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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, 1998
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)
2450 WHITE ROAD 2ND FLOOR 92614-6250
IRVINE, CALIFORNIA (Zip Code)
(Address of principal executive offices)
(949) 797-0200
(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
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 22, 1999 was approximately $40,171,000.
The registrant had 15,036,597 shares of common stock, par value $.001 per share
outstanding at March 22, 1999.
Documents Incorporated by Reference (To the Extent Indicated Herein): Portions
of the Definitive Proxy Statement for the 1999 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 lifestyle. The Company's apparel offerings include knit
and woven shirts, outerwear, denim products, sweatshirts, tee-shirts and shorts.
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 and women's accessories, men's tailored suits and dress
shirts and men's hosiery. Mossimo products are characterized by quality
workmanship and are targeted towards the fashion conscious consumer generally
age 35 or under.
In December 1998, the Company appointed Edwin H. Lewis as its President and
Chief Executive Officer and significantly restructured its executive management
team. Under the new management team, the Company intends to pursue a growth
strategy aimed at increasing sales to existing accounts and establishing
additional, profitable accounts. A key component of the Company's growth
strategy will be an emphasis on the Company's in-store shop concept whereby
participating retailers set aside exclusive floor space, highlighted by
signature Mossimo fixtures, to sell the Company's products. This concept 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 had 154 in-store shops as of December 31, 1998 compared to
155 in-store shops as of December 31, 1997. The Company intends to expand the
number of its in-store shops in 1999.
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 subsidiary 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 and principal designer, provides leadership and
direction for all aspects of the design process. The Company's design staff
reflects the Company's fashion conscious 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 of such products and their
adherence to the Company's distinctive image.
PRODUCTS
The Company's products include men's apparel, including knit and woven tops,
denim and related products, tee-shirts and shorts, women's apparel, including
knit and woven tops and denim and related products, and men's and women's
eyewear. The Company discontinued its Moss line, which consisted of activewear
products, in the Summer of 1998. The Company also licenses Mossimo trademarks to
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third-party licensees who manufacture and distribute women's swimwear and
bodywear, men's neckwear, men's tailored suits and dress shirts, men's hosiery
and men's and 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,
----------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
NET SALES % NET SALES % NET SALES %
----------- --------- ----------- --------- ----------- ---------
(NET SALES IN THOUSANDS)
Men's Apparel.................................... $ 20,879 46.1% $ 45,136 63.6% $ 83,717 77.0%
Women's Apparel.................................. 15,650 34.5 18,741 26.4 20,333 18.7
Moss Line........................................ 2,346 5.2 1,109 1.6 -- --
Eyewear.......................................... 1,742 3.8 3,086 4.4 2,777 2.6
Other (1)........................................ 4,693 10.4 2,864 4.0 1,847 1.7
----------- --------- ----------- --------- ----------- ---------
Total............................................ $ 45,310 100.0% $ 70,936 100.0% $ 108,674 100.0%
----------- --------- ----------- --------- ----------- ---------
----------- --------- ----------- --------- ----------- ---------
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(1) Other is comprised primarily of: sales by the Company's retail stores and
screen printing subsidiary; sales of the Company's Time collection of
watches (which was discontinued in 1997); and sales of fabric, trim,
merchandising supplies and fixtures to certain of the Company's licensees.
APPAREL
MEN'S APPAREL. Mossimo's men's line 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;
outerwear, including sweaters and jackets; screenprinted and embroidered
tee-shirts and sweatshirts; and volley and walk shorts. Mossimo's knits and
woven tops and denim and related products compete with other designer men's
lines such as Tommy Hilfiger, Calvin Klein, Polo/Ralph Lauren, Nautica, Liz
Claiborne, Perry Ellis and Guess?. Mossimo's tee-shirts and sweatshirts and
volley and walk shorts compete with various activewear designers such as
Quiksilver, Billabong, Rusty and Redsand. The Company's men's products generally
retail between $20 to $198. While the Company's men's 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 men's 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
higher-priced products are an important component of the Mossimo designer label,
they historically constitute less than 1% of net sales. The Company expects that
such higher-priced products will continue to represent a relatively small
percentage of its overall net sales. The men's line is targeted toward men
between the ages of 18 and 35.
WOMEN'S APPAREL. The Company formally launched its designer women's line in
July 1996. The line consists of knit tops, dresses, pants and jackets, denim and
outerwear, such as sweaters and leather jackets, and is characterized by
distinctive fabrics and contemporary styling. The women's line competes with
other designer women's lines such as Calvin Klein, Polo/Ralph Lauren, Guess?,
Esprit, DKNY and Tommy Hilfiger. The women's products generally retail between
$22 and $158 and are targeted toward young women between the ages of 16 and 35.
MOSS LINE. The Company's Moss line, which was targeted toward younger
designer-oriented consumers, was discontinued in the Summer of 1998.
EYEWEAR. The Company's eyewear line features three primary categories of
high quality men's and women's sunglasses manufactured to Mossimo's design
specifications. The eyewear collection features both glass and polycarbonate
lenses and highly stylized frames which are sold primarily in better department
stores and optical specialty stores. The eyewear collections include:
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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
$59 to $79.
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 The Lunada Bay Corporation which utilizes designs approved by the
Company bearing Mossimo trademarks. The high quality swimwear products include
both one-piece and two-piece swimsuits which are fashion-oriented and targeted
towards youthful-minded, body conscious women. The Mossimo swimwear line has
been featured in several magazines, including the SPORTS ILLUSTRATED swimsuit
issue, SHAPE, GLAMOUR and ELLE. The women's bodywear line is a collection of
fashionable aerobic and fitness activewear which prominently bears the Mossimo
trademarks and is designed using materials such as lycra, tactel and flexcel
nylon that stretch and compensate for body movements during strenuous exercise.
NECKWEAR. The Mossimo line of neckwear is manufactured and distributed
through a license agreement with Superba, Inc. This line was launched in Spring
1997.
MEN'S TAILORED SUITS AND DRESS SHIRTS. In July 1997, the Company signed a
license agreement with GFT Apparel Corporation to manufacture and distribute a
collection of men's tailored suits and dress shirts under the Mossimo and
Mossimo Giannulli brand names. This collection was launched in Fall 1998.
MEN'S HOSIERY. In 1997, the Company signed a license agreement with
Mountain High Hosiery, Ltd. to manufacture and distribute a hosiery product line
to complement Mossimo's men's products. This line was introduced in the fourth
quarter 1998.
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, Hong Kong, Macau, Korea, Phillipines, Thailand and
Indonesia. 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 10 domestic factories and mills and 30 overseas factories and
mills. During 1998, approximately 50% of the Company's products were
manufactured offshore. The balance of the Company's finished goods were
manufactured by domestic suppliers.
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 its products primarily based on
projected sales and orders received. While the Company receives a portion of its
customer orders prior to placement of its
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initial manufacturing orders, occasionally these customer orders may change with
respect to colors, sizes, allotments or assortments prior to the delivery date.
The Company utilizes such orders 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.
In the third quarter of 1998, the Company sold substantially all of the
assets of its subsidiary, Giannico, Inc., to Winterland Concession Company, a
San Francisco based producer of licensed and private label apparel and
merchandise ("Winterland"). In connection with this transaction, the Company and
Winterland entered into a multi-year agreement whereby Winterland will be the
exclusive manufacturer of Mossimo's tee-shirts and sweatshirts, subject to
certain conditions.
The Company does not own or operate any manufacturing facilities and is
therefore dependent on independent contractors for the manufacture of its
products. Except for the Winterland contract, 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 result in missing certain
retailing seasons with respect to some or all of the Company's products or could
otherwise have an adverse effect on the Company's financial condition and
results of operations.
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 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 ensures that quality control programs are in place for
licensees.
MARKETING AND ADVERTISING
The Company strives to maintain a consistent image through the coordination
of advertising, merchandising and promotion. Prior to the fourth quarter of
1998, the Company developed its advertising program in house. In the fourth
quarter of 1998, the Company engaged the Toth Brand Agency, an advertising firm
located in Concord, Massachusetts. The Company believes that Toth will bring a
fresh new brand vision to the Company. The Company advertises in magazines such
as GQ, DETAILS, ROLLING STONE, SPIN, IN-STYLE, ELLE and VANITY FAIR. The goal of
the Company's print and outdoor 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 also carried forward in the design of the
Company's in-store shops and in its Southern California signature retail store.
The Company maintains showrooms in Irvine, California, New York City and Dallas
to display various portions of its product line.
DISTRIBUTION
Distribution of all Mossimo non-licensed products is centralized in the
Company's Irvine, California 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 basic 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.
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During 1998, the Company's products were sold in over 1,500 department and
specialty retail store locations throughout the United States. The Company's
five largest customers accounted for approximately 44% and 40% of net sales in
1998 and 1997, respectively. The Company's largest customer, Macy's West,
accounted for approximately 20% of net sales in 1998. 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 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 shop
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 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, 1998, the Company had
154 in-store shops in department and specialty store retail chains compared to
155 in-store shops as of December 31, 1997. The Company's in-store shops are
located in such stores as Macy's, Rich's, Burdines, Bloomingdales and Bon
Marche. The Company plans to expand the in-store shops concept in 1999.
RETAIL STORES
The Company operates one signature retail store located in South Coast
Plaza, Costa Mesa, California (established in 1993). The store incorporates
contemporary architectural designs, which are consistent with the Company's
in-store shop environment and the Company's image and provides a means to
showcase the Company's products. The Company formerly operated a second retail
store in Old Towne, Pasadena, California, which was closed during the quarter
ended June 30, 1998.
The Company also 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 Mountain High Hosiery, Ltd. the exclusive right to manufacture and distribute
men's hosiery in the United States and Canada. This license expires in December
2001, subject to renewal by the licensee for an additional three-year period if
minimum sales and royalty criteria are met. In addition in 1996, the Company
licensed to Superba, Inc. the exclusive right to manufacture and distribute
finer men's neckwear in the United States and Canada. This license expires in
March 2000, subject to renewal by the licensee for an additional three-year
term, if minimum sales and royalty requirements are met. In 1997, the Company
licensed to GFT Apparel Corporation the exclusive right to manufacture and
7
distribute men's suits and dress shirts for the United States, Canada and
Mexico. This license expires June 2003 subject to renewal by the licensee for an
additional five-year term if minimum sales and royalty requirements are
fulfilled. The Company's license agreement with Aquarius, Ltd. for men's and
women's accessories was terminated on December 31, 1998 and Mossimo intends to
handle this category of products in-house until further arrangements are made.
In addition, the Company's license agreement with Giorgio of Beverly Hills for
fragrance products was terminated in March 1998. Under all license agreements,
Mossimo retains approval rights with respect to the design of products and
advertising. Royalty payments under these license agreements are due on a
monthly or quarterly basis and range from 4% to 10% 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, Peru, Argentina, Paraguay, Uruguay, Bolivia,
South Africa and surrounding states and Southeast Asia. The present terms of
these agreements (exclusive of renewal terms) expire at various dates ranging
from April 1999 through July 2003.
TRADEMARKS
The Company utilizes a variety of trademarks, including the script Mossimo
trademark. Currently, the Company has 15 registrations and 5 pending
applications for its trademarks in the United States, and approximately 280
trademark registrations and applications in over 62 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's men's designer sportswear lines encounter
substantial competition from Tommy Hilfiger, Calvin Klein, Polo/Ralph Lauren,
Nautica, Liz Claiborne, Perry Ellis and Guess?, as well as from certain other
designer and non-designer lines. With respect to its men's activewear products,
the Company encounters substantial competition from various activewear and
beachwear lines including Quiksilver, Billabong, Rusty and Redsand.
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?, Esprit, DKNY and Tommy Hilfiger. 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.
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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 dates. At December 31,
1998, the Company's backlog of orders for delivery primarily in the first
quarter of 1999 was approximately $9.0 million, as compared with backlog of
approximately $8.5 million at December 31, 1997. 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 December 31, 1998, the Company had approximately 105 full-time employees,
down from 264 at the same time last year. This decrease was due primarily to the
discontinuation of the Company's screen printing operations and the closure of
the Company's Pasadena retail store, which collectively reduced the headcount by
approximately 100. The remaining decrease was the result of Company-wide staff
reductions which resulted primarily from greater efficiencies. None of the
Company's employees are covered by collective bargaining agreements. The Company
considers its relations with its employees to be good.
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.
CHANGES IN FASHION TRENDS
The apparel industry is subject to rapidly changing consumer demands and
preferences, which may adversely affect companies which 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 other
designer and non-designer lines. With respect to its men's activewear products,
the Company encounters substantial competition from various activewear and
beachwear lines including Quiksilver, Billabong, Rusty and Redsand.
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/
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Ralph Lauren, Guess?, Esprit, DKNY and Tommy Hilfiger. 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. 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 Edwin Lewis, the Company's President and Chief Executive Officer,
and Mossimo Giannulli, the Company's lead designer. In addition, the Company is
dependent on the personal efforts and abilities of a small group of key
management executives. Mr. Lewis is not subject to an employment agreement with
the Company. Mr. Giannulli is subject to a consulting agreement with the
Company, which expires in January 2001 and includes a non-competition provision
effective through such expiration date.
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,
purchases 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. In addition, financial problems of one of the
Company's retail store customers could cause the Company's factor to limit the
amount of receivables of such customer that the factor would approve, which
could cause the Company to curtail business with such customer 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.
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 such accounts. The factor pays the Company the receivable amount
after the factor receives payment from the Company's customer or, if earlier,
shortly following the bankruptcy or insolvency of the customer or when the
receivable becomes 120 days past due. The factor approves the credit of the
Company's customers prior to sale. If the factor disapproves a sale to a
customer and the Company decides to proceed with the sale, the Company bears the
credit risk. After April 1, 2000, the factoring agreement can be terminated at
any time by the factor upon 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 and Capital Resources."
DEPENDENCE ON CERTAIN CUSTOMERS
The Company's department store customers include major United States
retailers. The Company's five largest customers accounted for approximately 44%
and 40% of net sales in 1998 and 1997,
10
respectively. Purchases by Macy's West, in its various regions, accounted for
approximately 20% of net sales in 1998. 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 1998. 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 Macy's West, or 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.
DEPENDENCE ON UNAFFILIATED MANUFACTURERS
The Company does not own or operate any manufacturing facilities and is
therefore dependent on independent contractors for the manufacture of its
products. Except for the contract with Winterland, under which Winterland will
be the exclusive manufacturer of Mossimo tee-shirts and sweatshirts, 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 result in missing
certain retailing seasons with respect to some or all of the Company's products
or could otherwise have an adverse effect on the Company's financial condition
and results of operations.
FOREIGN OPERATIONS
During 1998, approximately 50% of the Company's products were manufactured
outside of the United States. 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, 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.
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 markdown 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
11
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 STOCKHOLDERS
Mossimo Giannulli and Edwin Lewis collectively have 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 experienced during 1996 and the
declining sales experienced in 1997 and 1998, 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 and distribution facility are
located in Irvine, California and consist of two leased buildings totaling
approximately 106,000 square feet of space. In addition, the Company leases
showrooms in Irvine, California, New York City and Dallas as well as one retail
store in Costa Mesa and one outlet in Ontario, California.
ITEM 3 -- LEGAL PROCEEDINGS
On January 23, 1997, plaintiff Chaile Steinberg filed a purported class
action suit 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"). On April 7, 1997, 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 a general demurrer in the State Actions, challenging the
legal sufficiency of the complaints. On June 26, 1997, the judge sustained the
defendants' 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.
12
On July 9, 1998, plaintiffs filed their first amended consolidated complaint
against the same defendants, alleging three causes of action. On September 22,
1998, defendants filed a general demurer to the first amended consolidated
complaint. On March 16, 1999, the judge sustained the demurrer as to the Company
with respect to two of the three causes of action with leave to amend. As to the
third cause of action, the judge sustained the demurrer as to the Company with
respect to three of the five plaintiffs with leave to amend, and overruled the
demurrer with respect to the other two plaintiffs. Plaintiffs have until April
15, 1999 to amend their first amended and consolidated complaint.
Although the outcome of the litigation cannot be predicted, management
believes that the Company has meritorious defenses 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 1998.
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 22,
1999, there were approximately 6,800 shareholders 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:
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
1998
--------------------------
HIGH LOW
----- ---
First Quarter................. $ 7 5/8 $3
Second Quarter................ $ 9 9/16 $3 3/4
Third Quarter................. $ 4 5/8 $1
Fourth Quarter................ $16 $2 1/2
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 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."
Any future determination as to the payment of dividends will be at the
discretion of the Company's Board of Directors and will depend upon the
Company's results of operations, financial condition, contractual restrictions
and other factors deemed relevant by the Board of Directors.
13
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,
-------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ------------ ----------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Net sales......................................... $ 45,310 $ 70,936 $ 108,674 $ 71,961 $ 44,333
Cost of sales..................................... 35,994 63,963 69,364 41,210 26,027
---------- ------------ ----------- ---------- ----------
Gross profit...................................... 9,316 6,973 39,310 30,751 18,306
Royalty income, net............................... 3,214 3,798 3,919 3,413 2,375
Operating expenses................................ 25,469 32,802 25,283 14,586 9,380
---------- ------------ ----------- ---------- ----------
Operating income (loss)........................... (12,939) (22,031) 17,946 19,578 11,301
Interest income (expense), net.................... (612) (278) 191 (233) (148)
Miscellaneous..................................... (140) (362) 19 114 87
---------- ------------ ----------- ---------- ----------
Income (loss) before income taxes................. (13,691) (22,671) 18,156 19,459 11,240
Provision (benefit) for income taxes (1).......... 107 (3,935) 5,526 297 176
---------- ------------ ----------- ---------- ----------
Net income (loss)................................. $ (13,798) $ (18,736) $ 12,630 $ 19,162 $ 11,064
---------- ------------ ----------- ---------- ----------
---------- ------------ ----------- ---------- ----------
Net income (loss) per share:
Basic and diluted............................... $ (0.92) $ (1.25) $ .84 $ 1.47 $ .85
---------- ------------ ----------- ---------- ----------
---------- ------------ ----------- ---------- ----------
PRO FORMA DATA (2):
Historical income before income taxes............. $ 18,156 $ 19,459 $ 11,240
Pro forma provision for income taxes.............. 7,374 7,946 4,663
----------- ---------- ----------
Pro forma net income.............................. $ 10,782 $ 11,513 $ 6,577
----------- ---------- ----------
----------- ---------- ----------
Pro forma net income per share (basic and
diluted)........................................ $ .73
-----------
-----------
Pro forma weighted average common shares
outstanding (basic and diluted)................. 14,853
-----------
-----------
DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital....................................... $ 4,532 $ 13,419 $ 36,152 $ 12,621 $ 9,880
Total assets.......................................... $ 17,359 $ 36,824 $ 50,754 $ 17,162 $ 14,635
Long-term debt........................................ $ 10 $ 31 $ 85 $ 30 $ 64
Stockholders' equity.................................. $ 8,639 $ 22,395 $ 41,131 $ 14,035 $ 10,987
- ------------------------
(1) Represents California state franchise taxes for periods prior to the
Company's conversion to C corporation status.
(2) The Company converted from S corporation to C corporation status commencing
February, 1996. 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.
14
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, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Net sales decreased $25.6 million, or 36%, to $45.3 million in 1998 from
$70.9 million in 1997. This decrease was primarily a result of a decrease of
$24.3 million in sales of the men's apparel line, which represented a 46% of the
Company's net sales in 1998 and a $3.1 million decrease in sales of the women's
line, which represented 35% of the Company's net sales in 1998. The decrease in
the men's apparel line resulted from reduced sales of tees and tanks and shorts
to specialty stores and chains and reduced sales to unprofitable accounts due to
the Company's strategy of focusing on sales to profitable department store
accounts. The decline in the men's apparel sales was partially offset by a $1.2
million increase in sales of the recently-discountinued Moss line to $2.3
million in 1998 from $1.1 million in 1997. The decline in women's apparel sales
resulted from a reduction in denim sales in the second half of the year due to
lack of consumer demand and a reduction of sales to unprofitable accounts. Net
sales of the eyewear line, which represented 3.8% of the Company's net sales in
1998, decreased to $1.7 million in 1998 from $3.1 million in 1997 due to reduced
product releases, particularly in the Moss line, resulting from excess
inventories with core customers.
Gross profit increased to $9.3 million in 1998 from $7.0 million in 1997.
Gross profit as a percentage of net sales increased to 20.6% in 1998 from 9.8%
in 1997. The increase resulted primarily from lower inventory writedowns in 1998
compared with 1997. Gross profit as a percentage of sales, excluding excessive
inventory sales, additional reserves and inventory shortages, increased to 34%
compared to 31% in the same period in 1997.
Net royalty income decreased to $3.2 million, or 7.1% of net sales, in 1998
as compared to $3.8 million, or 5.4% of net sales, in 1997. The decrease was
primarily attributed to reduced sales by the Company's licensees that carry
swimwear, bodywear and accessory product categories. Management believes that
sales of the Company's swimwear licensee were negatively impacted, in part, by
poor weather conditions on the West Coast of the United States. Sales of the
Company's accessory licensee declined due to a reduction in product categories
offered during 1998 compared to 1997. In addition, unfavorable foreign exchange
rate variances from the Company's Australian licensee further impacted results.
Operating expenses decreased in nearly all categories to $25.5 million in
1998 from $32.8 million in 1997. Included in the 1998 operating expenses is a
lease restructuring charge of $3.8 million, which was finalized in the second
quarter of 1998, and a $463,000 in-store fixture reserve recorded in the third
quarter of 1998. The lease restructure charge includes (i) $2.7 million in
corporate lease restructuring expenses and costs, including the write down of
certain fixed assets; (ii) $900,000 for the discontinuation of the Company's
screen printing business; and (iii) $200,000 for the closing of the Company's
Pasadena retail store.
During 1998, the Company reevaluated its office and facilities requirements
and agreed to relinquish its existing space for its corporate headquarters and
approximately half of the space for its warehouse/distribution. This lease
restructuring relieved the Company of annual rental obligations of approximately
$1.0 million. The Company has moved into its new corporate headquarters located
in Irvine, California and has leased office space in Santa Monica, California.
The Company's annual rent obligation for both locations is approximately
$260,000. The Company, accordingly, will realize a reduction in annual rental
obligations of approximately $740,000.
Operating expenses, excluding the lease restructuring charge, decreased to
$21.7 million in 1998 from $32.8 million in 1997. General and administrative
expense decreased to $11.0 million in 1998
15
compared to $13.4 million in 1997 primarily as a result of staffing reductions
and cost cutting measures. Selling expense decreased to $5.9 million in 1998
from $8.5 million in 1997 primarily due to reduced sales commissions, partially
offset by an increase in salary expense for in-house sales representatives.
Marketing expense decreased to $2.3 million in 1998 from $7.0 million in 1997
primarily due to reduced print advertising and the elimination of certain
fashion shows. Design expense decreased to $2.4 million in 1998 from $3.9
million in 1997 primarily as a result of reduced staffing levels and overall
cost cutting measures in design expenses. Operating expenses, excluding the
lease restructuring charge, as a percentage of net sales increased to 47.8% in
1998 from 46.3% in 1997.
The Company had other expense of $140,000 in 1998 compared to $362,000 in
1997 primarily due to losses on disposals of fixed assets.
The Company had interest expense of $612,000 in 1998 compared to $278,000 in
1997 primarily due to increased borrowings on the Company's credit facility.
The Company had alternative minimum tax expense of $107,000 in 1998 compared
to an income tax benefit of $3,935,000 in 1997. Losses for 1997 and 1998 were
benefited only to the extent the Company could apply for carryback claims in its
income tax returns.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net sales decreased $37.8 million, or 35%, to $70.9 million in 1997 from
$108.7 million in 1996. This decrease was primarily a result of a decrease of
$38.6 million in sales of the men's apparel line, which represented a 64% of the
Company's net sales in 1997 and a $1.6 million decrease in sales of the women's
line, which represented 26% of the Company's net sales in 1997. The decrease in
the men's apparel line resulted from reduced sales of knits, denim, wovens,
screenprinted tee-shirts and fleece. The decline in the men's apparel sales was
partially offset by sales of the Moss line totaling $1.1 million. Net sales of
the eyewear line, which represented 4.4% of the Company's net sales in 1997,
increased to $3.1 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 9.8% 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 in 1997 as
compared to $3.9 million in 1996, or 5.4% and 3.6% of net sales, respectively.
Operating expenses increased in nearly all categories to $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, 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
16
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.
The Company had an income tax benefit of $3,935,000 in 1997 compared to a
pro forma 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.
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 provided by operating activities totaled $2.0
million during 1998. Cash provided by operating activities was comprised of the
Company's net loss of $13.8 million for the year ended December 31, 1998 and
cash used to pay down accrued liabilities of $3.2 million, offset by a federal
tax refund of $5.3 million, a $6.1 million reduction in inventory and the
non-cash charge of $3.0 million associated with the write-down of assets related
to the lease restructuring. At December 31, 1998, working capital was
approximately $4.5 million as compared to $13.4 million at December 31, 1997 due
primarily to a $6.1 million reduction in inventory, the collection of refundable
taxes and funding of the loss sustained by the Company during 1998. 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 $15.0 million
revolving credit facility with a factor to be used for general working capital
purposes. The facility also allows for up to $6 million in letters of credit.
All obligations under the credit facility, which includes a letter of credit
facility, are collateralized by the Company's inventory, receivables, machinery
and equipment and intangibles. The credit agreement has various restrictive
covenants which include the Company's earnings before interest, tax,
depreciation and amortization (EBITDA), exposure in excess of account receivable
availability and capital expenditure limitations. The Company was in compliance
with all debt covenants as of December 31, 1998. The Company had borrowings of
$4.8 million outstanding on the line of credit as of December 31, 1998. In March
1999, the lender's commitment under the finance agreement was extended through
April 1, 2000.
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 customer prior to sales. If the factor
disapproves of a sale to a customer and the Company decides to proceed with the
sales, the Company bears the credit risk. Prior to July 1997, the factoring
agreement provided that the Company's 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 factor agreement is in force through June 30, 2002.
Cash flows used in investing activities totaled $244,000 for 1998 and was
comprised of capital expenditures partially offset by proceeds received from the
disposal of assets from the Company's screen printing subsidiary, Giannico, Inc.
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
17
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.
The Company believes that current cash and their revolving line of credit
will be sufficient to meet its anticipated cash needs for at least the next 12
months. However, any projections of future cash needs and cash flows are subject
to substantial uncertainty. There can be no assurance that financing will be
available in amounts or on terms acceptable to the Company, if at all.
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,
1998 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.
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 experienced during 1996 and the
declining sales experienced in 1997 and 1998, 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.
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 three
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 June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (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
18
standards for the way public companies report financial information about
operating segments. The Company adopted both new standards in fiscal 1998, as
required. These statements affect disclosure and presentation in the financial
statements but do not have an effect on the Company's consolidated financial
position, liquidity, cash flows or results of operations.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designed as part of a
hedge transaction and, if it is, the type of hedge transaction. The Company does
not expect that the adoption of SFAS No. 133 will have a material impact on its
consolidated financial statements because the Company does not currently hold
any derivative instruments.
YEAR 2000
GENERAL
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. The Company's
computer equipment and software and devices with embedded technology that are
date-sensitive may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, and engage in similar normal business
activities.
The Company has assessed how it may be impacted by the Year 2000 issue and
has formulated and commenced implementation of a plan to address the known
aspects of the issue.
THE PLAN
The Company's plan encompasses its information systems, production and
facilities equipment that utilize date/time oriented software of computer chips,
products, vendors and customers and will be carried out in four phases: 1)
assessment and development of a plan; 2) remediation; 3) testing; and 4)
implementation.
With regard to information systems, production and facilities equipment and
products, the Company is substantially complete with the assessment and plan
development phase and is approximately 90% complete with its total planned
efforts including remediation, testing and implementation. The Company expects
that its remediation efforts in these areas will be substantially completed by
June 1999.
The Company is also reviewing the efforts of its vendors and customers to
become Year 2000 compliant. The Company has divided these vendors and customers
into several groups such as financial institutions, software and system
suppliers, critical customers and manufacturers. Each group was reviewed based
on its level of technological dependence, frequency of interactions and need by
the Company to continue operations. The Company has received approximately 95%
of the responses from the more technologically dependent vendors and customers,
of which 100% responded with written assurances that they expect to address all
of their known significant Year 2000 issues on a timely basis. The Company is
currently contacting its remaining vendors and customers to ensure that they are
Year 2000 compliant. The Company anticipates that these activities will be
on-going for the remainder of 1999 and will include follow-up telephone
interviews and on-site meetings as considered necessary in the circumstances.
Although this review is continuing, the Company is not currently aware of any
vendor or customer circumstances that may have a material adverse impact on the
Company. The Company will be seeking alternative suppliers if possible where
circumstances warrant. The Company can provide no assurance that Year 2000
compliance plans will be successfully completed by suppliers and customers in a
timely manner.
19
COST
The costs related to Year 2000 compliance are not expected to be
significant. Existing maintenance agreements with the software providers covered
the majority of costs related to the upgrade of its internal accounting and
proprietary business software. These systems were upgraded in December 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.
RISK
The Company believes that the Year 2000 issue will not pose significant
operational problems for the Company. However, if all Year 2000 issues are not
properly identified, or assessment, remediation and testing are not affected in
a timely manner with respect to problems that are identified, there can be no
assurance that the Year 2000 issue will not have a material adverse impact on
the Company's results of operations or adversely affect the Company's
relationships with customers, vendors, or others. Additionally, there can be no
assurance that the Year 2000 issues of other entities will not have a material
adverse impact on the Company's systems or results of operations.
CONTINGENCY PLAN
The Company has started a comprehensive analysis of the operational problems
and costs (including loss of revenue) that would be reasonably likely to result
from the failure by the Company and certain third parties to complete efforts
necessary to achieve Year 2000 compliance on a timely basis. A contingency plan
has not been finalized for dealing with the most reasonably likely worst case
scenario as such scenario has not yet been clearly identified. The Company is
currently undergoing this analysis and contingency planning which will be
complete by June 1999.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not have any derivative financial instruments as of
December 31, 1998. Further, the Company is not exposed to interest rate risk as
the Company's revolving line of credit and factoring agreement have variable
interest rates. Therefore, the fair value of these instruments are not affected
by changes in market interest rates. The Company believes that the market risk
arising from holdings of its financial instruments is not material.
FORWARD LOOKING INFORMATION
This report on Form 10-K contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These forward
looking statements relate to matters such as the Company's future operating
results, the Company's expansion of its in-store shop program, the ability of
the Company timely to deliver its products to customers, the success of the
Company's licensing program and the outcome of the Company's legal proceedings.
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. Such statements are based on management's current
expectations and are subject to certain risks, uncertainties and assumptions,
including those described in "Business--Risk Factors." 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.
20
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Effective May 29, 1997, Anthony C. Cherbak ("Cherbak"), former Executive
Vice President and Chief Financial Officer of the Company, resigned as an
officer of the Company, 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 the
Company pursuant to Rule 101-1 of the American Institute of Certified Public
Accountants Professional Standards and resigned as the Company's principal
accountant effective May 21, 1997. The Board accepted such resignation.
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 principals. During the
Company's two most recent fiscal years and any subsequent interim period through
May 21, 1997, there were no disagreements between the Company and Deloitte &
Touche on any matter of accounting principles or practices, financial statements
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.
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 1999 Annual Stockholders Meeting to be filed with the
Securities and Exchange Commission within 120 days after December 31, 1998 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 1999 Annual Stockholders Meeting to be filed with the
Securities and Exchange Commission within 120 days after December 31, 1998 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 1999 Annual Stockholders Meeting to be filed with the
Securities and Exchange Commission within 120 days after December 31, 1998 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 1999 Annual Stockholders Meeting to be filed with the
Securities and Exchange Commission within 120 days after December 31, 1998 and
is incorporated herein by reference.
21
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:
PAGE
-----
Reports of Independent Auditors
Arthur Andersen LLP.................................................................. F-2
Deloitte & Touche LLP................................................................ F-3
Consolidated Balance Sheets at December 31, 1998 and 1997.............................. F-4
Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997 and
1996................................................................................. F-5
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1998,
1997 and 1996........................................................................ F-6
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and
1996................................................................................. F-7
Notes to Consolidated Financial Statements............................................. F-8
22
(2) 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.
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)
10.4.4 Letter Amendment to Factoring Agreement dated May 21, 1998 (5)
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)
10.6.1 Amendment to the lease agreement with the Irvine Company, dated July 10, 1998 (5)
10.7 Financing Agreement, dated July 15, 1997, by and between the Registrant and The
CIT Group/Commercial Services, Inc. (4)
10.7.1 Amendment to the Financing Agreement dated April 1, 1998 (5)
10.8 Lease, dated August 19, 1998, between the Registrant and the Cornucopia, Inc. (6)
10.9 Lease, dated July 20, 1998, between the Registrant and 3002 Pennsylvania Avenue,
LLC (6)
10.10 Registration Rights Agreement, dated as of November 30, 1998, by and among the
Registrant, Edwin Lewis and Mossimo Giannulli
23.1 Independent Public Accountants Consent -- Arthur Andersen LLP
23.2 Independent Public Accountants Consent -- Deloitte & Touche LLP
27 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.
(5) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the Quarter ended June, 30, 1998.
(6) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the Quarter ended September, 30, 1998.
(b) Reports on Form 8-K:
A report on Form 8-K was filed with the commission on December 8, 1998,
announcing the appointment of Edwin Lewis as President and Chief Executive
Officer and related transactions.
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 25th day of
March, 1999.
MOSSIMO, INC.
By: /s/ EDWIN H. LEWIS
-----------------------------------------
Edwin H. Lewis
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 25th day of March, 1999.
/s/ MOSSIMO GIANNULLI
- ------------------------------ Chairman of the Board
Mossimo Giannulli
/s/ EDWIN H. LEWIS
- ------------------------------ Chief Executive Officer
Edwin H. Lewis and President
Secretary, Treasurer and
/s/ THORA B. THORODDSEN Senior Vice President
- ------------------------------ Finance (Principal
Thora B. Thoroddsen Accounting Officer)
/s/ ROBERT MARTINI
- ------------------------------ Director
Robert Martini
/s/ JOHN STAFFORD
- ------------------------------ Director
John Stafford
24
MOSSIMO, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
-----
REPORTS OF INDEPENDENT PUBLIC ACCOUNTANTS
Arthur Andersen LLP...................................................................................... F-2
Deloitte and Touche LLP.................................................................................. F-3
FINANCIAL STATEMENTS:
Consolidated balance sheets at December 31, 1998 and 1997.................................................. F-4
Consolidated statements of operations for the years ended December 31, 1998, 1997 and 1996................. F-5
Consolidated statements of stockholders' equity for the years ended December 31, 1998, 1997 and 1996....... F-6
Consolidated statements of cash flows for the years ended December 31, 1998, 1997 and 1996................. 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 sheets of Mossimo,
Inc. (a Delaware corporation) and subsidiary as of December 31, 1998 and 1997
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the two years in the period ended December 31, 1998.
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 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 referred to above
present fairly, in all material respects, the financial position of Mossimo,
Inc. and subsidiary as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Orange County, California
February 26, 1999 (except with respect to
Note 2 and Note 6 as to which
the date is March 22, 1999)
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Mossimo, Inc.:
We have audited the accompanying consolidated statement of operations,
stockholders' equity and cash flow of Mossimo, Inc. and subsidiary for the year
ended December 31, 1996. 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 and 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.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated results of Mossimo,
Inc. and subsidiary's operations and their cash flows for the year ended
December 31, 1996, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Costa Mesa, California
February 21, 1997
F-3
MOSSIMO, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
----------------------
1998 1997
---------- ----------
ASSETS
CURRENT ASSETS:
Cash...................................................................................... $ 176 $ 655
Accounts receivable, net of allowance for doubtful accounts of $696 -- 1998 and $891 --
1997.................................................................................... 979 2,473
Due from factor, net...................................................................... 3,064 4,001
Refundable taxes.......................................................................... 171 5,505
Inventories............................................................................... 8,325 14,437
Prepaid expenses and other current assets................................................. 202 296
---------- ----------
Total current assets.................................................................... 12,917 27,367
PROPERTY AND EQUIPMENT, at cost, net of accumulated depreciation and amortization......... 4,207 9,182
OTHER ASSETS.............................................................................. 235 275
---------- ----------
$ 17,359 $ 36,824
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit............................................................................ $ 4,759 $ 6,962
Accounts payable.......................................................................... 1,505 4,126
Accrued liabilities....................................................................... 1,834 2,457
Current portion of long-term debt......................................................... 21 41
S distribution note....................................................................... 266 362
---------- ----------
Total current liabilities............................................................... 8,385 13,948
DEFERRED ROYALTY INCOME................................................................... 325 450
LONG-TERM DEBT, net of current portion.................................................... 10 31
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
15,011,529 and 15,000,000 -- 1998 and 1997, respectively................................ 15 15
Additional paid-in capital................................................................ 31,428 31,386
Accumulated deficit....................................................................... (22,804) (9,006)
---------- ----------
Total stockholders' equity.............................................................. 8,639 22,395
---------- ----------
$ 17,359 $ 36,824
---------- ----------
---------- ----------
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,
-----------------------------------
1998 1997 1996
---------- ---------- -----------
Net sales.................................................................. $ 45,310 $ 70,936 $ 108,674
Cost of sales.............................................................. 35,994 63,963 69,364
---------- ---------- -----------
Gross profit........................................................... 9,316 6,973 39,310
Royalty income, net........................................................ 3,214 3,798 3,919
---------- ---------- -----------
12,530 10,771 43,229
---------- ---------- -----------
OPERATING EXPENSES:
General and administrative............................................... 11,036 13,430 9,363
Selling.................................................................. 5,933 8,482 9,329
Marketing................................................................ 2,297 7,014 4,223
Design................................................................... 2,411 3,876 2,368
Lease restructuring...................................................... 3,792 -- --
---------- ---------- -----------
Total operating expenses............................................... 25,469 32,802 25,283
---------- ---------- -----------
Operating income (loss).................................................... (12,939) (22,031) 17,946
---------- ---------- -----------
OTHER INCOME (EXPENSE):
Interest income (expense), net............................................. (612) (278) 191
Miscellaneous.............................................................. (140) (362) 19
---------- ---------- -----------
Net other income (expense)........................................... (752) (640) 210
---------- ---------- -----------
Income (loss) before income taxes.......................................... (13,691) (22,671) 18,156
Provision (benefit) for income taxes....................................... 107 (3,935) 5,526
---------- ---------- -----------
Net income (loss).......................................................... $ (13,798) $ (18,736) $ 12,630
---------- ---------- -----------
---------- ---------- -----------
Net income (loss) per common share
Basic and diluted........................................................ $ (.92) $ (1.25) $ .84
---------- ---------- -----------
---------- ---------- -----------
Weighted average common shares outstanding
Basic and diluted........................................................ 15,010 15,000 15,000
---------- ---------- -----------
---------- ---------- -----------
See accompanying notes to consolidated financial statements.
F-5
MOSSIMO, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
RETAINED
COMMON STOCK ADDITIONAL EARNINGS
---------------------- PAID-IN (ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT) TOTAL
--------- ----------- ----------- -------------- ----------
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
Issuance of common stock............................ 11 -- 42 -- 42
Net loss............................................ -- -- -- (13,798) (13,798)
--------- --- ----------- -------------- ----------
BALANCE, December 31, 1998.......................... 15,011 $ 15 $ 31,428 $ (22,804) $ (8,639)
--------- --- ----------- -------------- ----------
--------- --- ----------- -------------- ----------
See accompanying notes to consolidated financial statements.
F-6
MOSSIMO, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................................... $ (13,798) $ (18,736) $ 12,630
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization............................................... 1,766 1,751 686
Write-down of in-store fixtures............................................. 461 -- --
Loss on disposition of property and equipment............................... 2,992 265 19
Provision for doubtful receivables.......................................... 419 406 535
Deferred income taxes....................................................... -- 1,455 (1,455)
Changes in:
Accounts receivable....................................................... 1,075 (113) (1,839)
Due from factor........................................................... 937 9,560 (6,375)
Refundable taxes.......................................................... 5,334 (4,159) (1,352)
Inventories............................................................... 6,112 2,978 (7,642)
Prepaid expenses and other current assets................................. 94 573 (281)
Other assets.............................................................. (181) 486 (193)
Accounts payable.......................................................... (2,621) (2,575) 4,669
Accrued liabilities....................................................... (623) 1,233 215
---------- ---------- ----------
Net cash provided by (used in) by operating activities.................. 1,967 (6,876) (383)
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for acquisition of property and equipment.......................... (744) (6,355) (3,954)
Proceeds from disposition of property and equipment......................... 500 16 --
Proceeds from new licensing agreement....................................... -- -- 1,100
Payment for extinguishment of old licensing agreement....................... -- -- (1,100)
---------- ---------- ----------
Net cash used in investing activities................................... (244) (6,339) (3,954)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt................................................. (41) (99) (99)
Net proceeds from issuance of common stock.................................. 42 -- 32,102
Net change in factor advances............................................... (2,203) 6,962 (3,931)
Dividends paid.............................................................. -- -- (17,209)
---------- ---------- ----------
Net cash provided by (used in) financing activities..................... (2,202) 6,863 10,863
---------- ---------- ----------
NET CHANGE IN CASH.......................................................... (479) (6,352) 6,526
CASH, beginning of year..................................................... 655 7,007 481
---------- ---------- ----------
CASH, end of year........................................................... $ 176 $ 655 $ 7,007
---------- ---------- ----------
---------- ---------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest................................................................ $ 638 $ 355 $ 169
---------- ---------- ----------
---------- ---------- ----------
Income taxes............................................................ $ -- $ 225 $ 8,327
---------- ---------- ----------
---------- ---------- ----------
SCHEDULE OF NONCASH INVESTING AND FINANCING TRANSACTIONS:
Contractual obligations incurred for acquisition of equipment............... $ -- $ -- $ 190
---------- ---------- ----------
---------- ---------- ----------
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
DESCRIPTION OF BUSINESS -- The Company designs, sources and markets a
lifestyle collection of contemporary men's and women's apparel bearing
Mossimo-Registered Trademark- trademarks. The Company also licenses its
trademarks for use in collections of women's swimwear and bodywear, men's
neckwear, men's tailored suits and dress shirts, 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 one signature
retail store 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). Giannico's operations
were discontinued in the third quarter ended September 30, 1998. All significant
intercompany balances and transactions have been eliminated in consolidation.
SEGMENT AND GEOGRAPHIC INFORMATION -- The Company operates in one principal
business segment across domestic and international markets. International sales
are primarily made through the Company's licensees in their respective
territories.
COMPREHENSIVE INCOME (LOSS) -- As of January 1, 1998, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income", which establishes standards for the reporting and display
of comprehensive income and its components in the financial statements. There
are no items of comprehensive income (loss) that the Company is required to
report.
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 nonrecourse 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.
REVENUE RECOGNITION -- Revenue is recognized when merchandise is shipped to
a customer. Reserves for estimated returns and allowances are recorded at the
time of shipment based upon management's estimates and the Company's historical
experience.
INCOME TAXES -- The Company accounts for income taxes under the provisions
of SFAS No. 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
F-8
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
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 BASED COMPENSATION -- In fiscal 1996, the Company adopted 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.
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 years ended
December 31, 1998, 1997 and 1996, there was no dilution from outstanding
options.
During 1998, the Company issued stock options to Edwin Lewis under the Stock
Option Plan for Edwin Lewis (Note 12). The shares of common stock to be issued
upon exercise of these options will be contributed to the Company by Mossimo
Giannulli under a Contribution Agreement (Note 12). Accordingly, these shares
are included in basic weighted average shares outstanding as of December 31,
1998.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS -- In June 1998, the Financial
Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designed as part of a
hedge transaction and, if it is, the type of hedge transaction. The Company does
not expect that the adoption of SFAS No. 133 will have a material impact on its
consolidated financial statements because the Company does not currently hold
any derivative instruments.
MERCHANDISE RISK -- The Company's success 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.
RECLASSIFICATIONS -- Certain reclassifications have been made in the audited
consolidated 1997 and 1996 financial statements to conform to the 1998
presentation.
F-9
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. DUE FROM FACTOR
Pursuant to the provisions of a factoring agreement, the Company assigns a
substantial portion of its trade accounts receivable to a factor, which assumes
the credit risk with respect to collection of the nonrecourse accounts
receivable. The Company may request advances against a percentage, determined by
the factor, of the qualifying accounts receivable factored at any time before
their maturity date. The factoring charge ranged from .5% to .7% of the
receivables assigned. Interest at the prime rate plus .5% per annum is charged
on advances received through the Company's credit facility. Outstanding advances
on the credit facility are collateralized by the Company's receivables,
inventories, machinery and equipment and intangibles.
The factoring agreement continues in force from year to year and may be
terminated by the Company on June 30, 2002 with 60 days prior written notice or
by the factor at any time after April 1, 2000, with 180 days prior written
notice.
Due from factor consists of the following at December 31, 1998 and 1997:
1998 1997
--------- ---------
(IN THOUSANDS)
Unmatured accounts receivable:
Nonrecourse........................................................... $ 4,187 $ 5,839
With recourse......................................................... 93 653
Allowance for sales returns and markdowns............................... (1,216) (2,491)
--------- ---------
$ 3,064 $ 4,001
--------- ---------
--------- ---------
3. INVENTORIES
Inventories consist of the following at December 31, 1998 and 1997:
1998 1997
--------- ----------
(IN THOUSANDS)
Raw materials.......................................................... $ 2,415 $ 5,889
Work-in-process........................................................ 665 1,096
Finished goods......................................................... 5,245 7,452
--------- ----------
$ 8,325 $ 14,437
--------- ----------
--------- ----------
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.
F-10
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAXES
The provision (benefit) for income taxes consists of the following for the
years ended December 31:
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
Current:
Federal...................................................... $ 91 $ (5,390) $ 5,478
State........................................................ 16 -- 1,503
--------- --------- ---------
107 (5,390) 6,981
--------- --------- ---------
Deferred:
Federal...................................................... -- 1,205 (1,205)
State........................................................ -- 250 (250)
--------- --------- ---------
-- 1,455 (1,455)
--------- --------- ---------
Total provision (benefit) for income taxes..................... $ 107 $ (3,935) $ 5,526
--------- --------- ---------
--------- --------- ---------
The provision (benefit) 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, 1998, 1997 and
1996 are summarized as follows:
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
Provision (benefit) on income at federal statutory tax
rate...................................................... $ (4,655) $ (7,708) $ 6,355
State tax provision (benefit) taxes, net of federal tax
effect.................................................... ( 821) (1,383) 1,449
Increase in valuation allowance............................. 4,777 5,096 --
Limitations on state net operating loss utilization......... 773 -- --
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....................................................... 33 60 (473)
--------- --------- ---------
Total provision (benefit) for income taxes.................. $ 107 $ (3,935) $ 5,526
--------- --------- ---------
--------- --------- ---------
F-11
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAXES -- (CONTINUED)
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, 1998 and 1997 are as
follows:
1998 1997
--------- ---------
(IN THOUSANDS)
Deferred income tax assets (liabilities):
Reserves not currently deductible..................................... $ 1,867 $ 4,192
State income taxes.................................................... (687) (1,058)
Net operating loss carryforward....................................... 8,510 1,776
Other................................................................. 183 186
--------- ---------
Net deferred tax assets................................................. 9,873 5,096
Valuation allowance..................................................... (9,873) (5,096)
--------- ---------
Total net deferred tax asset............................................ $ -- $ --
--------- ---------
--------- ---------
The Company has provided a full valuation allowance on the net deferred tax
asset at December 31, 1998 and 1997 due to the uncertainty regarding its
realization.
As of December 31, 1998, the Company has approximately $17,600,000 and
$15,600,000 of federal and state net operating loss carryforwards, respectively,
available to offset future taxable income which expire in various years through
2013.
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, 1998 and
1997:
1998 1997
--------- ----------
(IN THOUSANDS)
Furniture and fixtures................................................. $ 3,986 $ 6,541
Machinery and equipment................................................ 2,937 4,132
Automobiles............................................................ 153 162
Construction in progress............................................... 342 969
--------- ----------
7,418 11,804
Accumulated depreciation and amortization.............................. (3,211) (2,622)
--------- ----------
$ 4,207 $ 9,182
--------- ----------
--------- ----------
6. LINE OF CREDIT AND LONG-TERM DEBT
The Company maintains a $15,000,000 revolving line of credit, collateralized
by inventory, receivables, machinery and equipment and intangibles, bearing
interest at the prime rate plus .5% (7.75% at December 31, 1998). The Company's
borrowings under the facility are limited to 50% of eligible inventory and 85%
of eligible receivables. The facility also allows for up to $6 million in
letters of credit. At December 31, 1998, there were borrowings totaling
$4,759,000 outstanding under the line of credit. The credit facility has various
restrictive covenants, which include the Company's earnings before interest,
tax, depreciation and amortization (EBITDA), exposure in excess of accounts
receivable availability and capital expenditure limitations. The Company was in
compliance with all debt covenants as of December 31, 1998. In March 1999, the
agreement was amended to commit the revolving line of credit through April 1,
2000, and to allow the Company to borrow amounts in excess of its advance rates
in varying monthly amounts from approximately $1.5 million to $5.5 million. The
amendment also extends the factoring agreement and the line of credit through
June 30, 2002.
Notes payable are due in aggregate monthly installments of $3,900, including
interest from 8.6% to 21.3% per annum, which mature at various dates through
June 2001. The notes are collateralized by the equipment.
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, 1998, 1997 and 1996 were $31,000,
$64,000 and $35,000, 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. During
1998, the Company issued 11,529 shares to employees through the Employee Plan.
As of December 31, 1998, the Company had collected $10,000 toward the purchase
of stock
F-13
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. EMPLOYEE BENEFIT PLANS -- (CONTINUED)
under the Employee Plan and had not yet issued the stock. This amount is
included in accrued liabilities on the accompanying balance sheet. 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, 1998, 1997 and 1996 was $2,492,000, $2,603,000 and
$1,039,000, 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:
1999............................................................. $ 1,773
2000............................................................. 1,522
2001............................................................. 847
2002............................................................. 628
2003............................................................. 563
Thereafter....................................................... 1,642
---------
Total scheduled maturities......................................... $ 6,975
---------
---------
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, 1998, the Company had outstanding letters of credit of $2,072,000.
LITIGATION -- On January 23, 1997, plaintiff Chaile Steinberg filed a
purported class action suit 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"). On April 7, 1997, 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.
F-14
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
Defendants filed a general demurrer in the State Actions, challenging the
legal sufficiency of the complaints. On June 26, 1997, the judge sustained the
defendants' 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.
On July 9, 1998, plaintiffs filed their first amended consolidated complaint
against the same defendants, alleging three causes of action. On September 22,
1998, defendants filed a general demurer to the first amended consolidated
complaint. On March 16, 1999, the judge sustained the demurrer as to the Company
with respect to two of the three causes of action with leave to amend. As to the
third cause of action, the judge sustained the demurrer as to the Company with
respect to three of the five plaintiffs with leave to amend, and overruled the
demurrer with respect to the other two plaintiffs. Plaintiffs have until April
15, 1999 to amend their first amended and consolidated complaint.
Although the outcome of the litigation cannot be predicted, management
believes that the Company has meritorious defenses 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, 1998, 1997 and 1996, sales to one
department store customer in its various regions represented approximately 20%,
13% and 11% 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 10% of the licensee's sales.
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.
F-15
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. STOCKHOLDERS' EQUITY
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
$266,000 and $362,000 at December 31, 1998 and 1997, 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. Options granted thereunder have an exercise price equal to the
fair market value of the common stock on the date of grant.
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.
Changes in shares under option for the 1995 Plan and the Directors Plan (the
"Plans") are summarized as follows:
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------
1998 1997 1996
------------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES PRICE SHARES PRICE SHARES PRICE
------------ ----------- ---------- ----------- ---------- -----------
Outstanding, beginning of year........... 405,600 $ 18.02 494,500 $ 20.23 -- --
Granted................................ 1,148,200 $ 3.45 90,600 $ 7.56 498,500 $ 20.22
Canceled............................... 346,350 $ 13.71 179,500 $ 18.85 4,000 $ 18.00
------------ ----------- ---------- ----------- ---------- -----------
Outstanding, end of year................. 1,207,450 $ 5.40 405,600 $ 18.02 494,500 $ 20.23
------------ ----------- ---------- ----------- ---------- -----------
------------ ----------- ---------- ----------- ---------- -----------
Options exercisable, end of year......... 236,825 $ 12.96 113,832 $ 20.70 -- --
------------ ----------- ---------- ----------- ---------- -----------
------------ ----------- ---------- ----------- ---------- -----------
Weighted average fair value of options
granted during the year................ $ 3.01 $ 4.16 $ 7.22
----------- ----------- -----------
----------- ----------- -----------
F-16
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. STOCKHOLDERS' EQUITY -- (CONTINUED)
Outstanding stock options for the Plans at December 31, 1998 consist of the
following:
OPTIONS OUTSTANDING
---------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -----------------------
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE
- ----------------- ------------ ------------- ----------- ---------- -----------
$2.00 - $ 5.00... 1,057,850 9.7 $ 3.36 125,200 $ 4.46
$6.00 - $ 8.50... 33,100 8.2 7.74 11,025 7.75
$9.00 - $26.00... 116,500 7.6 23.28 100,600 24.11
------------ --- ----------- ---------- -----------
1,207,450 9.5 $ 5.40 236,825 $ 12.96
------------ --- ----------- ---------- -----------
------------ --- ----------- ---------- -----------
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, 1998,
1997 and 1996 assuming risk-free interest rates of 5.29%, 5.75% and 5.2%,
respectively; volatility of 141%, 106% and 30%, respectively; zero dividend
yield; and expected lives of five years for all periods. The Company applies
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", 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.
As of December 31, 1998 there were 542,550 shares of common stock under the
Plans that were available for future grant.
STOCK OPTION PLAN FOR EDWIN LEWIS. On November 30, 1998, the Board of
Directors adopted the Stock Option Plan for Edwin Lewis (the "Lewis Plan"). The
total number of shares of common stock of the Company authorized for issuance
upon exercise of options under the Lewis Plan is established at 6,186,111,
subject to adjustment.
On November 30, 1998, subject to approval by the stockholders of the
Company, the Board of Directors granted the following stock options to Mr. Lewis
(the "Lewis Options") under the Lewis Plan: (i) a Nonqualified Stock Option
Agreement, under which Mr. Lewis was granted an immediately exercisable option
to purchase up to 5,152,778 shares of the common stock at a purchase price of
$3.00 per share, (i.e., the fair market value of the common stock on the date of
grant); (ii) an Incentive Stock Option Agreement, under which Mr. Lewis was
granted an immediately exercisable option to purchase up to 33,333 shares of
common stock at a purchase price of $3.00 per share; (iii) a Nonqualified
Performance Stock Option Agreement, under which Mr. Lewis was granted an option
to purchase up to 966,667 shares of common stock at a purchase price of $3.00
per share, with such options vesting on November 30, 2005, subject to
accelerated vesting upon the happening of certain events relating in part to the
common stock price; and (iv) a Performance Incentive Stock Option Agreement,
under which Mr. Lewis was granted an option to purchase 33,333 of common stock
at a purchase of $3.00 per share, with such options vesting on November 30,
2005, subject to accelerated vesting upon the happening of certain events
relating in part to the common stock price (together, the "Stock Option
Agreements").
F-17
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. STOCKHOLDERS' EQUITY -- (CONTINUED)
In connection with the execution of the Stock Option Agreements, the Company
and Mossimo Giannulli entered into (i) a Contribution Agreement dated as of
November 30, 1998, pursuant to which Mr. Giannulli has agreed to contribute to
the Company a number of shares of common stock equal to the aggregate number of
shares of common stock to be issued by the Company upon Mr. Lewis' exercise of
the Lewis Options and (ii) an Escrow Agreement dated as of November 30, 1998,
pursuant to which Mr. Giannulli agreed to place 6,186,111 shares of common stock
in an escrow account pending Mr. Lewis' exercise of the Lewis Options (together,
the "Funding Agreements"). Mr. Giannulli entered into the Funding Agreements for
no consideration payable by the Company.
The options contemplated by the Nonqualified Stock Option Agreement and the
Nonqualified Performance Stock Option Agreement will expire upon the earlier of
(i) November 30, 2018 and (ii) one year from the date of the death of Mr. Lewis.
The options contemplated by the Incentive Stock Option Agreement and the
Performance Incentive Stock Option Agreement will expire upon the earlier of (i)
November 30, 2008 and (ii) one year from the date of the death of Mr. Lewis.
Pursuant to the terms of the Escrow Agreement, if any Lewis Options expire,
shares of common stock underlying the Lewis Options will revert back to Mr.
Giannulli.
The Lewis Options have a weighted average remaining life of 18.4 years. The
fair value of each option is $2.86 and was estimated as of the grant date using
the Black-Scholes option-pricing model assuming a risk-free interest rate of
5.29% volatility of 141%, zero dividend yield and an expected life of seven
years.
As of December 31, 1998, 5,436,111 options are exercisable. There are no
remaining shares available for grant under the Lewis Plan.
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
income (loss) and net income (loss) per share would have resulted in the
approximate pro forma amounts indicated below for the years ended December 31,
1998, 1997 and 1996:
1998 1997 1996
---------- ---------- ----------
(IN THOUSANDS EXCEPT PER SHARE)
----------------------------------
Actual net income (loss)..................................................... $ (13,798) $ (18,736) $ 12,630
Pro forma net income (loss).................................................. (28,827) (19,113) 12,111
Actual net income (loss) per share:
Basic and diluted.......................................................... $ (.92) $ (1.25) $ .84
Pro forma net income (loss) per share:
Basic and diluted.......................................................... $ (1.92) $ (1.27) $ .81
F-18
MOSSIMO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. VALUATION AND QUALIFYING ACCOUNTS
Changes in the allowance for doubtful accounts, allowance for sales returns
and markdowns and lease restructuring reserve for the years ended December 31,
1998, 1997 and 1996, are as follows:
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END
OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
------------- -------------- --------------- -------------
Year ended December 31, 1998:
Allowance for doubtful accounts................ $ 891,000 $ 419,000 $ (614,000) $ 696,000
Allowance for sales returns and markdowns...... 2,491,000 4,162,000 (5,437,000) 1,216,000
Allowance for lease restructuring.............. -- 3,792,000 (3,593,000) 199,000
Year ended December 31, 1997:
Allowance for doubtful accounts................ $ 700,000 $ 406,000 $ (215,000) $ 891,000
Allowance for sales returns and markdowns...... 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 and markdowns...... 190,000 7,549,000 (6,574,000) 1,165,000
14. RELATED PARTY TRANSACTIONS
In October 1998, the Company entered into a lease agreement for a facility
in Santa Monica, California with 3002 Pennsylvania Avenue, LLC, of which Mr.
Giannulli is a partner. The Company intended to open a design studio in the
facility, however, due to management changes within the Company, these plans
were terminated. The Company is currently reviewing whether to open a showroom
in this facility. The annual rent obligation under the lease for the facility is
approximately $77,000.
On November 30, 1998, in connection with the transactions associated with
the appointment of Edwin H. Lewis as President, Chief Executive Officer and
Director of the Company, the Company entered into a Registration Rights
Agreement (the "Registration Rights Agreement") with Mossimo Giannulli and Edwin
H. Lewis. Pursuant to the Registration Rights Agreement, the Company granted
each of Mr. Giannulli and Mr. Lewis limited demand registration rights to
facilitate the resale of certain securities owned by them and certain piggyback
rights to sell their securities in connection with certain offerings of
securities of the Company.
F-19