxes and a portion
of the final S Corporation distribution, of $17.2 million. For the foreseeable
future, earnings will be retained in the operation of the business.
19
SIGNIFICANT ACCOUNTING ESTIMATES
In recent years certain customers of the Company have experienced financial
difficulties, including the filing of reorganization under bankruptcy laws. The
Company has not generally incurred significant losses outside the normal course
of business as a result of the financial difficulties of these customers. While
management believes that its allowance for doubtful accounts at December 31,
1997 is adequate, the Company carefully monitors developments regarding its
major customers. Additional material financial difficulties encountered by these
or other customers could have an adverse impact on the Company's financial
position or results of operations.
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 net sales or profitability. Although higher rates of
inflation have been experienced in a number of foreign countries in which the
Company's products are manufactured, the Company does not believe that they have
had a material effect on the Company's net sales or profitability. In the past,
the Company has been able to offset its foreign product cost increases by
increasing prices or changing suppliers, although no assurance can be given that
the Company will be able to continue to make such increases or changes in the
future.
EXCHANGE RATES
The Company receives United States dollars for substantially all of its
product sales and its licensing revenues. Inventory purchases from offshore
contract manufacturers are primarily denominated in United States dollars;
however, purchase prices for the Company's products may be impacted by
fluctuations in the exchange rate between the United States dollar and the local
currencies of the contract manufacturers, which may have the effect of
increasing the Company's cost of goods in the future. During the last two fiscal
years, exchange rate fluctuations have not had a material impact on the
Company's inventory costs. The Company does not engage in hedging activities
with respect to such exchange rate risk.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, EARNINGS PER SHARE, which requires the dual presentation of Basic
and Diluted Earnings per share. The Company adopted this pronouncement in fiscal
1997 and the Company's financial statements now include net income per share
assuming no dilution from outstanding options, and net income per share assuming
dilution. Prior periods were restated to reflect the adoption of this
pronouncement.
In June 1997, the FASB also issued SFAS No. 130, REPORTING COMPREHENSIVE
INCOME, and SFAS No. 131, DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION. SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components and SFAS No. 131 establishes standards
for the way public companies report financial information about operating
segments. The Company will adopt both in fiscal 1998, as required. These
statements will affect disclosure and presentation in the financial statements
but will not have a material impact on the Company's consolidated financial
position, liquidity, cash flows or results of operations.
YEAR 2000
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. This inability to recognize or properly treat the Year 2000
may cause the Company's systems and applications to process critical financial
and operational information incorrectly. The Company continues to assess the
impact of the Year 2000 issue on its reporting systems and operations.
20
The Company is currently in the process of investigating whether its
internal accounting systems and other operational systems are Year 2000
compliant. The Company has been informed by the vendor of its internal
accounting software that upgrades that will bring such software into Year 2000
compliance are currently available and will provide them to the Company under
its existing software maintenance agreement. The Company expects to effect the
conversion of its internal accounting system to such upgraded software by the
end of 1998. The Company believes that necessary conversions of other
operational systems can also be accomplished through vendor upgrades and
enhancements as provided under its system maintenance agreements currently in
effect. The Company does not anticipate significant costs associated with any
necessary conversions. However, there can be no assurance that certain of the
Company's internal computer systems or networks or those of its key vendors and
distributors will not be adversely affected by such Year 2000 issues, which
could have a material adverse effect on the Company's business, operating
results or financial condition.
FORWARD LOOKING INFORMATION
This report on Form 10-K 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" 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.
ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Index to Consolidated Financial Statements" at Item 14(a) for a listing
of the consolidated financial statements and supplementary data submitted as
part of this report.
ITEM 9-- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Effective May 29, 1997, Anthony C. Cherbak ("Cherbak"), Executive Vice
President and Chief Financial Officer of Registrant, resigned as an officer of
Registrant, for personal and family reasons, and rejoined his former employer,
Deloitte & Touche, LLP ("Deloitte & Touche"). As a result of Cherbak rejoining
Deloitte & Touche, the accounting firm will not be independent of Registrant
pursuant to Rule 101-1 of the American Institute of Certified Public Accountants
Professional Standards and resigned as Registrant's principal accountant
effective May 21, 1997. The Board accepted such resignation. Under an
arrangement between Registrant and Deloitte & Touche, Cherbak may remain
involved with Registrant on a consulting basis.
Deloitte & Touche's report on the financial statements for the past two
years did not contain an adverse opinion or a disclaimer of opinion and was not
qualified as to uncertainty, audit scope, or accounting principles. During
Registrant's two most recent fiscal years and any subsequent interim period
through May 21, 1997, there were no disagreements between Registrant and
Deloitte & Touche on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedures, which disagreements, if
not resolved to the satisfaction of Deloitte & Touche, would have caused it to
make a reference to the subject matter of the disagreements in connection with
its reports.
21
PART III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Stockholders Meeting to be held May 21, 1998 to
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1997 and is incorporated herein by reference.
ITEM 11--EXECUTIVE COMPENSATION
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Stockholders Meeting to be held May 21, 1998 to
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1997 and is incorporated herein by reference.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Stockholders Meeting to be held May 21, 1998 to
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1997 and is incorporated herein by reference.
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Stockholders Meeting to be held May 21, 1998 to
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1997 and is incorporated herein by reference.
ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
(1) Financial Statements:
Reports of Independent Auditors
Consolidated Balance Sheets at December 31, 1997 and 1996
Consolidated Statements of Operations for the Years Ended December
31, 1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended December
31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
(2) Financial Statement Schedule:
The following financial statement schedule of Mossimo, Inc. and
Subsidiary for the years ended December 31, 1997, 1996 and 1995 is
filed as part of this Report and should be read in conjunction with
the Consolidated Financial Statements of Mossimo, Inc. and
Subsidiary.
SCHEDULE PAGE
- ------------- -----
II Valuation and Qualifying Accounts S-I
(3) Exhibits:
The Exhibits listed on the accompanying Index to Exhibits immediately
following the financial statement schedules are filed as part of, or
incorporated by reference into, this Report.
22
EXHIBIT NO. DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
3.1 Certificate of Incorporation of Registrant (1)
3.2 Bylaws of the Registrant (1)
4.1 Specimen certificate of shares of Common Stock of the Registrant (1)
10.1 Registrant's 1995 Stock Plan (1)
10.2 Registrant's 1995 Directors Stock Option Plan (1)
10.3 Employment Agreement, dated January 1, 1996, by and between the Registrant and Mossimo Giannulli (1)
10.4 Factoring Agreement, dated January 2, 1990, by and between the Registrant and The CIT Group, as
amended to date (1)
10.4.1 Letter Amendment to Factoring Agreement dated June 16, 1995 (1)
10.4.2 Letter Amendment to Factoring Agreement dated February 1, 1996 (1)
10.4.3 Letter Amendment to Factoring Agreement dated November 1, 1996(2)
10.5 Form of Indemnification Agreement between the Registrant and its directors and officers (1)
10.6 Lease, dated May 3, 1996, between the Registrant and The Irvine Company (3)
10.7 Financing Agreement, dated July 15, 1997, by and between the Registrant and The CIT Group/Commercial
Services, Inc. (4)
10.8 Consulting Agreement dated January 13, 1998 by and between the Company and Brincko Associates, Inc.
10.9 Amendment to Consulting Agreement dated March 4, 1998 by and between the Company and Brincko
Associates, Inc.
21.1 Subsidiary
23.1 Independent Public Accountants Consent--Arthur Andersen LLP
23.2 Independent Public Accountants Consent--Deloitte & Touche LLP
27.1 Financial Data Schedule
- ------------------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (No. 33-80597), as amended, which became effective February 22,
1996.
(2) Incorporated by reference from the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(3) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996.
(4) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997.
(b) Reports on Form 8-K:
A report on Form 8-K was filed May 27, 1997 reporting the resignation of
the Company's public accountants and was amended by a report on Form
8-K/A filed June 13, 1997.
A report on Form 8-K was filed June 18, 1997 reporting the appointment of
Arthur Andersen LLP as the Company's principal accountants.
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 14th day of
April, 1998.
MOSSIMO, INC.
By: /s/ JOHN BRINCKO
-----------------------------------------
John Brincko
CHIEF EXECUTIVE OFFICER AND PRESIDENT
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the 14th day of April, 1998.
/s/ MOSSIMO GIANNULLI Chairman of the Board and
- ------------------------------ Visionary (Principal
Mossimo Giannulli Executive Officer)
/s/ JOHN BRINCKO
- ------------------------------ Chief Executive Officer
John Brincko and President
/s/ THORA THORODDSEN Secretary, Treasurer and
- ------------------------------ Controller (Principal
Thora Thoroddsen Accounting Officer)
/s/ FRANCESCA LUZURIAGA
- ------------------------------ Director
Francesca Luzuriaga
/s/ ROBERT MARTINI
- ------------------------------ Director
Robert Martini
/s/ JOHN STAFFORD
- ------------------------------ Director
John Stafford
MOSSIMO, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
-----
REPORTS OF INDEPENDENT PUBLIC ACCOUNTANTS
Arthur Andersen LLP...................................................................................... F-2
Deloitte & Touche LLP.................................................................................... F-3
FINANCIAL STATEMENTS:
Consolidated balance sheets at December 31, 1997 and 1996.................................................. F-4
Consolidated statements of operations for the years ended December 31, 1997, 1996 and 1995................. F-5
Consolidated statements of stockholders' equity for the years ended December 31, 1997, 1996 and 1995....... F-6
Consolidated statements of cash flows for the years ended December 31, 1997, 1996 and 1995................. F-7
Notes to consolidated financial statements................................................................. F-8
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Mossimo, Inc.:
We have audited the accompanying consolidated balance sheet of Mossimo, Inc.
(a Delaware corporation) and subsidiary as of December 31, 1997 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
The Company's revolving credit facility was amended and extended through
January 1, 1999. See Notes 1 and 6 for discussion regarding the terms of the
amended credit facility and management's plans in connection with this matter.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Mossimo,
Inc. and subsidiary as of December 31, 1997, and the result of their operations
and their cash flows for the year then ended in conformity with generally
accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule in the index of financial
statements is presented for the purposes of complying with the Securities and
Exchange Commissions rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states, in all
material respects, the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Orange County, California
February 21, 1998 (except with respect to
the matters discussed in the first paragraph
in Note 1 and the second paragraph of Note 6
as to which date is April 13, 1998)
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Mossimo, Inc.:
We have audited the accompanying consolidated balance sheet of Mossimo, Inc.
and subsidiary (the Company) as of December 31, 1996, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the two years in the period ended December 31, 1996. Our audits also included
the financial statement schedule listed in the Index at Item 14(a)(2). These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of Mossimo, Inc. and subsidiary as of
December 31, 1996, and the results of their operations and their cash flows for
each of the two years in the period ended December 31, 1996 in conformity with
generally accepted accounting principles. Also, in our opinion, such
consolidated financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
Deloitte & Touche LLP
Costa Mesa, California
February 21, 1997
F-3
MOSSIMO, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31,
--------------------
1997 1996
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................................... $ 655 $ 7,007
Accounts receivable, net of allowance for doubtful accounts of $891--1997 and $300--1996.... 2,473 2,831
Due from factor, net........................................................................ 4,001 13,561
Refundable taxes............................................................................ 5,505 1,346
Inventories................................................................................. 14,437 17,415
Deferred taxes.............................................................................. -- 1,455
Prepaid expenses and other current assets................................................... 296 869
--------- ---------
Total current assets...................................................................... 27,367 44,484
PROPERTY AND EQUIPMENT, net................................................................. 9,182 4,859
OTHER ASSETS................................................................................ 275 1,411
--------- ---------
$ 36,824 $ 50,754
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit.............................................................................. $ 6,962 $ --
Accounts payable............................................................................ 4,126 6,701
Accrued liabilities......................................................................... 2,389 1,118
Current portion of long-term debt........................................................... 41 86
S distribution note......................................................................... 362 427
--------- ---------
Total current liabilities................................................................. 13,880 8,332
DEFERRED ROYALTY INCOME..................................................................... 450 1,100
DEFERRED RENT............................................................................... 68 106
LONG-TERM DEBT, net of current portion...................................................... 31 85
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
15,000,000--1997 and 1996................................................................. 15 15
Additional paid-in capital.................................................................. 31,386 31,386
Retained earnings (accumulated deficit)..................................................... (9,006) 9,730
--------- ---------
Total stockholders' equity................................................................ 22,395 41,131
--------- ---------
$ 36,824 $ 50,754
--------- ---------
--------- ---------
See accompanying notes to consolidated financial statements.
F-4
MOSSIMO, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
---------- ---------- ---------
Net sales...................................................................... $ 70,936 $ 108,674 $ 71,961
Cost of sales.................................................................. 63,963 69,364 41,210
---------- ---------- ---------
Gross profit............................................................... 6,973 39,310 30,751
Royalty income, net............................................................ 3,798 3,919 3,413
---------- ---------- ---------
10,771 43,229 34,164
---------- ---------- ---------
OPERATING EXPENSES:
General and administrative................................................... 13,430 9,363 5,721
Selling...................................................................... 8,482 9,329 5,773
Marketing.................................................................... 7,014 4,223 2,055
Design....................................................................... 3,876 2,368 1,037
---------- ---------- ---------
Total operating expenses................................................... 32,802 25,283 14,586
---------- ---------- ---------
Operating (loss) income........................................................ (22,031) 17,946 19,578
---------- ---------- ---------
OTHER (EXPENSE) INCOME:
Other, net................................................................... (362) 19 114
Interest, net................................................................ (278) 191 (233)
---------- ---------- ---------
Net other (expense) income................................................. (640) 210 (119)
---------- ---------- ---------
(Loss) income before income taxes.............................................. (22,671) 18,156 19,459
(Benefit) provision for income taxes........................................... (3,935) 5,526 297
---------- ---------- ---------
Net (loss) income.............................................................. $ (18,736) $ 12,630 $ 19,162
---------- ---------- ---------
---------- ---------- ---------
Net (loss) income per common share
Basic and diluted............................................................ $ (1.25) $ .84 $ 1.47
---------- ---------- ---------
---------- ---------- ---------
Weighted average common shares outstanding
Basic and diluted............................................................ 15,000 15,000 13,000
---------- ---------- ---------
---------- ---------- ---------
PRO FORMA DATA:
Historical income before income taxes........................................ $ 18,156
Pro forma provision for income taxes......................................... 7,374
----------
Pro forma net income......................................................... $ 10,782
----------
----------
Pro forma net income per common share $ .73
----------
----------
Pro forma weighted average common shares....................................... 14,853
----------
----------
See accompanying notes to consolidated financial statements.
F-5
MOSSIMO, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
RETAINED
COMMON STOCK ADDITIONAL EARNINGS
---------------------- PAID-IN (ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT) TOTAL
--------- ----------- ----------- ------------ ----------
BALANCE, December 31, 1994.............................. 13,000 $ 13 $ 137 $ 10,837 $ 10,987
Capital contribution.................................... -- -- 1,050 -- 1,050
Net income.............................................. -- -- -- 19,162 19,162
Dividends............................................... -- -- -- (17,164) (17,164)
--------- --- ----------- ------------ ----------
BALANCE, December 31, 1995.............................. 13,000 13 1,187 12,835 14,035
Issuance of common stock................................ 2,000 2 32,100 -- 32,102
Reclassification of undistributed S corporation
earnings.............................................. -- -- (1,901) 1,901 --
Net income.............................................. -- -- -- 12,630 12,630
Dividends............................................... -- -- -- (17,636) (17,636)
--------- --- ----------- ------------ ----------
BALANCE, December 31, 1996.............................. 15,000 15 31,386 9,730 41,131
Net loss................................................ -- -- -- (18,736) (18,736)
--------- --- ----------- ------------ ----------
BALANCE, December 31, 1997.............................. 15,000 $ 15 $ 31,386 $ (9,006) $ 22,395
--------- --- ----------- ------------ ----------
--------- --- ----------- ------------ ----------
See accompanying notes to consolidated financial statements.
F-6
MOSSIMO, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income............................................................... $ (18,736) $ 12,630 $ 19,162
Adjustments to reconcile net (loss) income to net cash (used in) provided by
operating activities:
Depreciation and amortization................................................. 1,751 686 366
Loss on disposition of property and equipment................................. 265 19 31
Deferred rent................................................................. (30) 12 14
Provision for doubtful receivables............................................ 406 535 388
Deferred income taxes......................................................... 1,455 (1,455) --
Changes in:
Accounts receivable......................................................... (113) (1,839) (847)
Due from factor............................................................. 9,560 (6,375) (908)
Refundable income taxes..................................................... (4,159) (1,352) (27)
Inventories................................................................. 2,978 (7,642) (4,108)
Prepaid expenses and other current assets................................... 573 (281) (588)
Other assets................................................................ 486 (193) (64)
Accounts payable............................................................ (2,575) 4,669 (564)
Accrued liabilities......................................................... 1,263 203 308
--------- --------- ---------
Net cash (used in) provided by operating activities....................... (6,876) (383) 13,163
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for acquisition of property and equipment.............................. (6,355) (3,954) (763)
Proceeds from disposition of property and equipment............................. 16 -- 131
Proceeds from new licensing agreement........................................... -- 1,100 --
Payment for extinguishment of old licensing agreement........................... -- (1,100) --
--------- --------- ---------
Net cash used in investing activities..................................... (6,339) (3,954) (632)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt..................................................... (99) (99) (49)
Net proceeds from issuance of common stock...................................... -- 32,102 --
Net change in factor advances................................................... 6,962 (3,931) 3,931
Dividends paid.................................................................. -- (17,209) (17,164)
Capital contribution............................................................ -- -- 1,050
Repayment of note payable to stockholder........................................ -- -- (225)
--------- --------- ---------
Net cash provided by (used in) financing activities....................... 6,863 10,863 (12,457)
--------- --------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS......................................... (6,352) 6,526 74
CASH AND CASH EQUIVALENTS, beginning of year.................................... 7,007 481 407
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year.......................................... $ 655 $ 7,007 $ 481
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION--
Cash paid during the year for:
Interest.................................................................... $ 355 $ 169 $ 233
--------- --------- ---------
--------- --------- ---------
Income taxes................................................................ $ 225 $ 8,327 $ 324
--------- --------- ---------
--------- --------- ---------
SCHEDULE OF NONCASH INVESTING AND FINANCING TRANSACTIONS:
Contractual obligations incurred for acquisition of equipment................... $ -- $ 190 $ 22
--------- --------- ---------
--------- --------- ---------
S distribution note payable to stockholder...................................... $ -- $ 427 $ --
--------- --------- ---------
--------- --------- ---------
See accompanying notes to consolidated financial statements.
F-7
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RISK FACTORS
DECLINING FINANCIAL CONDITION--During the year ending December 31, 1997, the
Company experienced a significant decline in revenues and an increase in
operating costs. As a result, the Company reported an operating loss and
negative cash flow in fiscal 1997. At December 31, 1997, the Company was in
violation of certain covenants of its revolving credit facility that is used to
fund operations. The Company subsequently received a waiver for such violations
and the bank amended the existing covenants and extended the arrangement through
January 1, 1999.
In response to these declining financial conditions, in late fiscal 1997 the
Company began cost cutting measures to align its expense level with its
declining sales. Accordingly, the Company has reduced staffing levels, reduced
compensation to existing staff and is reviewing other cost cutting measures
which are planned to reduce operating expenses over the next fiscal year and is
pursuing equity investments. Although management believes that the Company will
be in compliance with its amended credit facility, management anticipates that
the Company will continue to experience operating losses and negative cash flows
throughout fiscal 1998. Should such losses exceed management's plans, the
Company may experience future violations of its new loan covenants and
additional funds may not be available pursuant to the Company's revolving credit
facility. In such event, management would execute additional cost cutting
measures and explore alternative financing with third party lenders.
DESCRIPTION OF BUSINESS--The Company designs, sources and markets a
lifestyle collection of contemporary men's activewear and men's and women's
sportswear bearing Mossimo-Registered Trademark- trademarks. The Company also
designs, sources and markets men's and women's eyewear and licenses its
trademarks for use in collections of women's swimwear and bodywear, men's
neckwear, men's tailored clothing, men's hosiery and men's and women's
accessories. The Company distributes its products to a diversified account base,
including department stores, specialty retailers, and sports and activewear
stores located throughout the United States, as well as two signature retail
stores and one outlet store in Southern California.
PRINCIPLES OF CONSOLIDATION--The consolidated financial statements include
the accounts of Mossimo, Inc., a Delaware corporation and its wholly-owned
subsidiary, Giannico, Inc. (collectively, the Company). All significant
intercompany balances and transactions have been eliminated in consolidation.
CONCENTRATION OF CREDIT RISK--The Company assigns a substantial portion of
its receivables to a factor, which assumes the credit risk with respect to
collection of non-recourse receivables. Ongoing customer credit evaluations are
performed with respect to the Company's trade receivables, and collateral is
generally not required.
CASH AND CASH EQUIVALENTS--Cash and cash equivalents include cash on hand
and investments purchased with original maturities of three months or less.
INVENTORIES--Inventories are stated at the lower of cost, determined by the
first-in, first-out method, or market.
PROPERTY AND EQUIPMENT--Property and equipment are stated at cost, net of
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over generally a five to ten-year period for automobiles,
machinery and equipment. Leasehold improvements are amortized over the term of
the related lease if less than the estimated service life. The Company's share
of the cost of constructing in-store shop displays is capitalized and amortized
using the straight-line method over a three-year period. These costs are
included in furniture and fixtures.
F-8
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RISK FACTORS (CONTINUED)
REVENUE RECOGNITION--Revenue is recognized when merchandise is shipped to a
customer. Revenues are recorded net of estimated returns, chargebacks and
markdowns based upon management's estimates and the Company's historical
experience.
INCOME TAXES--The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards No. 109 (SFAS 109), ACCOUNTING FOR
INCOME TAXES. Deferred taxes on income result from temporary differences between
the reporting of income for financial statements and tax reporting purposes.
Prior to February 23, 1996, Mossimo, Inc. elected to be treated as an S
corporation under the provisions of the Internal Revenue Code. Accordingly, the
provision for income taxes for periods through February 22, 1996 is computed by
applying the California franchise tax rate for S corporations of 1.5% to
Mossimo, Inc.'s pretax earnings. Effective February 23, 1996, the Company
converted to a C corporation and became subject to regular Federal and state
income taxes on an ongoing basis. As a result of converting to a C Corporation,
the Company established deferred income tax assets and thereby recorded an
income tax benefit of $700,000 on February 23, 1996.
USE OF ESTIMATES--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that effect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
STOCK SPLIT--On February 15, 1996, the Company effected a 13,000-for-one
stock split of its common stock. All share and per share amounts included in the
accompanying consolidated financial statements and notes have been restated to
reflect the stock split.
STOCK BASED COMPENSATION--In fiscal 1996, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation". The Company adopted the pro forma disclosure requirements of SFAS
No. 123, which requires presentation of the pro forma effect of the fair value
based method on net income and net income per share in the financial statement
footnotes. See Note 12--Stockholders' Equity.
PRO FORMA DATA--Pro forma net income represents the results of operations
adjusted to reflect a provision for income taxes on historical income, which
gives effect to the change in the Company's income tax status to a C corporation
subsequent to the public sale of its common stock. The principal difference
between the pro forma income tax rate and Federal statutory rate relates to
state income taxes. Pro forma net income per common share has been computed by
dividing pro forma net income by the weighted average number of shares of common
stock outstanding during the year.
EARNINGS PER SHARE--Effective fiscal 1997 the Company adopted SFAS No. 128,
"Earnings Per Share". As required, the Company's financial statements include
net income per share assuming no dilution from outstanding options and net
income per share assuming dilution. Prior period net income per share data was
restated for consistency. The impact of SFAS No. 128 did not materially change
the Company's reported results of operations. For the two years in the period
ended December 31, 1997, all options to purchase Common Stock were excluded from
the diluted per share calculations as the effect of such inclusion would be
antidilutive. There were no stock options outstanding in 1995.
F-9
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RISK FACTORS (CONTINUED)
PENDING ACCOUNTING PRONOUNCEMENTS--In June 1997, the FASB issued SFAS No.
130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information". SFAS No. 130 and SFAS No.
131 must be adopted by the Company beginning with fiscal 1998 and will result in
an additional statement that reports comprehensive income and expanded
disclosure regarding the Company's operations on a segmented basis.
MERCHANDISE RISK--The ability of the Company to be successful is largely
dependent upon its ability to gauge the fashion tastes of its targeted consumers
and provide merchandise that satisfies consumer demand. Any inability to provide
appropriate merchandise in sufficient quantities in a timely manner could have a
material adverse effect on the Company's business, operating results and
financial condition.
2. DUE FROM FACTOR
Historically, the Company has sold a substantial portion of its trade
accounts receivable to a factor, which assumes the credit risk with respect to
collection of nonrecourse accounts receivable in exchange for a fee. The factor
approves the credit of the Company's customers prior to sale. If the factor
disapproves of a sale to a customer and the Company decides to proceed with the
sale, the Company bears the credit risk. Prior to July 1997, the factoring
agreement provided that the Company could request advances against qualifying
accounts receivable. In conjunction with the Company's credit facility, the
advance facility associated with the factoring agreement was terminated. The
factoring fee has historically ranged from .5% to .6% of the receivables
assigned, and was increased to .7% in connection with the April 1998 amendment
to the credit facility. The factoring agreement is in force until June 1, 2000.
The agreement may be terminated by the factor at any time with 180 days prior
notice. (See Note 6).
Due from factor consists of the following at December 31, 1997 and 1996:
1997 1996
--------- ---------
(IN THOUSANDS)
Unmatured accounts receivable:
Nonrecourse............................................................ $ 5,839 $ 12,866
With recourse.......................................................... 653 1,460
Matured accounts receivable (advances)................................... -- 800
Allowance for sales returns, markdowns, chargebacks and doubtful
accounts............................................................... (2,491) (1,565)
--------- ---------
$ 4,001 $ 13,561
--------- ---------
--------- ---------
Matured accounts receivable represent amounts due from the factor for cash
collected by the factor from customers in excess of advances made by the factor
on these receivables. The Company receives interest at the prime rate minus 2%
per annum on matured accounts receivable. At December 31, 1997, the prime rate
was 8.5%.
F-10
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVENTORIES
Inventories consist of the following at December 31, 1997 and 1996:
1997 1996
--------- ---------
(IN THOUSANDS)
Raw materials............................................................ $ 5,889 $ 7,445
Work-in-process.......................................................... 1,096 1,928
Finished goods........................................................... 7,452 8,042
--------- ---------
$ 14,437 $ 17,415
--------- ---------
--------- ---------
The Company's import operations are subject to constraints imposed by
bilateral textile agreements between the United States and a number of foreign
countries. These agreements impose quotas on the amount and type of goods which
can be imported into the United States from these countries and can limit or
prohibit importation of products on very short notice. The Company's imported
products are also subject to United States customs duties which are a material
portion of the Company's cost of imported goods. A substantial increase in
customs duties or a substantial reduction in quota limits applicable to the
Company's imports could have a material adverse effect on the Company's
financial condition and results of operations.
4. INCOME TAXES
The (benefit) provision for income taxes consists of the following for the
years ended December 31:
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
Current:
Federal........................................................ $ (5,390) $ 5,478 $ --
State.......................................................... -- 1,503 297
--------- --------- ---------
(5,390) 6,981 297
--------- --------- ---------
Deferred:
Federal........................................................ 1,205 (1,205) --
State.......................................................... 250 (250) --
--------- --------- ---------
1,455 (1,455) --
--------- --------- ---------
Total (benefit) provision for income taxes....................... $ (3,935) $ 5,526 $ 297
--------- --------- ---------
--------- --------- ---------
F-11
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INCOME TAXES (CONTINUED)
The provision for income taxes differs from the amount of tax determined by
applying the Federal statutory rate to pretax income. The components of this
difference for the years ended December 31, 1997 and 1996 are summarized as
follows:
1997 1996
--------- ---------
(IN THOUSANDS)
(Benefit) provision on income at Federal statutory tax rate.............. $ (7,708) $ 6,355
State income (benefit) taxes, net of Federal tax effect.................. (692) 1,449
Increase in valuation allowance on deferred income tax asset............. 5,035 --
Recording of deferred income tax assets in connection with conversion to
C corporation.......................................................... -- (700)
S corporation earnings not subject to Federal tax........................ -- (1,105)
Other.................................................................... (570) (473)
--------- ---------
Total (benefit) provision for income taxes............................... $ (3,935) $ 5,526
--------- ---------
--------- ---------
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred income taxes as of December 31, 1997 and 1996 are as
follows:
1997 1996
--------- ---------
(IN THOUSANDS)
Deferred income tax assets (liabilities):
Reserves not currently deductible...................................... $ 3,893 $ 876
State income taxes..................................................... -- 438
Net operating loss carryforwards....................................... 864 --
Other.................................................................. 278 141
--------- ---------
Net deferred tax assets.................................................. 5,035 1,455
Valuation allowance...................................................... (5,035) --
--------- ---------
Total net deferred tax asset............................................. $ -- $ 1,455
--------- ---------
--------- ---------
The Company has provided a full valuation allowance on the net deferred tax
asset at December 31, 1997 due to the uncertainty regarding its realization.
In January 1998, the Company filed a carryback claim for the majority of the
1997 loss. Such claim resulted in a refund of 1996 taxes previously paid. The
Company has approximately $1,557,000 and $7,445,000 of Federal and state net
operating loss carryforwards, respectively, available to offset future taxable
income which expire in various years through 2012.
Prior to February 23, 1996, Mossimo, Inc. elected to be treated as an S
corporation under the provisions of the Internal Revenue Code. Accordingly, the
provisions for income taxes for the period ended February 23, 1996 and the year
ended December 31, 1995 are computed by applying the California franchise tax
rate for S corporations of 1.5%. Effective February 23, 1996, the Company
converted to a C corporation and became subject to regular Federal and state
income taxes on an ongoing basis. As a result, the Company recorded $700,000 of
deferred income tax assets at February 23, 1996.
F-12
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 1997 and
1996:
1997 1996
--------- ---------
(IN THOUSANDS)
Furniture and fixtures................................................... $ 6,541 $ 3,164
Machinery and equipment.................................................. 4,132 2,025
Automobiles.............................................................. 162 173
Construction in progress................................................. 969 769
--------- ---------
11,804 6,131
Accumulated depreciation and amortization................................ (2,622) (1,272)
--------- ---------
$ 9,182 $ 4,859
--------- ---------
--------- ---------
6. LINE OF CREDIT AND LONG-TERM DEBT
At December 31, 1997, the Company had a $20,000,000 secured line of credit
collateralized by inventory and receivables, bearing interest at either the
prime rate (8.5% at December 31, 1997) or LIBOR (5.97% at December 31, 1997)
plus 2.25%. At December 31, 1997, there were borrowings totaling $6,962,000
outstanding under the line of credit. The credit facility has various
restrictive covenants, which include the maintenance of minimum tangible net
worth (approximately $41,000,000 at December 31, 1997), an annual net income
minimum and certain other financial ratios. At December 31, 1997, the Company
was not in compliance with these restrictive covenants, however, the Company
subsequently received a waiver from its factor for the violations of the
covenants.
In April 1998, the credit facility was amended to a $15,000,000 revolving
credit line which is collateralized by inventory, receivables, machinery and
equipment and tradenames. The covenants in the credit agreement under which the
Company was in violation at December 31, 1997 were modified in the amended
agreement. The Company's borrowings under the amended agreement are limited to
eligible inventory and receivables. Advances under the amended agreement bear
interest at the prime rate plus 0.5% and factoring charges increased to .7%.
Whereas the Company's factoring and finance agreements run through June 1, 2000,
the revolving line is committed through January 1, 1999 with an extension
through March 31, 1999, subject to certain conditions. The agreement provides
for early termination penalties during the first three years.
Long-term debt consists of notes payable which are due in aggregate monthly
installments of $7,500, including interest from 7.5% to 14.6% per annum, which
mature at various dates through June 2001. The notes are collateralized by
automobiles and equipment.
The following are annual maturities of long-term debt (in thousands):
Year ending December 31:
1998................................................................................. $ 41
1999................................................................................. 21
2000................................................................................. 8
2001................................................................................. 2
---
Total scheduled maturities............................................................. $ 72
---
---
F-13
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution plan under Section 401(k) of the
Internal Revenue Code covering all full-time employees after six months of
employment. The plan provides for annual matching contributions by the Company
as a percentage of employee contributions and annual wages. Contributions made
to the plan for the years ended December 31, 1997, 1996 and 1995 were $64,000,
$35,000 and $16,000, respectively.
In February 1997, the Company adopted the Mossimo, Inc. Employee Stock
Purchase Plan (the "Employee Plan"), which provides eligible employees of the
Company the opportunity to acquire stock in the Company through periodic payroll
deductions that will be applied at semi-annual intervals to purchase shares of
common stock at a discount from the then current market price. The purchase
price of the shares amounts to the lower of; 85% of the fair market value of the
Company's common stock on the first day of the purchase period; or, 85% of the
fair market value of the Company's common stock on the purchase date. As of
December 31, 1997, the Company had collected $26,000 toward the purchase of
stock under the Employee Plan and had not yet purchased any stock. A total of
500,000 shares have been reserved under the Employee Plan.
8. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES--The Company is committed under noncancelable operating
leases expiring at various dates through June 2007. Rent expense for the years
ended December 31, 1997, 1996 and 1995 was $2,603,000, $1,039,000 and $847,000,
respectively.
Future minimum annual rental payments required under noncancelable operating
leases in excess of one year are as follows (in thousands):
Year ending December 31:
1998............................................................. $ 2,577
1999............................................................. 2,576
2000............................................................. 2,170
2001............................................................. 1,619
2002............................................................. 1,399
Thereafter....................................................... 5,808
---------
Total scheduled maturities......................................... $ 16,149
---------
---------
LETTERS OF CREDIT--The Company has an agreement with its factor to
facilitate the purchase of goods by issuing letters of credit to various
companies overseas. The letters of credit are collateralized by inventories. At
December 31, 1997, the Company had outstanding letters of credit of $5,314,000.
CONSULTANT--In January 1998, the Company entered into a contract with a
consultant for services through December 1998 for compensation of approximately
$732,000. The Company has the option to continue with the consultant for an
additional six months at the end of fiscal 1998.
LITIGATION--On January 23, 1997, plaintiff Chaile Steinberg filed a
purported class action against the Company and certain other defendants on
behalf of individuals who purchased the Company's common stock in the initial
public offering pursuant to the Registration Statement and Prospectus
("Prospectus"), dated February 22, 1996, and on the open market from February
22, 1996 through January 14, 1997 (the "Class Period"). In addition to naming
the Company, the plaintiffs Igor Glaudnikov, Cara Debra Marks
F-14
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
and Lois Burke filed a second related action against the same defendants. The
two cases were subsequently consolidated by court order, dated May 19, 1997.
Both Steinberg and Glaudnikov (collectively, the "State Actions") contain
identical factual allegations, and only differ in the number of shares purchased
by plaintiffs and the California residence of two of the plaintiffs in the
Glaudnikov action.
The State Actions allege that defendants made false and misleading
statements and intentionally concealed material negative information in the
Prospectus and afterward during the Class Period, which artificially inflated
prices for the Company's common stock. Plaintiffs contend that the class was
damaged in an unspecified amount as a result of this artificial inflation of the
Company's stock price.
On September 23, 1997, a federal class action complaint was filed on behalf
of plaintiff James Frenkil by the same law firm that represents the plaintiffs
in the State Actions. One of the named plaintiffs in the federal action is a
plaintiff in the State Actions. The class period and precipitating events are
the same as in the State Actions, but the federal complaint purports to allege
violations of certain federal securities laws. On October 17, 1997, the judge
stayed the federal action pending resolution of the State Actions.
Defendants filed demurrers in the State Actions, challenging the legal
sufficiency of the complaints. On June 26, 1997, the judge sustained the
defendant's general demurrer to the complaints in the State Actions, finding
that neither complaint pleaded facts sufficient to constitute causes of action
against the defendants. The judge sustained the demurrer as to four of the
causes of action with leave to amend, and as to the fifth cause of action for
unlawful, unfair or fraudulent business practices and false or misleading
advertising without leave to amend. Since that time, no amended complaint nor
motion for class certification has been filed by the plaintiffs.
Although the outcome of the litigation cannot be predicted with certainty,
management believes that the Company has meritorious defenses to the claims
alleged and intends to defend this action with vigor.
The Company is involved in certain other legal and administrative
proceedings and threatened legal and administrative proceedings arising in the
normal course of its business. While the outcome of such proceedings and
threatened proceedings cannot be predicted with certainty, in the opinion of
management, the ultimate resolution of these matters individually or in the
aggregate will not have a material adverse effect on the Company.
9. MAJOR CUSTOMERS
During the years ended December 31, 1997, 1996 and 1995, sales to one
department store customer in its various regions represented approximately
12.8%, 10.5% and 10.9% of net sales, respectively. A decision by a significant
customer to decrease the amount purchased from the Company or to cease carrying
the Company's products could have a material effect on the Company's financial
condition and results of operations.
10. ROYALTY INCOME, NET
The Company has licensing agreements with several unrelated companies for
the use of its trademarks and designs. Royalty payments are due on a monthly or
quarterly basis and range from 4% to 12% of the licensee's sales. Royalty
income, net of direct expenses, for the years ended December 31, 1997, 1996 and
1995 was $3,798,000, $3,919,000 and $3,413,000, respectively.
F-15
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's consolidated balance sheets include the following financial
instruments: cash and cash equivalents, accounts receivable, amounts due to and
from its factor and long-term debt. The carrying value of long-term debt
approximates fair value as it bears interest at rates currently available to the
Company. The Company considers the carrying amounts in the financial statements
to approximate fair value for cash and cash equivalents, accounts receivable and
amounts due to and from its factor, because of the relatively short period of
time between origination and their expected realization.
12. STOCKHOLDERS' EQUITY
COMMON STOCK--In February 1996, the Company completed an initial public
offering of 2,000,000 shares of the Company's common stock for $18.00 per share,
generating proceeds to the Company after underwriting discounts and expenses of
approximately $32,100,000.
In conjunction with its initial public offering, the Company terminated its
S corporation status and distributed to its stockholder $17,600,000,
representing previously earned and undistributed taxable S corporation earnings
in the form of promissory notes (S distribution notes). The estimated remaining
amount payable to stockholder for previously earned and undistributed taxable S
Corporation earnings under the S distribution notes was $362,000 and $427,000 at
December 31, 1997 and 1996, respectively.
In accordance with a regulation of the Securities and Exchange Commission,
the Company reclassified $1,901,000 from additional paid-in capital for that
portion of the previously earned and undistributed taxable S corporation
earnings which was in excess of the balance of retained earnings at the date of
termination of the Company's S corporation status.
1995 STOCK OPTION PLAN--In December 1995, 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 certain advisors or consultants to
the Company. A total of 1,500,000 shares have been reserved for issuance under
the 1995 Plan.
1995 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN--The Company's Non-Employee
Directors Stock Option Plan (the "Directors Plan") provides for the automatic
grant to each of the Company's non-employee directors of (i) an option to
purchase 30,000 shares of common stock on the date of such director's initial
election or appointment to the Board of Directors and (ii) an option to purchase
3,000 shares of common stock on each anniversary thereof on which the director
remains on the Board of Directors. A total of 250,000 shares have been reserved
under the Directors Plan. Options granted thereunder have an exercise price
equal to the fair market value of the common stock on the date of grant.
F-16
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. STOCKHOLDERS' EQUITY (CONTINUED)
Changes in shares under option for the 1995 Plan and the Directors Plan (the
"Plans") are summarized as follows:
YEARS ENDED DECEMBER 31,
------------------------------------------
1997 1996
WEIGHTED AVERAGE WEIGHTED AVERAGE
-------------------- --------------------
SHARES PRICE SHARES PRICE
--------- --------- --------- ---------
Outstanding, beginning of year...................... 494,500 $ 20.23 -- --
Granted........................................... 90,600 7.56 498,500 $ 20.22
Exercised......................................... -- -- -- --
Canceled.......................................... 179,500 18.85 4,000 18.00
--------- --------- --------- ---------
Outstanding, end of year............................ 405,600 $ 18.02 494,500 $ 20.23
--------- --------- --------- ---------
--------- --------- --------- ---------
Options exercisable, end of year.................... 113,832 $ 20.70 -- --
--------- --------- --------- ---------
--------- --------- --------- ---------
Weighted average fair value of options granted
during the year................................... $ 4.16 $ 7.22
--------- ---------
--------- ---------
Outstanding stock options for the Plans at December 31, 1997 consist of the
following:
OPTIONS OUTSTANDING
--------------------------------------- OPTIONS EXERCISABLE
WEIGHTED ----------------------
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE
- -------------------------------------- --------- --------------- ----------- --------- -----------
$7.00 - $8.50........................ 58,100 9.3 $ 7.53 -- $ --
18.00 - 25.375....................... 347,500 8.3 19.77 113,832 20.70
--
--------- ----------- --------- -----------
$7.00 - $25.375....................... 405,600 8.4 $ 18.02 113,832 $ 20.70
--
--
--------- ----------- --------- -----------
--------- ----------- --------- -----------
The fair value of each option grant was estimated as of the grant date using
the Black-Scholes option-pricing model for the years ended December 31, 1997 and
1996 assuming risk-free interest rates of 5.75% and 5.2%, respectively,
volatility of 106% and 30%, respectively, zero dividend yield and expected lives
of five years for all periods. The Company applies Accounting Principles Board
Opinion 25 and related interpretations in accounting for its plans. Accordingly,
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.
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 (loss) income
and net (loss) income per share
F-17
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. STOCKHOLDERS' EQUITY (CONTINUED)
would have resulted in the approximate pro forma amounts indicated below for the
years ended December 31:
1997 1996
---------- ---------
(IN THOUSANDS)
Actual net (loss) income............................................... $ (18,736) $ 12,630
Pro forma net (loss) income............................................ (19,113) 12,111
Actual net (loss) income per share:
Basic and diluted.................................................... $ (1.25) $ 0.84
Pro forma net (loss) income per share:
Basic and diluted.................................................... $ (1.27) $ 0.81
As of December 31, 1997 there were 1,344,400 shares of common stock under
the Plans that were available for future grant.
F-18
MOSSIMO, INC. AND SUBSIDIARY
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END
OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
------------ ------------- -------------- ------------
Year ended December 31, 1997:
Allowance for doubtful accounts..................... $ 700,000 $ 406,000 $ (215,000) $ 891,000
Allowance for sales returns, markdowns and
chargebacks....................................... 1,165,000 11,578,000 (10,252,000) 2,491,000
Year ended December 31, 1996:
Allowance for doubtful accounts..................... $ 415,000 $ 535,000 $ (250,000) $ 700,000
Allowance for sales returns, markdowns and
chargebacks....................................... 190,000 7,549,000 (6,574,000) 1,165,000
Year ended December 31, 1995:
Allowance for doubtful accounts..................... $ 162,000 $ 388,000 $ (135,000) $ 415,000
Allowance for sales returns, markdowns and
chargebacks....................................... 140,000 2,489,000 (2,439,000) 190,000
S-I