**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

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**FORM 10-K**

**x**                              ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**FOR THE FISCAL YEAR ENDED DECEMBER 31,2005**

**OR**

**o**                                 TRANSITION REPORT PURSUANT TO SECTION 13OR 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)           |   |                     |
| **2016 BROADWAY**                        |   | **90404**                |
| **SANTA MONICA, CALIFORNIA**             |   | (Zip Code)               |
| (Address of principal executive offices) |   |                     |

 

**(310) 460-0040**

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of theAct:** None**

Securities registered pursuant to Section 12(g) of theAct:** Common stock, par value $.001 per share**

Indicate by check mark if the Registrantis a well-known seasonal issuer, as defined in rule 405 of the SecuritiesAct. Yes o No x

Indicate by check mark if the Registrantis not required to file reports pursuant to Section 13 or Section 15(d) ofAct. Yes o No x

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x No o

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference and Part IIIof this Form 10-K or any amendment to this Form 10-K. x

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

| Large accelerated  filer o | Accelerated filer o | Non-accelerated filer x |
|---------------------------------|--------------------------|------------------------------|

 

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o No x

The aggregate market value of the votingstock held by non-affiliates of the registrant on June 30, 2005, the lastbusiness day of the registrant’s most recently completed second quarter wasapproximately $24,759,000 (based on the closing sales price of the registrant’scommon stock on that date).

The registrant had 15,899,749 shares ofcommon stock, par value $.001 per share outstanding at February 28, 2006.

**DOCUMENTSINCORPORATED BY REFERENCE**

Part III of this Form 10-Kincorporates by reference information from the Registrant’s Proxy Statement forthe 2006 Annual Meeting of Stockholders to be filed within 120 days of the endof the fiscal year ended December 31, 2005.

 

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**FORWARD LOOKING INFORMATION**

This report on Form 10-K contains certainforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. These forward looking statements relate tomatters such as the Company’s future operating results, the success andlongevity of its licensing program with Target in the United States, and otherlicensees, and the Company’s success in executing its business plan for ModernAmusement. Such forward-looking statements are based on the beliefs of theCompany’s management as well as assumptions made by and information currentlyavailable to the Company’s management. The words “anticipate”, “believe”, “may”,“estimate”, “plan”, “expect”, “future”, “intend”, “will”, “should”, “continue”and similar expressions, variations of such terms or the negative of such termsas they relate to the Company or its management when used in this document, areintended to identify such forward-looking statements. In particular, theforward looking statements in this Form 10-K include, among otherthings, statements regarding or expectations about our future revenues andearnings. Forward looking statements include known or unknown risks and uncertaintiesthat may cause our results, performance and stock price to be materiallydifferent from the forward looking statements. Such statements are based onmanagement’s current expectations and are subject to certain risks,uncertainties and assumptions, including those described in “Business—RiskFactors”. Should one or more risks or uncertainties materialize, or shouldunderlying assumptions prove incorrect, the Company’s actual results,performance or achievements could differ materially from those expressed in, orimplied by such forward-looking statements. The Company’s future operations,financial performance, business and share price may be affected by a number offactors, including but not limited to the financial condition of the apparelindustry and the retail industry, the overall level of consumer spending, theeffect of intense competition from other apparel lines, within and outside ofTarget Stores, adverse changes in licensee or consumer acceptance of productsbearing the Mossimo or Modern Amusement name as a result of fashion trends orotherwise, the ability and/or commitment of Target and our other licensees tomanufacture and market Mossimo branded products, our dependence on Target formost of our revenue, our dependence on key management personnel and the otherfactors described in “Business-Risk Factors.” Accordingly, undue relianceshould not be placed on these forward-looking statements.

**PART I**

**ITEM 1—BUSINESS**

**GENERAL**

Mossimo, Inc.(the “Company”) is a Delaware corporation formed in November 1995, andpresently operates as a designer and licensor of apparel and related productsunder the “Mossimo” brand and other brands it owns or may acquire. The Companylicenses the Mossimo brand to third parties domestically and internationally,our primary domestic licensee is Target Corporation. Our design and licensingstrategy is operated with the understanding that almost all aspects ofmoderately priced apparel and accessories can be sourced more effectively bylarge retailers who interact daily with the end consumer and who operate withsignificant economies of scale. By direct sourcing, stocking and selling widelyrecognized brand names licensed from others, these retailers in general may beable to obtain higher gross margins and increase store traffic, than throughcarrying only private label goods or brands, from third-party vendors.

In addition to the Target Agreement, the Company also licenses itsMossimo trademarks and provides design services outside of the United States,and also licenses its Mossimo trademarks for use in collections of eyewear andwomen’s swimwear and bodywear sold in Target stores in the United States.

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**MODERN AMUSEMENT**

In January 2004,the Company acquired Modern Amusement, which is focused on design anddistribution of premium branded west coast-lifestyle casual sportswear appareland related accessories for young men and young women under the ModernAmusement brand. The products are offered at moderate to upper price pointsthrough traditional specialty stores and better department store distributionchannels. The Modern Amusement business includes sourcing manufacturedproducts, wholesale distribution, inventory management, marketing, promoting,and advertising of apparel and related accessories under the Modern Amusementbrand. While the Modern Amusement business is relatively small, as the Companyexpands into the wholesale products business, it will encounter increasedexposure to excess and obsolete inventories, potential delays and cancellationsfrom sourcing manufactured products domestically and internationally, andproduct returns and allowances from retail customers, as well as marketing,promotion and advertising expenditures that may not result in successfulcampaigns.

The Company’s strategy in developing Modern Amusement is todiversify the Company’s current design and licensing businesses through thedevelopment of mass wholesale distribution channels.

**DESIGN ANDMERCHANDISING**

The cornerstone of the Company’s business is its ability to designproducts embodying the image of a contemporary, active, and youthful lifestyle.The Company’s designs are inspired by subtle changes in culture and societyincluding such areas as music, television, cinema, architecture and other formsof artistic expression, and appeal to the contemporary consumer. The work ofthe Company’s design staff reflects the Company’s fashion conscious consumer asthey consistently monitor changes in fashion, style, culture and society, anddevelop designs that interpret such trends considering the targeted consumergroup. The Company’s product design and merchandising services provided tolicensees, along with the right to approve design, advertising, and promotionalmaterials are an important aspect for continuity of product quality, maintainingand enhancing the Company’s distinctive image and the value of its Mossimotrademark.

**LICENSING**

*Domestic Licensing*

The Companyentered into a multi-year licensing and design services agreement with Targetin March 2000 which was subsequently amended in April 2002, and in February andJune 2003 (hereinafter referred to as the “Target Agreement”). Under theterms of the Target Agreement, Target has the exclusive license, for productionand distribution through Target stores, of substantially all Mossimo brandedproducts sold in the United States. The Company, therefore can not enter intoany other wholesale or retail licensing agreements in the United States withrespect to the Mossimo brand.

Under the TargetAgreement, the Company provides design services and has approval rights forproduct design, marketing and advertising materials. Target collaborates on productdesign and is responsible for product development, sourcing, quality controland inventory management with respect to the Target licensed product line.Target is obligated to pay the Company design service fees and license royaltyfees. Total fees payable by Target are based upon a percentage of Target’s netsales of Mossimo brand products that varies according to the volume of sales ofmerchandise. Target has agreed to pay minimum guaranteed fees of approximately$9.6 million annually. Target fees are based on net salesachieved multiplied by a rate, as defined in the Target Agreement. The Companypays a 15% commission, based on fees received from Target, to a third party whoassisted the Company in connection with entering into the initial agreementwith Target. If Target is current with payments of its obligations under theTarget Agreement, Target has the right to renew the Target Agreement, on thesame terms and conditions, for additional terms of two years each. In January 2003,Target exercised its first renewal 

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option extending the Target Agreementthrough January 31, 2006. In January 2005, Target exercised itssecond renewal option extending the Target Agreement through January 31,2008. The next renewal option could be exercised by Target on or before January 2007,this renewal option could extend the Target Agreement through January 2010,if it is exercised by Target.

The TargetAgreement is subject to early termination under certain circumstances,including a material failure by Mossimo Giannulli to perform certain servicesor the termination of employment, death or permanent disability of Mr. Giannullior a material change in his ownership or control of the Company which is deemedto materially affect the Company’s ability to perform its obligations under theTarget Agreement.

The Company haslicensed the exclusive right to manufacture and distribute eyewear bearing itsMossimo trademarks through specialty retail stores such as opticians, opticalchains and specialty eyeglass and sunglass stores pursuant to a licenseagreement with the Marcolin Group. This agreement ended on December 31,2004. The Company is in the process of negotiating a new agreement withLuxottica Retail. No eyewear royalty income was earned in 2005.

The Company haslicensed the exclusive right to manufacture and distribute women’s swimwear andbodywear bearing its Mossimo trademarks through Target stores in the UnitedStates pursuant to a license agreement with The Lunada Bay Corporation. Thisagreement extends through September 30, 2006, and is renewable annually.

Under license agreements, the Company grants retailers a licenseto use its trademarks on certain categories of merchandise. The Companyprovides design directions and to the extent licensees desire to modify thedesigns to accommodate seasonal, regional or category needs, the Companyretains approval rights with respect to the design of products, advertising,and marketing. In all cases, all products are subject to our pre-approvedpackaging, graphics and quality control standards. The retailer is responsiblefor manufacturing the merchandise. All payments under the Target Agreement aredue on a quarterly basis and range from one to four percent of net salesdepending on the volume of sales achieved in each contract year. Under allother license agreements, royalty payments are due generally on a quarterlybasis and range from approximately two to five percent of the licensee’s netsales.

*InternationalLicensing*

The Company entersinto international licensing agreements of its Mossimo branded products forcertain geographical territories where the Company believes such arrangementsprovide effective manufacturing, distribution and marketing of such products.The Company generally maintains substantial control over the design, quality,advertising, and marketing of its licensed products, and maintains a policy ofevaluating its licensing arrangements to ensure consistent presentation of theMossimo brand image.

In May 2002, theCompany entered into an agreement with Hudson’s Bay Company. Under theagreement, the Company provided product design services, and granted a licensefor the Mossimo trademark to Hudson’s Bay Company exclusively in Canada, inreturn for license royalties and design service fees. Hudson’s Bay Companycollaborated on product design, and was responsible for manufacturing,importing, marketing, advertising, selling and distributing merchandise bearingthe Mossimo trademark. The initial term of the agreement was three yearsbeginning in May 2002. The agreement expired in May of 2005, weexpect to receive royalty payments through the third quarter of 2006. There areno plans to renew the agreement.

**PRODUCTS**

MEN’S, WOMEN’S ANDCHILDREN’S APPAREL AND ACCESSORIES.   Mossimo branded apparel encompass avariety of products, including: knit and woven tops, including polo shirts andcollared, 

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button-down shirts; outerwear, including sweaters and jackets; denimand related products, including jeans, shirts and jackets; dresses; pants;screenprinted and embroidered sweatshirts and tee-shirts; and shorts. Theseproducts are designed exclusively for distribution under the Company’slicensing agreements. The initial Target licensed product lines were launchedin Target’s stores in the Fall of 2000. The Company complements its apparelproduct lines with footwear and other fashion accessories such as jewelry,watches, handbags, belts, neckwear and gloves.

OPTICS LINE.   The Company had an exclusivelicense agreement with the Marcolin Group for the production and distributionof the Mossimo branded product line of eyewear, including sunglasses, sportglasses and optical frames. Marcolin sells Mossimo branded eyewear throughspecialty retail stores such as opticians, optical chains and specialtyeyeglass and sunglass stores. This agreement, however, permits Target to sellMossimo branded eyewear in Target stores. The license agreement expired on December 31,2004. The Company is negotiating a licensing agreement with Luxottica Retailfor the production and distribution of the Mossimo branded product line ofoptical frames. The Company expects Luxottica Retail will sell Mossimo brandedeyewear through Target stores.

WOMEN’S SWIMWEARAND BODYWEAR.   The Mossimo branded product line ofwomen’s swimwear and bodywear is manufactured and distributed through Targetstores in the United States under an exclusive license agreement with TheLunada Bay Corporation. The high quality swimwear products include one-pieceand two-piece swimsuits which are fashion-oriented and targeted towardsyouthful-minded, body-conscious women. The line of women’s bodywear is acollection of fashionable fitness active wear which is designed and manufacturedusing materials such as lycra, tactel and flexcel nylon that stretch andcompensate for body movements during strenuous exercise. The license agreementextends through September 30, 2006, and is renewable annually.

MODERN AMUSEMENT BRANDED PRODUCTS.   Modern Amusement is focused ondesign and distribution of premium branded west coast-lifestyle casualsportswear apparel and related accessories for young men under the ModernAmusement trademarked brand.

**SOURCING, MANUFACTURING, AND DISTRIBUTION**

*Design and Licensing.*   Under the Company’s retaillicensing agreement, the retailer is responsible for product development,sourcing, manufacturing, quality control, distribution, and inventorymanagement.

*Modern Amusement.*   The Modern Amusement business includes sourcingmanufactured products, distribution, and inventory management of apparel andrelated accessories under the Modern Amusement trademarked brand. We currentlypurchase most of our product from international vendors. We supply themanufacturers with the product design and fabric selection. We do not maintainany long-term or exclusive commitments or arrangements to purchase merchandisefrom any single supplier, and there are many vendors who could supply ourmerchandise. We warehouse and distribute our finished goods through afulfillment company. Write downs are taken as required affecting the sale ofslow-moving inventory. Written down merchandise that remain unsold is sold to aclearance company.

**MARKETING ANDADVERTISING**

*Design and Licensing.*   The Company has developed adistinctive image of a contemporary, active, and youthful lifestyle and strivesto maintain consistency through the coordination of product merchandising,advertising, and marketing promotions.

Under itsLicensing Agreements, the Company primarily relies on its licensees toadvertise the Mossimo branded product and intends to continue to promote apositive brand image through licensee-sponsored advertising and marketingpromotions. The Company has approval rights for marketing and advertisingmaterials.

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*Modern Amusement.*   The Modern Amusement business includes marketing andadvertising of apparel and related accessories under the Modern Amusement brandthrough tradeshows, as well as promoting the Modern Amusement brand.

**TRADEMARKS**

The Companyutilizes a variety of trademarks, including the script Mossimo (signature),MOSS, MOSSIMO (in block lettering), Baby Moss, M (in a box design), and MossimoGiannulli trademarks. Currently, the Company has 14 registrations and 2 pendingapplications for its trademarks in the United States, and approximately 350trademark registrations and applications in over 70 other countries.

In connection withthe Modern Amusement business, the Company acquired worldwide trademark rightsfor Modern Amusement and the Crow Design marks, except for the Asia territory.The current Modern Amusement trademark portfolio includes 17 registrations and5 pending applications in eleven nations.

The Company regards its trademarks and other proprietary rights asvaluable assets and believes they have significant value in the sales andmarketing of its products. The Company vigorously protects its trademarksagainst infringement by using, among other things, cease-and-desist letters,administrative proceedings, and applicable legal action.

**PERSONNEL**

The Company currently employs twenty-two full time employees, ofwhom nine are employed by Modern Amusement. Four additional employees areemployed by Target on the Company’s behalf. The salaries for the employeesemployed by Target are deducted from Target Royalty payments to the Company. TheCompany also employs temporary personnel on an as needed basis. A substantialnumber of the Company’s personnel and resources are dedicated to providingdesign services. The Company believes that it is able to recruit and retain thehigh level of creative personnel to continue to provide the necessary designservices to maintain the continuity of product quality, the Company’sdistinctive image, and the value of its trademarks. None of the Company’s employeesare covered by collective bargaining agreements. The Company considers itsrelations with its employees to be satisfactory.

**CODE OF ETHICS**

The Company hasadopted a Code of Ethics in accordance with the rules of the Securitiesand Exchange Commission and NASDAQ. A copy of such a code can be obtained bywritten request from:

Chief Financial OfficerMossimo, Inc.2016 BroadwaySanta Monica, CA 90404

**RISK FACTORS**

In addition to the other information contained herein orincorporated by reference, the risks and uncertainties and other factorsdescribed below could have a material adverse effect on our business, financialcondition, results of operations, cash flows and share price and could alsocause our future business, financial condition and results of operations andcash flows to differ materially from the results contemplated by anyforward-looking statement we may make herein, in any other document we filewith the Securities Exchange Commission, or in any press release or otherwritten or oral statement we may make.

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***DEPENDENCE ON THE TARGET STORES LICENSE WHICH ACCOUNTED FOR 69% OFOUR CONSOLIDATED REVENUES IN 2005.***

The Company’srevenues under the Target Agreement commenced in November 2000, andrepresented 69% in 2005, 79% in 2004, and 88% in 2003, of total consolidatedrevenue. The Company expects that its revenues under the Target Agreement willcontinue to represent a significant portion of the Company’s total revenuesduring the remaining term of the Target Agreement, which has been extended throughJanuary 2008, and is subject to future extension. Because the amount ofthe Company’s revenues under the Target Agreement are dependent on the sales ofMossimo branded products in Target stores, the Company’s revenue potential isimpacted by the number of Target stores and the patronage at these stores, andTarget’s ability and/or commitment to manufacture and market Mossimo brandedproducts. Termination or non-extension of the Target Agreement, or a materialadverse change in the business of Target stores, could have a material adverseeffect on the Company’s business, financial condition, and results ofoperations. The term of the Amended Target Agreement currently extends until January 31,2008 and, unless Target stores gives us one year’s advance notice of itsintention to terminate the agreement, the Agreement will continue toautomatically renew provided that Target stores has paid a minimum guaranteedroyalty equal to or greater than $9.6 million for the preceding fiscal year. IfTarget stores elects to terminate the agreement, effective after January 31,2008 or at any other time, it would have a material adverse effect on ourbusiness, financial condition, cash flows and results of operations. There canbe no guarantee that we would be able to replace the Target stores royaltypayments from other sources. The Amended Target Agreement, however, requiresone year’s advance notice of termination by Target stores to prevent automaticrenewal, during which period we believe we could enter into one or morelicensing agreements for the Mossimo brand with either retailers and/orwholesalers, which we expect would enable us to replace some of the lostrevenues from Target stores. Nonetheless, we could suffer substantiallydecreased royalty revenues under the Target Agreement if Target were to reduceits sale of Mossimo branded products while continuing to pay the minimumroyalties required under the agreement.

Modern Amusement is in theearly stages of development with an unproven business model and a shortoperating history, which makes it difficult to evaluate our current businessand future prospects for this segment of our business. The risks anddifficulties we encounter include acceptance of the Modern Amusement brand,manufacturing arrangements, management of inventory and distribution andoverall execution of a successful business model. In 2005, Modern Amusement hadan operating loss of $1.45 million. There is no assurance that the ModernAmusement business will become profitable on an operating basis in the nearterm.

***CHANGES IN FASHIONTRENDS***

The apparel industry is subject to rapidly changing consumerdemands and preferences, which may adversely affect companies which misjudgesuch demands and preferences. The Company believes that its success depends onits ability to anticipate, gauge and respond in a timely manner to changingconsumer demands and fashion trends. There can be no assurance that the Companywill be successful in this regard. If fashion trends shift away from theCompany’s products, or if the Company otherwise misjudges the market for itsproduct lines, resulting in a decline in sell-through rates at retail, theCompany may be faced with conditions which could have a material adverse effecton the Company’s financial condition and results of operations. Decisions withrespect to product designs often need to be made several months in advance ofthe time when consumer acceptance of such products is known. In addition, anyfailure by the Company to identify and respond to changing demands and trendscould adversely affect consumer acceptance of the Mossimo and Modern Amusementbrand names, which may have an adverse effect on the Company’s business andprospects.

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***NEW PRODUCTINTRODUCTIONS***

The Company’s success is dependent upon its ability to create anddevelop new product designs and new product lines. As is typical with newproducts, demand for and market acceptance of new designs and productsintroduced by the Company is subject to uncertainty. There can be no assurancethat the Company’s efforts will be successful. In addition, the failure of newproduct designs or new product lines to gain sufficient market acceptance couldadversely affect the image of the Mossimo brand name and consumers’ demand forother Mossimo and Modern Amusement branded products.

***DEPENDENCE ON KEYPERSONNEL***

The success of the Company is largely dependent on the efforts andabilities of its design staff, which includes Mossimo Giannulli, the Company’sfounder and Co-Chief Executive Officer. The Company has only twenty-sixemployees, and Mr. Giannulli’s leadership and experience in the apparellicensing industry is critical to the successful implementation of the Company’sbusiness and marketing strategy. The Company has key person life insurancecovering Mr. Giannulli. The Target Agreement is subject to earlytermination under certain circumstances, including a material failure by Mr. Giannullito perform certain services or the termination of employment, death orpermanent disability of Mr. Giannulli, or a material change in hisownership or control of the Company which is deemed to materially affect theCompany’s ability to perform its obligations under the Target Agreement. During2005, the Company extended the employment agreement with Mr. Giannullithru January 2008. The loss of Mr. Giannulli services could have amaterial adverse effect on our business, financial condition, and results ofoperations.

***COMPETITION***

Competition in thecontemporary apparel and related fashion accessories industry is extensive. TheCompany’s products are subject to competition from designer and non-designerlines sold in a wide variety of retail stores, including Target stores, many ofwhich have increased in recent years the amount of sportswear and activewearmanufactured specifically for them and sold under their own private labels.

The Company’s Mossimo branded products compete based on factorsincluding brand name appeal, design, style and color selection, quality ofgarment construction and price. Such competitors include Cherokee, Sideout, TheGAP, Old Navy, V.F. Corp., Levi Strauss, Quicksilver, among others. Increasedcompetition by existing and future competitors could result in reductions inretail sales and reductions in revenues to the Company, orreduction of prices of the Company’s products that could have a materialadverse effect on the Company’s revenues, financial condition, and results ofoperations. The Company’s success is dependant on its licensees’ ability tomanufacture and sell product bearing the Mossimo brand and to respond to everchanging consumer demands. The Company’s Modern Amusement branded productscompete based on factors including brand name appeal, design, style and colorselection, and quality of garment construction. Such competitors include Diesel,Penguin, Lacoste, Fred Perry, Howe, Ben Sherman, 7 Diamond, Paper, Denim &Cloth, AG Jeans, among others. Increased competition by existing and futurecompetitors could result in reductions in retail sales and reductions inrevenues to the Company, or reduction of prices of the Company’s products thatcould have a material adverse effect on the Company’s revenues, financialcondition, and results of operations. The Company expects that its productswill continue to face significant competition in the future, in particular asother companies with established trademarks enter into licensing arrangementswith retailers.

***UNCERTAINTIES INAPPAREL RETAILING; GENERAL ECONOMIC CONDITIONS***

The apparel industry historically has been subject to substantialeconomic cyclical variations. Economic observers have recently commented thatthe United States economy may be rebounding. As the economic conditions changethe trends in discretionary consumer spending become unpredictable, and 

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could be subject to reductions due touncertainties about the future. When discretionary spending is reduced,purchases of apparel and related products tend to decline. Additionally, thecontinued military responses to current international military situations, andpossible future terrorist attacks on the United States may exacerbate currenteconomic conditions and lead to a downturn in the economy. Adverse economicconditions and any related decreases in discretionary spending by consumerscould have a material adverse effect on the Company’s results of operations.

***PROTECTION OFTRADEMARKS***

The Company believes that its trademarks and other proprietaryrights are important to its success and its competitive position. Accordingly,the Company devotes substantial resources to the establishment and protectionof its trademarks on a worldwide basis. There can be no assurance that theactions taken by the Company to establish and protect its trademarks and otherproprietary rights will be adequate to prevent imitation of its products byothers or to prevent others from seeking to block sales of the Company’sproducts as a violation of the trademarks and proprietary rights of others. Noassurance can be given that others will not assert rights in, and ownership of,trademarks and other proprietary rights of the Company. In addition, the lawsof certain foreign countries do not protect proprietary rights to the sameextent as do the laws of the United States. Despite our efforts to protect ourintellectual property rights, unauthorized parties may attempt to copy aspectsof our intellectual property, which would have a material adverse effect on ourbusiness prospects, financial condition, results of operations and liquidity. Inthe future we may be required to assert infringement claims against thirdparties, and there can be no assurance that one or more partieswill not assert infringement claims against us. While we currently have theresources to pursue or defend most infringement claims, any resultinglitigation could result in significant expense and divert the efforts of ourmanagement personnel whether or not such litigation is determined in our favor.

***CONTROL BYPRINCIPAL STOCKHOLDERS***

Mossimo Giannulli has majority control of the Company and theability to control the election of directors and the results of other matterssubmitted to a vote of stockholders. Such concentration of ownership, togetherwith the anti-takeover effects of certain provisions in the Delaware GeneralCorporation Law and in the Company’s Certificate of Incorporation and Bylaws,may have the effect of delaying or preventing a change in control of theCompany that other stockholders may view as beneficial.

***CHANGING CORPORATEGOVERNANCE AND PUBLIC DISCLOSURE REGULATIONS***

We are subject to rules andregulations by various governing bodies, including the Securities and ExchangeCommission, NASDAQ and Public Company Accounting Oversight Board, that arecharged with the protection of investors and the oversight of companies whosesecurities are publicly traded. Our efforts to comply with these newregulations, most notably the Sarbanes-Oxley Act, or SOX, have resulted in, andare likely to continue to result in, increased general and administrativeexpenses and a diversion of management time and attention fromrevenue-generating activities to compliance activities.

In 2007, we willbe required to comply on an on-going basis with the SOX requirements involvingthe assessment of our internal controls over financial reporting and ourexternal auditors’ audit of that assessment. Our efforts to comply with the SOXrequirements will require us to commit significant financial and managerialresources.

Moreover, because these laws, regulations and standards aresubject to varying interpretations, their application in practice may evolveover time as new guidance becomes available. This evolution may result incontinuing uncertainty regarding compliance matters and additional costsnecessitated by ongoing 

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revisions to our disclosure and governancepractices. If we fail to address and comply with these regulations and anysubsequent changes, our business may be harmed.

***CERTAIN FEDERALTAX CONSEQUENCES***

In addition to theCompany’s taxable income being subject to federal, state and local incometaxes, the Company may be classified as a “personal holding company” from timeto time. Personal holding company status results from more than 50% of thevalue of outstanding stock being owned directly or indirectly by five or fewerindividuals, and more than 60% of the Company’s income, as defined, beingderived from royalties. Personal holding companies are subject to an additionalfederal tax at a 15% tax rate on undistributed after tax earnings.

Over 50% of the value of the Company’s outstanding stock is ownedby one stockholder, and in 2002 and 2001, more than 60% of the Company’sincome, as defined, was derived from license royalties. Accordingly, theCompany was classified as a personal holding company in 2002 and 2001. However,no personal holding company tax was due in 2002 because the Company recognizedcertain expenses for tax purposes in 2002 that had been recognized in previousyears for financial reporting purposes, and which offset the taxable incomesubject to personal holding company tax in 2002. In addition, no personalholding company taxes were due in 2001 because the Company was able to use itstax operating loss carry forward to offset the taxable income subject topersonal holding company tax in 2001. In 2003, 2004 and 2005 less than 60percent of the Company’s income, as defined, was derived from licenseroyalties, accordingly it was not classified as a personal holding company andwas not subject to the personal holding company tax. The Company intends tocontinue to take appropriate measures to avoid being classified as a personalholding company in future years. However, there can be no assurance that theCompany will be successful in its efforts to avoid classification as a personalholding company in the future.

**ITEM 1B—UNRESOLVEDSTAFF COMMENTS**

None.

**ITEM 2—PROPERTIES**

The Company’s current corporate headquarters and design studiosare located in Santa Monica, California and consist of a leased facilitytotaling approximately 6,000 square feet of space. In January 2004, theCompany expanded its leased facilities from 6,000 to approximately 9,000 squarefeet of space to  accommodate newlyacquired Modern Amusement at a near-by but separate facility.

**ITEM 3—LEGALPROCEEDINGS**

On April 12,2005, Mossimo Giannulli (“Giannulli”) offered to acquire all of the outstandingpublicly held common stock of the Company at a price of $4.00 per share. Followingthe announcement, six purported class action lawsuits were filed in the Courtof Chancery of the State of Delaware. Each of the complaints asserted that thedirectors breached their fiduciary duties to the Company’s shareholders, andsought an injunction preventing the acquisition. On April 19, 2005, theBoard of Directors appointed a Special Committee to consider and evaluate Mr. Giannulli’sproposal. The Special Committee retained Houlihan Lokey and Gibson Dunn &Crutcher to serve as the Committee’s independent financial advisor and legalcounsel, respectively, with respect to the Committee’s evaluation of Mr. Giannulli’sproposal. On May 27, 2005, the above referenced cases were consolidatedunder the following caption: In re Mossimo, Inc. Shareholder Litigation,Consolidated Civil Action No.1246-N (the “Action”).

On October 10,2005, the Company and other defendants entered into a Memorandum ofUnderstanding (“MOU”) to settle the Action. Under the terms of the MOU,Giannulli agreed that his proposal to acquire all of the Company’s outstandingshares would be priced at $5.00 per share and that 

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the tender offer pursuant to which the acquisition was proposed tobe consummated would be conditioned upon no less than 50 percent of all publicstockholders of the Company unaffiliated with Giannulli accepting or approvingthe tender offer. The MOU further provided that plaintiffs’ lead counsel wouldbe afforded the opportunity to comment on and suggest inclusions to thedisclosures made to the Company’s public stockholders in conjunction with theacquisition. In addition, the Company agreed to negotiate in good faith withthe plaintiffs’ lead counsel concerning the amount of attorney fees and expensesto be paid, subject to Delaware Chancery Court approval. The Company also  agreed to pay whatever fee and expense amountthe Delaware Chancery Court might have awarded to plaintiffs’ lead counsel. Inconsideration of these terms, the parties agreed that they would fully andfinally release and discharge all claims against each other.

The settlement was conditioned on the consummation of theacquisition by Giannulli, the negotiation of a definitive stipulation ofsettlement and the entry of a Final Order and Judgment approving the settlementby the Delaware Chancery Court. On November 14, 2005 Giannulli announcedthat he had withdrawn the proposal to acquire the outstanding shares of theCompany that he did not already own. The provisions of the MOU have thus becomemoot. The Action remains on file. The Company is working with plaintiffs’counsel to seek voluntary dismissal of the Action.

**ITEM 4—SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

On December 15, 2005, the Companyheld its Annual Meeting of Shareholders. The following are the results of thevarious proposals submitted for stockholder approval:
| a.         | ** ** | **Election of Directors**                     | ** ** | ** ** | ** ** | **For**     | ** ** | **Withheld** | ** ** | ** ** | ** ** |
|------------|------------|---------------------------------------------------------|------------|------------|------------|-------------|------------|--------------|------------|------------|------------|
|       |       | Mossimo G. Giannulli                                    |       | 12,951,253 |       | 2,238,004   |       |         |       |
|       |       | Edwin H. Lewis                                          |       | 12,951,253 |       | 2,241,004   |       |         |       |
| ** ** | ** ** | ** **                                              | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain**  | ** ** |
| b.         |       | Amended and Restated Mossimo Giannulli Bonus Plan  |       | 10,906,110 |       | 2,316,261   |       | 25,620       |       |
| c.         |       | Amended and Restated Edwin Lewis Bonus Plan             |       | 10,944,659 |       | 2,278,375   |       | 24,960       |       |
| d.         |       | Mossimo, Inc. 2005 Stock Option Plan               |       | 10,874,141 |       | 2,348,239   |       | 25,614       |       |

** **

**PART II**

**ITEM 5—MARKET FOR REGISTRANT’S COMMONEQUITY AND RELATED STOCKHOLDER MATTERS**

Our common stock trades on The NasdaqStock Market under the symbol MOSS. The table below sets forth for each of thefiscal quarters during our last two fiscal years the range of the high and lowclosing price for our common stock.
| Fiscal Year ended December 31, 2005 | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First Quarter                                                |       | $          | 4.10       |     | $          | 3.13    |       |
| Second Quarter                                               |       | $          | 4.53       |     | $          | 3.32    |       |
| Third Quarter                                                |       | $          | 5.72       |     | $          | 4.25    |       |
| Fourth Quarter                                               |       | $          | 5.91       |     | $          | 4.94    |       |
| **Fiscal Year ended December 31, 2004**                 | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter                                                |       | $          | 4.95       |     | $          | 3.80    |       |
| Second Quarter                                               |       | $          | 4.39       |     | $          | 3.79    |       |
| Third Quarter                                                |       | $          | 4.16       |     | $          | 2.88    |       |
| Fourth Quarter                                               |       | $          | 3.87       |     | $          | 2.99    |       |

 

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The high and lowsales prices on the Company’s common stock reported on the Nasdaq Stock Marketon February 28, 2006 were $6.30 and $6.10 per share, respectively. On February 28,2006, the closing sales price of the Company’s common stock reported on theNasdaq Stock Market was $6.29 per share.

As of February 28, 2006, the Company had 205 stockholders ofrecord. This does not include beneficial owners whose shares may be held ofrecord by brokerage firms and clearing agencies.

**DIVIDENDS**

To date, the Company has never paid a dividend on its common stock.Any future determination as to the payment of dividends will be at thediscretion of the Company’s Board of Directors and will depend upon the Company’sresults of operations, financial condition, contractual restrictions, andchanges in the tax laws, and other factors deemed relevant by the Board ofDirectors.

**ITEM 6—SELECTEDFINANCIAL DATA**

The following table sets forth certainselected financial data regarding the Company which is qualified by referenceto, and should be read in conjunction with, the consolidated financialstatements and notes thereto (see “Index to Financial Statements”) and “Item 7- Management’s Discussion and Analysis of Financial Condition and Results ofOperations.” The statement of earnings and balance sheet data presented belowhas been derived from the Company’s audited financial statements.
|                                                                      | ** ** | **YEARS ENDED DECEMBER 31,**                                 | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                           | ** ** | **(IN THOUSANDS, EXCEPT FOR PER SHARE DATE)** | ** ** |
| STATEMENTS OF EARNINGS DATA:                                         |       |                                                                        |       |   |   |   |   |   |   |   |   |
| Revenue from license  royalties & design service fees  |       | $                                                                           | 24,298     |   | $ | 18,714 |   | $ | 19,895 |   | $ | 19,881 |   | $ | 16,666 |   |
| Product sales                                                        |       | 6,730                                                                       |       | 1,821 |   | — |   | — |   | — |   |
| Total revenues                                                       |       | 31,028                                                                      |       | 20,535 |   | 19,895 |   | 19,881 |   | 16,666 |   |
| Operating expenses:                                                  |       |                                                                        |       |   |   |   |   |   |   |   |   |
| Cost of product sales                                                |       | 3,993                                                                       |       | 1,241 |   | — |   | — |   | — |   |
| Selling, general, and  administrative expenses                       |       | 20,294                                                                      |       | 14,843 |   | 12,834 |   | 11,925 |   | 10,455 |   |
| Goodwill impairment loss                                             |       | 212                                                                         |       | — |   | — |   | — |   | — |   |
| Settlement costs of  disputed commissions                            |       | —                                                                      |       | 71 |   | 643 |   | 600 |   |   |   |
| Total operating expenses                                             |       | 24,499                                                                      |       | 16,155 |   | 13,477 |   | 12,525 |   | 10,455 |   |
| Operating earnings                                                   |       | 6,529                                                                       |       | 4,380 |   | 6,418 |   | 7,356 |   | 6,211 |   |
| Other income (expense):                                              |       |                                                                        |       |   |   |   |   |   |   |   |   |
| Other, net                                                           |       | —                                                                      |       | — |   | — |   | 181 |   | 536 |   |
| Interest Income                                                      |       | 420                                                                         |       | 104 |   | 23 |   | 75 |   | 74 |   |
| Interest expense                                                     |       | —                                                                      |       | — |   | — |   | (351 | ) | (938 | ) |
| Other income (expense),  net                                         |       | 420                                                                         |       | 104 |   | 23 |   | (95 | ) | (328 | ) |
| Earnings before income  taxes                                        |       | 6,949                                                                       |       | 4,484 |   | 6,441 |   | 7,261 |   | 5,883 |   |
| Income tax expense  (benefit) (a)                                    |       | 2,248                                                                       |       | 1,783 |   | 1,875 |   | (6,404 | ) | (3,153 | ) |
| Net earnings                                                         |       | $                                                                           | 4,701      |   | $ | 2,701 |   | $ | 4,566 |   | $ | 13,665 |   | $ | 9,036 |   |
| Net earnings per common share:                                       |       |                                                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                                |       | $                                                                           | 0.30       |   | $ | 0.17 |   | $ | 0.29 |   | $ | 0.89 |   | $ | 0.59 |   |
| Diluted                                                              |       | $                                                                           | 0.30       |   | $ | 0.17 |   | $ | 0.29 |   | $ | 0.87 |   | $ | 0.59 |   |
| Weighted average common shares outstanding:                          |       |                                                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                                |       | 15,751                                                                      |       | 15,738 |   | 15,613 |   | 15,409 |   | 15,080 |   |
| Diluted                                                              |       | 15,784                                                                      |       | 15,759 |   | 15,658 |   | 15,648 |   | 15,080 |   |
|                                                                      |            |                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Note (a): Reflects the reductions of thevaluation allowance against certain components of deferred tax assets in 2002and 2001.
|                                      | ** ** | **DECEMBER 31,**   | ** ** |
|--------------------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                           | ** ** | **(IN THOUSANDS)** | ** ** |
| BALANCE SHEET DATA:                  |       |                    |       |   |   |   |   |   |   |   |   |
| Working Capital                      |       | $                       | 24,016     |   | $ | 14,243 |   | $ | 11,918 |   | $ | 5,971 |   | $ | (1,342 | ) |
| Total Assets                         |       | 32,234                  |       | 23,473 |   | 26,413 |   | 20,536 |   | 9,294 |   |
| Long-term debt                       |       | —                  |       | — |   | — |   | — |   | — |   |
| Other long-term  Liabilities         |       | —                  |       | — |   | — |   | 191 |   | 1,596 |   |
| Stockholders’ equity  (deficit) |       | 26,873                  |       | 21,713 |   | 19,012 |   | 13,480 |   | (678 | ) |
|                                      |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7—MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

Management’s Discussion and Analysis should be read in conjunctionwith the Company’s consolidated financial statements and the notes thereto setforth in this Form 10-K commencing on page F-1.

**RESULTS OFOPERATIONS**

**YEAR ENDED DECEMBER 31, 2005 COMPARED TOYEAR ENDED DECEMBER 31, 2004**

Our financial results are significantly impacted by key executivecompensation, the development of the Modern Amusement business, and by theretail sales of our Mossimo branded products under the licensing and designservices agreement with Target, which is exclusive to the United States.

*Revenues*

Under the Target Agreement,we earn fees based on percentage of Target stores net sales of Mossimo brandedproducts. The percentage we earn varies according to the volume of sales. Thecontract year for Target sales was from February 1st to January 31st.We earn 4% on the first $100 million of sales, 21¤4% on $100 million to $500 millionof sales, and 1% on sales above $500 million each year. As a result, ourrevenues from license royalties and design service fees are highest at thebeginning of each contract year and decrease throughout each year as Targetreaches the specific retail thresholds. Therefore, the amount of the royaltyrevenue received by us in any quarter is dependent not only on retail sales ofbranded products in such quarter, but also the cumulative level of retailsales, and the resulting attainment of royalty rate reductions in any precedingquarters in the same year.

Revenues from Target were 69% and 79% of total revenues in 2005and 2004, respectively. The change in 2005 was primarily due to the largercontribution to total revenues of Modern Amusement. Modern Amusement generatedrevenues of $6.73 million in 2005 compared to $1.82 million in 2004. Totalrevenue in 2005 increased by $10.5 million, or 51.1% from 2004. The remainingincrease was due to growth of the Target business which increased royaltyincome from Target 33% from 2004. The increase in Target revenue was primarilydue to increased volume of consumer purchases of Mossimo brandedproducts in 2005 at Target stores. Net sales of Mossimo branded products at Target stores increasedby 50% to $1.3 billion in 2005 from $868 billion in 2004.

*Cost of productsales*

Cost of sales in 2005 resulted entirely from Modern Amusementproduct sales. Cost of sales approximated 59% of sales as compared to 68% in2004. We experienced a higher profit margin from 2004 due to a greater brandawareness which resulted in better buying and a proportionality smaller amountof off price sales compared to regular priced sales. Cost of sales includes allcosts and expenses incurred prior to the receipt of finished goods at theCompany’s distribution facilities. These costs include, but are not limited to,product cost, inbound freight charges, purchasing and receiving costs,inspection costs, insurance, duty, and brokers’ fees.

*Selling, generaland administrative expenses*

Selling, generaland administrative expenses (SG&A) for both the Mossimo segment and theModern Amusement segment increased approximately $5.66 million or 38% from$14.8 million in 2004 to $20.3 million in 2005.

Operationalexpenses for the Mossimo segment, as a percent of revenues from royalties anddesign service fees, increased to 67% for 2005 compared to 64% for 2004. Selling,general and administrative 

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expenses (SG&A) for the Mossimo segment increased byapproximately $4.27 million or 26% from $12.0 million in 2004 compared to$16.3 million in 2005, principally due to: (i) increases of accruedexecutive officer bonuses of $2.73 million (Executive bonuses were increased to$3.34 million for 2005 from $607,000 for 2004 consistent with the Company’scomparative performance.) These bonuses which are determined at the discretionof the Compensation Committee, in accordance with a performance criteriaoutlined in respective bonus plans, and are subject to a maximum annual amountbased on a percent of Target license royalty fees in excess of the minimumannual fee, are estimated and accrued on a quarterly basis, with a finaldetermination made by the Compensation Committee at the end of each year. Inthe fourth quarter, management and the compensation committee concluded thatthe Company achieved its performance targets previously established in thebonus plan, and accordingly, approved bonuses of approximately $3.34 millionfor 2005. The bonuses were accrued ratably throughout the year as Targetlicense royalties were projected. Exclusive of the bonus accruals operationalexpenses would have been 53% of royalty and design fees in 2005 compared to 61%in 2004, (ii) commissions due to a third party who assisted the Company inconnection with entering into the initial agreement with Target increased by$610,000 to $3.23 million in 2005 compared to $2.62 million for 2004, theincrease was due to the increased revenue generated from Target in 2005, and (iii) $2.18million increase in costs incurred for legal and financial advisor expenses forthe Company and its special committee associated with the review andconsideration of the transaction proposed by Mossimo Giannulli for theacquisition of all of the companies remaining outstanding shares and pendinglitigation relating to the proposal. The increases in SG&A were offsetprimarily by decreases in non-executive officer salaries of $497,000 and travelexpense of $486,000 as well as some operational improvements.

Selling, generaland administrative expenses for the Modern Amusement segment for 2005 were$3.98 million compared to $2.80 million for the period of January 16, 2004to December 31, 2004. The increase was primarily due to: (i) commissionsof $257,000, (ii) sample costs of $199,000, (iii) outsourcing of$190,000,(iv) advertising and promotion of $248,000, (v) bad debts of$88,000,  and (vi) depreciation andamortization of $141,000. These increases were associated with the growth ofthe Modern Amusement brand.

The ModernAmusement segment is tested for goodwill impairment on an annual basis at theend of the fourth quarter. Due to the expected continuing investment in theModern Amusement brand, the cash flow from this reporting segment is expectedto be negative until 2008. In December 2005, a goodwill impairment loss of$212,000 was recognized in the Modern Amusement reporting segment. The fairvalue of that reporting segment was estimated using the expected present valueof future cash flows.

Provision for income taxes increased from 2004 to 2005 by $465,000due to an increase in income. The 2005 and 2004 provision for income taxes iscomprised of a deferred provision of $1.7 million and $1.2 million,respectively, and a current provision of $509,000 and $612,000, respectively. Theeffective rate decreased to 32.3% in 2005 compared to 39.8% in 2004, thedecrease in the rate was due to the reduction of the valuation allowance. As ofDecember 31, 2005, the Company has approximately $10.2 million and $8.2million of federal and state income tax net operating loss carry-forwards,respectively, available to offset future taxable income, which expires invarious years through 2022.

**YEAR ENDED DECEMBER 31, 2004 COMPARED TOYEAR ENDED DECEMBER 31, 2003**

Revenues fromTarget were 79% and 88% of total revenues in 2004 and 2003, respectively. Thechange in 2004 was primarily due to the contribution to revenues of ModernAmusement, and the sale of our Mossimo branded products in Canada under alicensing and design services agreement with Hudson’s Bay Company fordistribution through its Zellers stores exclusively in Canada. Total revenuesfor 2004 were $20.5 million compared to $19.9 million in 2003. The increase wasprimarily due to revenues of $1.82 million generated from Modern Amusement.Total revenue in 2004 increased by $0.6 million, or 3% 

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from 2003, and revenue from Target decreased 7% from 2003. Thedecrease in Target revenue was primarily due to reduced consumerpurchases of Mossimo branded products in 2004 at Target stores.

Cost of sales in2004 resulted entirely from Modern Amusement product sales. Cost of sales approximated68% of sales. We experienced a low profit margin due to markdowns as theCompany attempted to penetrate the wholesale distribution channel. Cost ofsales included all costs and expenses incurred prior to the receipt of finishedgoods at the Company’s distribution facilities. These costs include, but arenot limited to, product cost, inbound freight charges, purchasing and receivingcosts, inspection costs, insurance, duty, and brokers’ fees.

The majorcomponents of selling, general and administrative (SG&A)****expenses were payroll, executive bonuses, commissionspayable to a third party in connection with the Target agreement, and expensesincurred in connection with design related and business development activitiessuch as travel, samples and artwork purchases, and free-lance artists, as wellas facilities, legal, accounting, and insurance expenses. Our SG&Aincreased approximately $2.0 million or 16% from 2003 to 2004, principally dueto the acquisition of Modern Amusement in January of 2004 and an increasein travel expense of $519,000 from 2003 primarily attributed to developing andmarketing the Modern Amusement business. Selling, general and administrativeexpenses for the Modern Amusement segment for 2004 were $2.8 million. Althoughoverall SG&A increased in 2004, executive bonuses decreased by $1.25million in 2004 from 2003. Executive bonuses were reduced consistent with theCompany’s comparative performance. These bonuses which are determined at thediscretion of the Compensation Committee, in accordance with a performancecriteria outlined in respective bonus plans, and are subject to a maximumannual amount based on a percent of Target license royalty fees in excess ofthe minimum annual fee, are estimated and accrued on a quarterly basis, with afinal determination made by the Board of Directors at the end of each year. Inthe fourth quarter of 2004, management and the Compensation Committee concludedthat the Company was not going to achieve its performance targets previouslyestablished in the bonus plan, and accordingly, accrued bonuses ofapproximately $1.13 million were reversed.

Provision for income taxes decreased from 2003 to 2004 by $92,000due to a decrease in income. The 2004 and 2003 provision for income taxes arecomprised of a deferred provision of $1.2 million and $1.1 million and acurrent provision of $612,000 and $766,000, respectively. The effective rateincreased to 39.8% in 2004 compared to 29.1% in 2003. The 2003 tax effectivetax rate included the benefit of foreign tax credits and alternative minimumtax credits that had previously been fully reserved.

**LIQUIDITY ANDCAPITAL RESOURCES**

Our sources ofliquidity and capital resources as of December 31, 2005 consisted of $19.7million of cash and cash equivalents, and $0.7 million of short-term restrictedcash, as well as potential future cash flows from operations primarilyresulting from the Target agreement. As of December 31, 2005 we hadpositive working capital of approximately $24.0 million compared to $14.3million at December 31, 2004. The increase in working capital is due toincreased earnings and associated collections and revenues from Target in the twelvemonths ended December 31, 2005. The increase in cash of $14.8 million wasprincipally due to the sale of $4.8 million in investment securities and cashflow from operating activities of approximately $10.0 million.

Cash provided by operatingactivities includes primarily $4.7 million of net earnings, deferred incometaxes of $1.5 million, accrued commissions of $130,000, and accrued bonuses of$3.3 million, primarily offset by a change in accounts receivable of $1.5million. The change was primarily due to the increase in accrued revenue fromTarget, which increased accrued commissions payable to a third party andaccrued bonuses.

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Net cash providedby investing activities was primarily generated from the sale of securities of$4.8 million, classified as available-for-sale. Capital expenditures forthe twelve months ended December 31, 2005 were $181,000.

Net cash used byfinancing activities was primarily generated from obtaining additionalcertificates of deposits in the amount of $313,000 used to secure letters ofcredit with foreign supplies for finished goods for Modern Amusement. Net cashprovided by financing activities was generated from the exercise of stockoptions in the amount of $418,000.

The Companyestablished a revolving line of credit with a bank in the amount of $300,000 inFebruary 2004. The line of credit was established to open letters ofcredit with foreign suppliers for finished goods for Modern Amusement. The lineof credit was increased to $400,000 in June of 2004, and subsequentlyincreased to $500,000 in January of 2005 and increased again to $900,000in May of 2005. The line of credit is secured by three certificates ofdeposit totaling approximately $726,000, which is recorded as restricted cashin our consolidated balance sheet. There is no expiration date for this line,and there are no covenants. There is a fee charged per letter of credit openedand closed. Open letters of credit at December 31, 2005 were approximately$875,000.

We have acommission obligation under an agreement with a third party for 15% of feesreceived from Target for the duration of the Target Agreement through January 2008,and for subsequent extensions if they are exercised by Target. Fees incurredunder this obligation were $3.2 million in 2005 and $2.6 million in 2004.

In January 2004we completed the acquisition of Modern Amusement and we amended our facilitylease increasing our space from approximately 6,000 square feet toapproximately 9,000 square feet, and extending the lease term thru July 2009.The expanded facility is intended to also accommodate Modern Amusement. Thefuture annual obligation under the amended lease varies each year, starts atapproximately $290,000 in 2004, increasing to $334,000 in 2008. The purchaseprice of the Modern Amusement assets of $375,000 was funded with existing cash.The expected cash requirements in 2006 for Modern Amusement are approximately$600,000, and is comprised mainly of selling, general, and administrativeexpenses. Most of this working capital will be satisfied through operating cashflows, and we do not expect to incur any significant capital expenditures.

The Company isapproached from time to time by parties seeking to sell their businesses,brands and related trademarks. Should an established viable business andmarketable brand become available on favorable terms, the Company may beinterested in pursuing such an acquisition and may elect to fund suchacquisition, in whole or in part, with available cash as well as differentfinancing alternatives, including the issuance of debt instruments and / orequity securities.

We believe thatthe Company’s sources of liquidity and capital will be sufficient to meet ourexpected operational and capital needs for the next 12 months and likely willbe sufficient to meet our operating needs for the foreseeable future and atleast through January 2008, which is the most recently extended contractterm with Target.

The following table provides informationrelated to our contractual cash obligations under various financial andcommercial agreements (amounts in thousands):

| ** **                                | ** ** | **Payments Due by Period(s):** | ** ** | ** **                          | ** ** |
|-------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------------|------------|
| **Contractual Obligations**          | ** ** | ** **                                    | ** ** | **Less than 1 year** | ** ** | **1 - 3 years** | ** ** | **4 - 5 years** | ** ** | **After 5 years** | ** ** | **Total** | ** ** |
| Operating  Leases(a)                      |       |                                          | $          | 315                                 |       |   |   | $ | 657 |   |   |   | $ | 196 |   |   |   | $ | — |   |   | $ | 1,168 |   |
| Other Long-Term  Obligations(b), (c)      |       |                                          | 2,865      |                                |       |   | 2,535 |   |   |   | — |   |   |   | — |   |   | 5,400 |   |
| Total Contractual Cash  Obligations  |       |                                          | $          | 3,180                               |       |   |   | $ | 3,192 |   |   |   | $ | 196 |   |   |   | $ | — |   |   | $ | 6,568 |   |
|                                           |            |                                               |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Notes:

(a)           These amounts represent future minimum non-cancelable leasepayments under an operating lease agreement through July 2009 for ouroffice and design studio facilities in Santa Monica, California including thefacilities for Modern Amusement.

(b)          These amounts include $900,000 per year under our employmentagreement with Mossimo Giannulli, our Chairman and Co-Chief Executive Officerthrough January 2008, that provides for a $900,000 annual salary, plus abonus which is determined at the discretion of the Board of Directors, inaccordance with a performance criteria outlined in the Amended and RestatedMossimo Giannulli Bonus Plan, and is subject to a maximum annual amount basedon a percent of Target license royalty fees in excess of the minimum annual feeunder the Target Agreement. The future bonus amounts, if any, have beenexcluded because they are at the discretion of the Board of Directors and cannot be determined.

These amounts also include $900,000 per year, commencing August 1,2005, under our employment agreement with Edwin Lewis, our Co-Chief ExecutiveOfficer through August 1, 2006, that provides for a $900,000 annualsalary, plus a bonus which is determined at the discretion of the Board ofDirectors, in accordance with a performance criteria outlined in the Amendedand Restated Edwin Lewis bonus plan, and is subject to a maximum annual amountbased on a percent of Target license royalty fees in excess of the minimumannual fee under the Target Agreement. The future bonus amounts, if any, havebeen excluded because they are at the discretion of the Board of Directors andcan not be determined.

(c)           We have a commission obligationunder an agreement with a third party for 15% of fees received from Target forthe duration of the Target agreement through January 2008, and forsubsequent extensions if they are exercised by Target. The future commissionsare based on the minimum royalty and design fee payment from target ofapproximately $9.6 million through January 2008.

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

**REVENUERECOGNITION**

Revenue fromlicense royalties and design service fees are recognized in accordance with theterms of the underlying agreements, which is generally after the designservices are performed, and as the licensee achieves sales of the Company’sproducts. Revenue from license royalties and design service fees are generallycollected on a quarterly basis, and they range from one percent to five percentof sales as defined in the respective agreements. During the periods presentedherein, a substantial amount of the Company’s revenue from license royaltiesand design fees were generated under the Target Agreement under a decliningrate as the year progresses and Target achieves certain levels of retail sales.Accordingly, the Company’s revenues from Target decrease as the yearprogresses. The declining rate is reset each contract year beginning on February 1.Revenue recognized in the first and second quarters of the Company’s calendaryear in connection with the Target Agreement is significantly higher than inthe third and fourth quarters of the Company’s calendar year due to thedeclining rates in the Target Agreement. If Target sales of Mossimo brandedproducts increase in the future, as a result of opening new stores orotherwise, the minimum rate of fees may apply earlier in the Company’s futurecalendar years, shifting additional revenue recognition to the first half ofthe year, and potentially reducing the revenue recognition in the second halfof the year.

Modern Amusementextends credit to customers in the normal course of business, subject toestablished credit limits. Accounts receivable, net, in the consolidatedbalance sheets, consists of amounts due from customers net of allowance fordoubtful accounts. The allowance for doubtful accounts is 

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determined by reviewing accounts receivable aging and evaluatingindividual customer receivables, considering customers’ financial condition,credit history and current economic conditions.

Modern Amusement recognizes wholesale operations revenue from thesale of merchandise when products are shipped, FOB Modern Amusement’sdistribution facilities, and the customer takes title and assumes risk of loss,collection is reasonably assured, pervasive evidence of an arrangement exists,and the sales price is fixed or determinable.

**INVENTORY**

We maintaininventories for the Modern Amusement segment of our business. Inventories arevalued at the lower of cost (first-in, first-out) or market. The Companycontinually evaluates its inventories by assessing slow moving current productas well as prior seasons’ inventory. Market value of non-current inventory isestimated based on the impact of market trends, an evaluation of economicconditions and the value of current orders relating to the future sales of thistype of inventory.

To the extent that management’s estimates of price reductionsnecessary to rapidly sell inventory differ from actual results, additionalprice reductions may be required that could reduce our gross margin, operatingincome and the carrying value of inventories. Our success is largely dependentupon our ability to anticipate the changing fashion tastes of our customers andto respond to those changing tastes in a timely manner. If we fail to anticipate,identify or react appropriately to changing styles, trends or brand preferencesof our customers, we may experience lower sales, excess inventories and morefrequent and extensive markdowns, which would adversely affect our operatingresults.

**IMPAIRMENT OFLONG-LIVED ASSETS**

Goodwill represents the excess of costs over fair value of assetsof businesses acquired. Goodwill and intangible assets acquired in a purchasebusiness combination and determined to have an indefinite useful life are notamortized, but instead tested for impairment at least annually in accordancewith the provisions of FASB Statement No. 142, Goodwill and OtherIntangible Assets. Intangible assets with estimable useful lives are amortizedover their respective estimated useful lives to their estimated residualvalues, and reviewed for impairment in accordance with FASB Statement No. 144,Accounting for Impairment or Disposal of Long-Lived Assets.

**DEFERRED TAXES**

The Companyaccounts for income taxes in accordance with SFAS No. 109, “Accounting forIncome Taxes” (SFAS 109). Deferred taxes primarily result from the recognitionof the income tax benefit to be derived from the Company’s net operating losscarry forward for income taxes purposes. As of December 31, 2005, the Companyhas approximately $10.2 million, and $8.2 million of federal and state incometax net operating loss carry-forwards, respectively, available to offset futuretaxable income, which expires in various years through 2022. In accordance withthe provisions of SFAS No. 109 the Company records a valuation allowanceto reduce deferred tax assets to the amount expected to “more likely than not”be realized in future tax returns. The Company monitors its profitability andconsiders the credit and collections risk of future fees under its agreements,particularly in connection with the Target Agreement. Should we determine thatwe would not be able to realize all or part of our net deferred tax assets inthe future, adjustments to the valuation allowance for deferred tax assets maybe required.

In addition to theCompany’s taxable income being subject to federal, state and local incometaxes, the Company may be classified as a “personal holding company” from timeto time. Personal holding company status results from more than 50 percent ofthe value of outstanding stock being owned directly or indirectly by five orfewer individuals, and more than 60 percent of the Company’s income, asdefined, 

19

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being derived from royalties. Personal holding companies aresubject to an additional federal tax at a 15 percent tax rate onundistributed after tax earnings.

Over 50 percent of the value of the Company’s outstanding stock isowned by one stockholder. In 2005, 2004 and 2003, less than 60 percent of theCompany’s income as defined was derived from license royalties, accordingly theCompany is not classified as a personal holding company and is not subject tothe personal holding company tax. The Company intends to continue to takeappropriate measures to avoid being classified as a personal holding company infuture years. However, there can be no assurance that the Company will besuccessful in its efforts to avoid classification as a personal holding companyin the future.

**CONTINGENCIES ANDLITIGATION**

Management evaluates contingent liabilities including pending orthreatened litigation in accordance with SFAS No. 5, and records accrualswhen the outcome of these matters is deemed probable and the amount of theliability is subject to reasonable estimation. Management makes theseassessments based on the facts and circumstances available at the time, and insome instances based in part on the advice of outside counsel.

**INFLATION**

The Company does not believe that the relatively moderate rates ofinflation experienced in the United States over the last three years have had asignificant effect on its operations. Since the Company’s future revenues arebased on a percentage of sales of licensed products by licensees, the Companydoes not anticipate that inflation will have a material impact on futureoperations.

**EXCHANGE RATES**

The Company receives United States dollars for all its revenuefrom license royalties and design service fees, other than from its business inCanada, which began in 2003 and does not represent a substantial amount ofrevenue at this time. During the last three fiscal years, exchange ratefluctuations have not had a material impact on the Company’s operating results.The Company does not engage in hedging activities with respect to exchange raterisk.

**IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS**

In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and ErrorCorrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3.”This statement applies to all voluntary changes in accounting principle andchanges required by an accounting pronouncement where no specific transitionprovisions are included. SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. Retrospective application islimited to the direct effects of the change; the indirect effects should berecognized in the period of the change. This statement carries forward withoutchange the guidance contained in APB Opinion No. 20 for reporting thecorrection of an error in previously issued financial statements and a changein accounting estimate. However, SFAS No. 154 redefines restatementas the revising of previously issued financial statements to reflect thecorrection of an error. The provisions of SFAS No. 154 are effectivefor accounting changes and corrections of errors made in fiscal periods thatbegin after December 15, 2005, although early adoption is permitted. TheCompany does not anticipate that the implementation of this standard will havea material impact on its financial condition and results of operations.

In December 2004,the FASB issued SFAS No. 123R (revised 2004), “Share-Based Payment.”SFAS No. 123R addresses the accounting for share-based paymenttransactions in which a company 

20

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receives employee services in exchange for either equityinstruments of the company or liabilities that are based on the fair value ofthe company’s equity instruments or that may be settled by the issuance of suchequity instruments. SFAS No. 123R eliminates the ability to accountfor share-based compensation transactions using the intrinsic method that iscurrently used and requires that such transactions be accounted for using afair value-based method and recognized as expense in the consolidated statementof earnings. SFAS No. 123R is effective for the Company on January 1,2006. Accordingly, the Company will adopt SFAS No. 123R in our firstquarter of 2006. See Note 1 Summary of Business Description and SignificantAccounting Policies—Stock-Based Compensation for the pro forma effects of howSFAS No. 123R would have affected results of operations in 2005, 2004 and2003. We are currently assessing the impact this prospective change inaccounting guidance will have on our financial condition and results ofoperations, but we believe that the impact will not be material.

In November 2004,the FASB issued SFAS No. 151, “Inventory Costs, an amendment ofAccounting Research Bulletin No. 43, Chapter 4.” SFAS No. 151requires that abnormal amounts of idle facility expense, freight, handlingcosts and wasted materials (spoilage) be recorded as current periodcharges and that the allocation of fixed production overhead to inventory bebased on the normal capacity of the production facilities. SFAS No. 151is effective for the Company on January 1, 2006. The Company does notbelieve that the adoption of SFAS No. 151 will have a material impacton its consolidated financial statements.

In November 2002, the FASB issued FASB Interpretation No. 45(“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others”. This interpretationclarifies the requirements of a guarantor in accounting for and disclosingcertain guarantees issued and outstanding. The initial recognition andmeasurement provisions of this interpretation are applicable on a prospectivebasis to guarantees issued after December 31, 2002. The Company licensesits trademarks, provides design services and has approval rights for productdesign, marketing and advertising materials under licensing and design serviceagreements which include certain provisions for indemnifying the licensee. Asan element of its standard commercial terms, the Company includes anindemnification clause in its licensing and design services agreements thatindemnifies the licensee against liability and damages arising from any claims,suits, damages, or costs relating to the breach of any warranty,representation, term or condition made or agreed to by its licensees involvingthe manufacture, packaging, distribution, promotion, sale, marketing,advertising or other use of the trademarks under license. We believe that ourpolicies and practices limit our exposure related to the indemnificationprovisions of the license and design services agreements. For several reasons,including the lack of prior indemnification claims and the lack of monetaryliability limit for certain infringement cases under the license and designservices agreements, we cannot determine the maximum amount of potential futurepayments, if any, related to such indemnification provisions.

**ITEM 7A—QUANTITATIVEAND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

The Company makes temporary investments of cash in liquid interestbearing accounts and marketable securities. The Company does not use interestrate swaps, futures contracts or options on futures, or other types ofderivative financial instruments. The Company does not believe that futuremarket risks arising from holdings of its financial instruments will have amaterial impact on its financial position or results of operations.

**ITEM 8—FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

The financial statements required to be filed hereunder are setforth on pages F-1 through F-18 of this report.

21

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**ITEM 9—CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

Not applicable.

**ITEM 9A—CONTROLSAND PROCEDURES**

Based on theirevaluation as of December 31, 2005, our Co-Chief Executive Officers andChief Financial Officer have concluded that our internal controls anddisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Act of 1934, as amended) wereeffective to ensure that the information required to be disclosed by us in thisannual report on Form 10-K was recorded, processed, summarized andreported within the time periods specified in the SEC’s rules andinstructions for Form 10-K.

Our management, including our Co-Chief Executive Officers andChief Financial Officer, does not expect that our internal controls anddisclosure controls and procedures will prevent all errors and all fraud. Acontrol system, no matter how well conceived and operated, can provide onlyreasonable, not absolute assurance that the objectives of the control systemare met. Further, the design of the control system must reflect the fact thatthere are resource constraints, and the benefits of controls must be consideredrelative to their costs. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within the Company have beendetected.

**CHANGES IN INTERNAL CONTROLS OVERFINANCIAL REPORTING**

There are no changes in our internal controls over financialreporting during the quarter ended December 31, 2005 that have materiallyaffected, or are reasonably likely to materially affect our internal controlsover financial reporting.

**ITEM 9B—OTHERINFORMATION**

None.

**PART III**

**ITEM 10—DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

The information required by this item will be contained in theCompany’s Proxy Statement for its 2006 Annual Stockholders Meeting to be filedwith the Securities and Exchange Commission within 120 days after December 31,2005 and is incorporated herein by reference.

**ITEM 11—EXECUTIVECOMPENSATION**

The information required by this item will be contained in theCompany’s Proxy Statement for its 2006 Annual Stockholders Meeting to be filedwith the Securities and Exchange Commission within 120 days after December 31,2005 and is incorporated herein by reference.

**ITEM 12—SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

The information required by this item will be contained in theCompany’s Proxy Statement for its 2006 Annual Stockholders Meeting to be filedwith the Securities and Exchange Commission within 120 days after December 31,2005 and is incorporated herein by reference.

22

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**ITEM 13—CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

The information required by this item will be contained in theCompany’s Proxy Statement for its 2006 Annual Stockholders Meeting to be filedwith the Securities and Exchange Commission within 120 days after December 31,2005 and is incorporated herein by reference.

**ITEM 14—PRINCIPALACCOUNTING FEES AND SERVICES**

The information required by this item will be contained in theCompany’s Proxy Statement for its 2006 Annual Stockholders Meeting to be filedwith the Securities and Exchange Commission within 120 days after December 31,2005 and is incorporated herein by reference.

**ITEM 15—EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

(a)(1) Listof Financial Statements—see Index to Financial Statements on page 26.

(2) List of Financial Statement Schedules—None

(b) List ofExhibits

The exhibitslisted in the accompanying Index of Exhibits are filed as part of this Form 10-K.

23

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**EXHIBIT INDEX**
| 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            |        |       | Mossimo License Agreement, dated as of  March 28, 2000, between Mossimo, Inc. and Target Stores, a division  of Target Corporation(2) |       |
|             | 10.3.1          |        |       | Amendment to License and Design Services  Agreement, dated February 1, 2002(7)                                                             |       |
|             | 10.3.2          |        |       | Consent of Assignment and Amendment to  License and Design Services Agreement dated February 2, 2003(8)                                    |       |
|             | 10.3.3          |        |       | Amendment to License and Design Services  Agreement dated June 20, 2003(9)                                                                 |       |
|             | 10.5            |        |       | Cherokee-Mossimo Finders Agreement dated  March 27, 2000 between Mossimo, Inc. and Cherokee Inc.(2)                                   |       |
|             | 10.6            |        |       | Lease, dated June 29, 2000, between  the Registrant and Lexington-Broadway Place, LLC(3)                                                   |       |
|             | 10.6.1          |        |       | First Amendment to Office Lease dated  June 26, 2002(9)                                                                                    |       |
|             | 10.6.2          |        |       | Second Amendment to Office Lease dated  January 1, 2004(10)                                                                                |       |
|             | 10.7            |        |       | Sunglasses Agreement, dated as of  December 1, 2000, between Mossimo, Inc., Marcolin S.P.A. and Target  Stores(4)                     |       |
|             | 10.8*           |        |       | Amended and Restated Employment  Agreement between the Registrant and Mossimo Giannulli dated February 1,  2002(7)                         |       |
|             | 10.8.1*         |        |       | Amendment Number One to the Mossimo  Giannulli Employment Agreement, dated September 23, 2002(6)                                           |       |
|             | 10.8.2          |        |       | Amendment Number Two to the Mossimo  Giannulli Employment Agreement, dated March 18, 2002(8)                                               |       |
|             | 10.9            |        |       | Amended and Restated Mossimo Giannulli  Bonus Plan(11)                                                                                          |       |
|             | 10.10           |        |       | Amended and Restated Edwin Lewis Bonus  Plan(11)                                                                                                |       |
|             | 10.11           |        |       | 2005 Stock Option Plan(11)                                                                                                                      |       |
|             | 10.12           |        |       | Form of Stock Option Agreement for  2005 Stock Option Plan(11)                                                                             |       |
|             | 14.1            |        |       | Code of Ethics                                                                                                                                  |       |
|             | 21              |        |       | Subsidiaries of Registrant                                                                                                                      |       |
|             | 23              |        |       | Consent of Independent Registered Public  Accounting Firm - KPMG LLP                                                                            |       |
|             | 31.1            |        |       | Certification of Principal Executive Officer  as required by Rule 13a - 14(a) of the Securities Act of 1934                           |       |
|             | 31.2            |        |       | Certification of Principal Executive  Officer as required by Rule 13a - 14(a) of the Securities Act of  1934                          |       |
|             | 31.3            |        |       | Certification of Principal Financial  Officer as required by Rule 13a - 14(a) of the Securities Act of  1934                          |       |
|             | 32.1            |        |       | Certification of Principal Financial  Officer as required by Rule 13a - 14(a) of the Securities Act of  1934                          |       |
|             | 32.2            |        |       | Certification of Principal Executive  Officer as required by Rule 13a - 14(b) of the Securities Act of  1934                          |       |
|             | 32.3            |        |       | Certification of Principal Financial Officer as required by  Rule 13a - 14(b) of the Securities Act of 1934                           |       |

 

24

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----

NOTES:

(1)          Incorporated byreference from the Registrant’s Registration Statement on Form S-1(No. 33-80597), as amended,which became effective February 22, 1996.

(2)          Incorporated byreference from the Registrant’s Current Report on Form 8-K, dated March 28, 2000.

(3)          Incorporated byreference from the Registrant’s Quarterly Report on Form 10-Q forthe Quarter ended September 30, 2000.

(4)          Incorporated byreference from the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2000.

(5)          Incorporated byreference from the Registrant’s Quarterly Report on Form 10-Q forthe Quarter ended June 30, 2002.

(6)          Incorporated byreference from the Registrant’s Quarterly Report on Form 10-Q forthe Quarter ended September 30, 2002.

(7)          Incorporated byreference from the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2002.

(8)          Incorporated byreference from the Registrant’s Quarterly Report on Form 10-Q forthe Quarter ended March 31, 2003.

(9)          Incorporated byreference from the Registrant’s Quarterly Report on Form 10-Q forthe Quarter ended June 30, 2003.

(10)   Incorporated by reference fromthe Registrant’s Annual Report on Form 10-K for the year ended December 31,2004.

(11)   Incorporated by reference fromthe Registrant’s Form 8-K dated December 15, 2005.

*                    Indicates a management contract orcompensatory plan or arrangement

25

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**SIGNATURES**

Pursuant to the requirements of Section 13or 15(d) of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized on the 31st day of March 2006.
|        |   |   |   | MOSSIMO, INC.                                  |
|--------|--------|--------|--------|------------------------------------------------|
|   |   | By:    |   | /s/ MOSSIMO GIANNULLI                          |
|   |   |   |   | Mossimo  Giannulli*CO-CHIEF EXECUTIVE OFFICER* |

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by the followingpersons on behalf of the Registrant and in the capacities indicated on the 31stday of March 2006.
| /s/ MOSSIMO GIANNULLI  |   | Chairman of the  Board and Co-Chief Executive Officer    |
|------------------------|--------|----------------------------------------------------------|
| Mossimo Giannulli      |   |                                                     |
| /s/ EDWIN  LEWIS       |   | Vice Chairman, President, and Co-Chief Executive Officer |
| Edwin Lewis            |   |                                                     |
| /s/ VICKEN  FESTEKJIAN |   | Chief Financial Officer (Principal Accounting Officer)   |
| Vicken Festekjian      |   |                                                     |
| /s/ ROBERT  MARTINI    |   | Director                                                 |
| Robert Martini         |   |                                                     |
| /s/ WILLIAM  HALFORD   |   | Director                                                 |
| William Halford        |   |                                                     |
| /s/ BRYANT  RILEY      |   | Director                                                 |
| Bryant Riley           |   |                                                     |

 

26

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**MOSSIMO, INC.**

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

|                                                                                                    | ** ** | **PAGE** |
|----------------------------------------------------------------------------------------------------|------------|----------|
| REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING  FIRM                                           |       | F-1      |
| CONSOLIDATED FINANCIAL STATEMENTS:                                                                 |       |     |
| Balance sheets as of December 31, 2005 and 2004                                               |       | F-2      |
| Statements of earnings for the years ended  December 31, 2005, 2004 and 2003                  |       | F-3      |
| Statements of stockholders’ equity for the years ended  December 31, 2005, 2004 and 2003 |       | F-4      |
| Statements of cash flows for the years ended  December 31, 2005, 2004 and 2003                |       | F-5      |
| Notes to consolidated financial statements                                                         |       | F-6      |

 

27

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

The Board ofDirectors and StockholdersMossimo, Inc.:

We have auditedthe accompanying consolidated balance sheets of Mossimo, Inc. andsubsidiary as of December 31, 2005 and 2004, and the related consolidatedstatements of earnings, stockholders’ equity, and cash flows for each of theyears in the three-year period ended December 31, 2005. These consolidatedfinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

We conducted ouraudit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financial statements referred toabove present fairly, in all material respects, the financial position ofMossimo, Inc. and subsidiary as of December 31, 2005 and 2004, andthe results of their operations and their cash flows for each of the years inthe three-year period ended December 31, 2005, in conformity with U.S.generally accepted accounting principles.

/s/ KPMG LLP

Los Angeles, CaliforniaMarch 24, 2006

F-1

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**MOSSIMO, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(INTHOUSANDS, EXCEPT SHARE DATA)**

| ** **                                                                                                                                                          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                          | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ASSETS                                                                                                                                                              |       |                  |       |   |   |
| CURRENT ASSETS:                                                                                                                                                     |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                           |       | $                     | 19,658     |   | $ | 4,903 |   |
| Restricted cash                                                                                                                                                     |       | 726                   |       | 413 |   |
| Investments                                                                                                                                                         |       | —                |       | 4,800 |   |
| Accounts receivable, net                                                                                                                                            |       | 4,372                 |       | 2,908 |   |
| Merchandise inventory                                                                                                                                               |       | 101                   |       | 539 |   |
| Deferred income taxes                                                                                                                                               |       | 4,004                 |       | 1,869 |   |
| Prepaid expenses and other current assets                                                                                                                           |       | 388                   |       | 436 |   |
| Total current assets                                                                                                                                                |       | 29,249                |       | 15,868 |   |
| PROPERTY AND EQUIPMENT, at cost, net of accumulated  depreciation and amortization                                                                                  |       | 893                   |       | 1,117 |   |
| DEFERRED INCOME TAXES                                                                                                                                               |       | 1,923                 |       | 6,068 |   |
| GOODWILL                                                                                                                                                            |       | —                |       | 212 |   |
| TRADENAME                                                                                                                                                           |       | 90                    |       | 112 |   |
| OTHER ASSETS                                                                                                                                                        |       | 79                    |       | 96 |   |
|                                                                                                                                                                |       | $                     | 32,234     |   | $ | 23,473 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                           |       |                  |       |   |   |
| CURRENT  LIABILITIES:                                                                                                                                               |       |                  |       |   |   |
| Accounts payable                                                                                                                                                    |       | $                     | 884        |   | $ | 352 |   |
| Accrued liabilities                                                                                                                                                 |       | 503                   |       | 809 |   |
| Accrued commissions                                                                                                                                                 |       | 388                   |       | 258 |   |
| Accrued bonuses                                                                                                                                                     |       | 3,458                 |       | 206 |   |
| Total current liabilities                                                                                                                                           |       | 5,233                 |       | 1,625 |   |
| DEFERRED RENT                                                                                                                                                       |       | 128                   |       | 135 |   |
| Total liabilities                                                                                                                                                   |       | 5,361                 |       | 1,760 |   |
| 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 15,828,754 at December 31, 2005 and 15,738,442  at December 31, 2004 |       | 15                    |       | 15 |   |
| Additional paid-in capital                                                                                                                                          |       | 40,222                |       | 39,763 |   |
| Accumulated deficit                                                                                                                                                 |       | (13,364               | )          | (18,065 | ) |
| Net stockholders’ equity                                                                                                                                       |       | 26,873                |       | 21,713 |   |
|                                                                                                                                                                |       | $                     | 32,234     |   | $ | 23,473 |   |

 

See accompanying notes to consolidated financial statements

F-2

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**MOSSIMO, INC.**

**CONSOLIDATEDSTATEMENTS OF EARNINGS**

**(INTHOUSANDS, EXCEPT PER SHARE DATA)**

| ** **                                              | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                              | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue from  license royalties and design service fees |       | $                                           | 24,298     |   | $ | 18,714 |   | $ | 19,895 |   |
| Product sales                                           |       | 6,730                                       |       | 1,821 |   | — |   |
| Total revenues                                          |       | 31,028                                      |       | 20,535 |   | 19,895 |   |
| Operating  expenses:                                    |       |                                        |       |   |   |   |   |
| Cost of product sales                                   |       | 3,993                                       |       | 1,241 |   | — |   |
| Selling, general and administrative                     |       | 20,294                                      |       | 14,843 |   | 12,834 |   |
| Goodwill impairment loss                                |       | 212                                         |       | — |   | — |   |
| Settlement costs of disputed commissions                |       | —                                      |       | 71 |   | 643 |   |
| Total operating expenses                                |       | 24,499                                      |       | 16,155 |   | 13,477 |   |
| Operating earnings                                      |       | 6,529                                       |       | 4,380 |   | 6,418 |   |
| Interest income                                         |       | 420                                         |       | 104 |   | 23 |   |
| Earnings before income taxes                            |       | 6,949                                       |       | 4,484 |   | 6,441 |   |
| Income taxes                                            |       | 2,248                                       |       | 1,783 |   | 1,875 |   |
| Net earnings                                            |       | $                                           | 4,701      |   | $ | 2,701 |   | $ | 4,566 |   |
| Net earnings per  common share:                         |       |                                        |       |   |   |   |   |
| Basic                                                   |       | $                                           | 0.30       |   | $ | 0.17 |   | $ | 0.29 |   |
| Diluted                                                 |       | $                                           | 0.30       |   | $ | 0.17 |   | $ | 0.29 |   |
| Weighted average common  shares outstanding:            |       |                                        |       |   |   |   |   |
| Basic                                                   |       | 15,751                                      |       | 15,738 |   | 15,613 |   |
| Diluted                                                 |       | 15,784                                      |       | 15,759 |   | 15,658 |   |

 

See accompanying notes to consolidated financial statements

F-3

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**MOSSIMO, INC.**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**(INTHOUSANDS)**

| ** **                                        | ** ** | ** **            | ** ** | ** **  | ** ** | **ADDITIONAL**  | ** ** | ** **  | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------|------------|------------|------------|
| ** **                                        | ** ** | **COMMON STOCK** | ** ** | **PAID-IN** | ** ** | **ACCUMULATED** | ** ** | ** **  | ** ** |
| ** **                                        | ** ** | **SHARES**            | ** ** | **AMOUNT**  | ** ** | **CAPITAL**     | ** ** | **DEFICIT** | ** ** | **TOTAL**  | ** ** |
| BALANCE,  December 31, 2002                  |       |                  | 15,488     |        |       |            | $          | 15          |       |       |       | $ | 38,797 |   |   |   | $ | (25,332 | ) |   | $ | 13,480 |   |
| Exercise of stock options                         |       |                  | 250        |        |       |            | —     |        |       |       | 749        |   |   |   | — |   |   | 749 |   |
| Income tax benefit from exercise of stock options |       |                  | —     |        |       |            | —     |        |       |       | 217        |   |   |   | — |   |   | 217 |   |
| Net earnings                                      |       |                  | —     |        |       |            | —     |        |       |       | —     |   |   |   | 4,566 |   |   | 4,566 |   |
| BALANCE,  December 31, 2003                  |       |                  | 15,738     |        |       |            | 15         |        |       |       | 39,763     |   |   |   | (20,766 | ) |   | 19,012 |   |
| Net earnings                                      |       |                  | —     |        |       |            | —     |        |       |       | —     |   |   |   | 2,701 |   |   | 2,701 |   |
| BALANCE,  December 31, 2004                  |       |                  | 15,738     |        |       |            | 15         |        |       |       | 39,763     |   |   |   | (18,065 | ) |   | 21,713 |   |
| Exercise of stock options                         |       |                  | 90         |        |       |            |       |        |       |       | 418        |   |   |   |   |   |   | 418 |   |
| Income tax benefit from exercise of stock options |       |                  |       |        |       |            |       |        |       |       | 41         |   |   |   |   |   |   | 41 |   |
| Net earnings                                      |       |                  | —     |        |       |            | —     |        |       |       | —     |   |   |   | 4,701 |   |   | 4,701 |   |
| BALANCE,  December 31, 2005                  |       |                  | 15,828     |        |       |            | $          | 15          |       |       |       | $ | 40,222 |   |   |   | $ | (13,364 | ) |   | $ | 26,873 |   |

 

See accompanying notes to consolidated financial statements

F-4

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**MOSSIMO, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(INTHOUSANDS)**

| ** **                                                                           | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                           | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                               |       |                                        |       |   |   |   |   |
| Net income                                                                           |       | $                                           | 4,701      |   | $ | 2,701 |   | $ | 4,566 |   |
| Adjustments to reconcile  net earnings to net cash provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                                       |       | 427                                         |       | 329 |   | 257 |   |
| Inventory  write-down                                                                |       | 328                                         |       | — |   | — |   |
| Deferred rent                                                                        |       | (7                                          | )          | — |   | — |   |
| Provision for bad  debt                                                              |       | 88                                          |       |   |   |   |   |
| Deferred income  taxes                                                               |       | 1,458                                       |       | 1,171 |   | 1,109 |   |
| Goodwill  impairment                                                                 |       | 212                                         |       |   |   |   |   |
| Changes in:                                                                          |       |                                        |       |   |   |   |   |
| Restricted cash                                                                      |       | —                                      |       | 4,585 |   | (4,585 | ) |
| Accounts receivable                                                                  |       | (1,552                                      | )          | (876 | ) | (81 | ) |
| Merchandise inventory                                                                |       | 110                                         |       | (539 | ) | — |   |
| Prepaid expenses and other current assets                                            |       | 48                                          |       | (154 | ) | (158 | ) |
| Other assets                                                                         |       | 17                                          |       | 154 |   | (152 | ) |
| Accounts payable                                                                     |       | 532                                         |       | (173 | ) | (407 | ) |
| Accrued liabilities                                                                  |       | 287                                         |       | (569 | ) | 181 |   |
| Accrued commissions                                                                  |       | 130                                         |       | (4,993 | ) | 2,590 |   |
| Accrued bonuses                                                                      |       | 3,252                                       |       | 94 |   | (953 | ) |
| Net cash provided by operating activities                                            |       | 10,031                                      |       | 1,730 |   | 2,367 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                               |       |                                        |       |   |   |   |   |
| Proceeds from  sale of available-for-sale securities                                 |       | 4,800                                       |       | 3,950 |   | — |   |
| Purchases of  available-for-sale securities                                          |       | —                                      |       | (3,750 | ) | (5,000 | ) |
| Payments for  acquisition of property and equipment                                  |       | (181                                        | )          | (946 | ) | (129 | ) |
| Acquisition of  Modern Amusement                                                     |       | —                                      |       | (375 | ) | — |   |
| Net cash provided by (used in) investing activities                                  |       | 4,619                                       |       | (1,121 | ) | (5,129 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                               |       |                                        |       |   |   |   |   |
| Restricted  cash—certificates of deposit                                        |       | (313                                        | )          | (413 | ) | — |   |
| Proceeds from  issuance of common stock                                              |       | 418                                         |       | — |   | 749 |   |
| Payments of loan  payable                                                            |       | —                                      |       | — |   | (1,066 | ) |
| Net cash provided by (used in) financing activities                                  |       | 105                                         |       | (413 | ) | (317 | ) |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                 |       | 14,755                                      |       | 196 |   | (3,079 | ) |
| CASH AND CASH  EQUIVALENTS, beginning of year                                        |       | 4,903                                       |       | 4,707 |   | 7,786 |   |
| CASH AND CASH  EQUIVALENTS, end of year                                              |       | $                                           | 19,658     |   | $ | 4,903 |   | $ | 4,707 |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                   |       |                                        |       |   |   |   |   |
| Cash paid during the year for interest                                               |       | $                                           | —     |   | $ | — |   | $ | 10 |   |
| Cash paid during  the year for state income taxes                                    |       | $                                           | 415        |   | $ | 60 |   | $ | 640 |   |

 

See accompanying notes to consolidated financial statements

F-5

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**MOSSIMO, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.**                 SUMMARY BUSINESS DESCRIPTION ANDSIGNIFICANT ACCOUNTING POLICIES

Mossimo, Inc.(the Company) is a Delaware corporation formed in November 1995, andpresently operates as a designer and licensor of apparel and related products.A substantial amount of the Company’s revenue is derived under an agreementwith Target Corporation as further described below.

In January 2004 the Company acquired substantially all theassets of Modern Amusement LLC through a wholly owned subsidiary, ModernAmusement, Inc. (“Modern Amusement”). Modern Amusement designs,merchandises, sources, markets, sells and distributes wholesale apparel andrelated accessories for young men. The products are offered at moderate toupper price points thru traditional specialty store and better department storedistribution channels.

**LICENSINGAGREEMENTS**

The Companyentered into a multi-year licensing and design services agreement with TargetCorporation (“Target”) in March 2000, subsequently amended in February 2002,and in February and June 2003, hereinafter referred to as the “TargetAgreement”. Under the terms of the Target Agreement, Target has the exclusivelicense, for production and distribution through Target stores, of substantiallyall Mossimo products sold in the United States.

Under the TargetAgreement the Company provides design services and has approval rights forproduct design, marketing and advertising materials. Target collaborates ondesign and is responsible for product development, sourcing, quality controland inventory management with respect to the Target licensed product line.Target is obligated to pay the Company design service fees and license royaltyfees. Total fees payable by Target are based upon a percentage of Target’s netsales of Mossimo branded products, with minimum total guaranteed fees ofapproximately $9.6 million annually. Target fees are based on net salesachieved multiplied by a rate, as defined in the Target Agreement. The Companypays a 15 percent commission, based on fees received from Target, to a thirdparty who assisted the Company in connection with entering into the initialagreement with Target. The Target Agreement is subject to early terminationunder certain circumstances. If Target is current with payments of itsobligations under the Target Agreement, Target has the right to renew theTarget Agreement, on the same terms and conditions, for additional terms of twoyears each. In January 2003, Target exercised its first renewal option extendingthe Target Agreement through January 31, 2006. In January 2005,Target exercised its second renewal option extending the Target Agreementthrough January 31, 2008. The next renewal option could be exercised byTarget on or before January 2007, this renewal option could extend theTarget Agreement thru January 2010, if it is exercised by Target.

In addition to theTarget Agreement, the Company also licenses its trademarks and provides designservices outside of the United States, and also licenses its trademarks for usein collections of eyewear and women’s swimwear and body-wear sold in Targetstores in the United States.

In May 2002, the Company entered into an agreement withHudson’s Bay Company. Under the agreement, the Company provided product designservices, and granted a license for the Mossimo trademark to Hudson’s BayCompany exclusively in Canada, in return for license royalties and designservice fees. Hudson’s Bay Company collaborated on product design, and wasresponsible for manufacturing, importing, marketing, advertising, selling anddistributing merchandise bearing the Mossimo trademark. The initial term of theagreement was three years beginning in May 2002. The agreement expired in May of2005, we expect to receive royalty payments through the third quarter of 2006. Thereare no plans to renew the agreement.

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**BASIS OFPRESENTATION**

The consolidatedfinancial statements include the accounts of Mossimo, Inc. and itswholly-owned subsidiary, Modern Amusement, Inc. All significant intercompanybalances and transactions have been eliminated in consolidation.

**USE OF ESTIMATES**

The preparation of financial statements in conformity withaccounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amountsof revenues and expenses during the reporting period. Actual results coulddiffer from those estimates.

**REVENUERECOGNITION**

Revenue fromlicense royalties and design service fees are recognized in accordance with theterms of the underlying agreements, which is generally after the designservices are performed, and as the licensee achieves sales of the Company’sproducts. During the periods presented herein, a substantial amount of theCompany’s revenue from license royalties and design fees were generated underthe Target Agreement under a rate that declines as the contract year progressesand Target achieves certain levels of retail sales. Accordingly, the Company’srevenues from Target decrease as the year progresses. The declining rate isreset each contract year beginning on February 1. Revenue recognized inthe first and second quarters of the Company’s calendar year in connection withthe Target Agreement is significantly higher than in the third and fourthquarters of the Company’s calendar year due to the declining rates in theTarget Agreement. Revenue from license royalties and design service fees aregenerally collected on a quarterly basis, and they range from one percent tofive percent of sales, as defined in the respective agreements.

Modern Amusement recognizes wholesale operations revenue from thesale of merchandise when products are shipped, FOB Modern Amusement’sdistribution facilities, and the customer takes title and assumes risk of loss,collection is reasonably assured, pervasive evidence of an arrangement exists,and the sales price is fixed or determinable.

**CASH AND CASHEQUIVALENTS**

Cash and cash equivalents include temporary investment of cash inliquid interest bearing accounts with original maturities of 30 days or less.

**INVESTMENTS**

Short-term investments, which consist of market auction ratepreferred securities are classified as “available for sale” under theprovisions of SFAS No. 115, “Accounting for Certain Investments in Debtand Equity Securities.” Accordingly, the short-term investments are reported atfair value, with any unrealized gains and losses included as a separatecomponent of stockholders’ equity, net of applicable taxes. Realized gains andlosses, interest and dividends are included in interest income. The fair valueof the short-term investments approximated cost at December 31, 2004. Therewere no investments on hand at December 31, 2005.

**INVENTORIES**

We maintain inventories for the Modern Amusement segment of ourbusiness. Inventories are valued at the lower of cost (first-in, first-out) ormarket. The Company continually evaluates its inventories by assessing slowmoving current product as well as prior seasons’ inventory. Market value ofnon-current inventory is estimated based on the impact of market trends, anevaluation of economic conditions and the 

F-7

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value of current orders relating to thefuture sales of this type of inventory. During 2005, the company wrote-downcertain inventories by $328,000 to their net realizable value.

**PROPERTY ANDEQUIPMENT**

Property and equipment are stated at cost, net of accumulateddepreciation and amortization. Depreciation is calculated using thestraight-line method over the estimated useful life of the asset, which isgenerally three to seven years for furniture, fixtures, and equipment. Amortizationof leasehold improvements is calculated using the straight line method over theshorter of its useful life or the remaining term of the lease. The Companyevaluates the impairment of long-lived assets when certain triggering eventsoccur. If such assets are determined to be impaired, a write-down to fair marketvalue is recorded.

**GOODWILL ANDTRADENAME**

Goodwill represents the excess of costs over fair value of assetsof businesses acquired. Goodwill and intangible assets acquired in a purchasebusiness combination and determined to have an indefinite useful life are notamortized, but instead tested for impairment at least annually in accordancewith the provisions of FASB Statement No. 142, Goodwill and OtherIntangible Assets. Intangible assets with estimable useful lives are amortizedover their respective estimated useful lives to their estimated residualvalues, and reviewed for impairment in accordance with FASB Statement No. 144,Accounting for Impairment or Disposal of Long-Lived Assets.

**SEGMENTS**

The Company operates in two business segments: Mossimo and ModernAmusement (Modern).Inaccordance with SFAS No. 131, “*DisclosureAbout Segments of an Enterprise and Related Information”,*theCompany’s principal segments are divided between the generation of revenuesfrom products and royalties. The Mossimo segment derives its revenues fromroyalties associated from the use of its brand names primarily with Target. TheModern segment derives its revenues from the design, and distribution ofapparel to department stores and other retail outlets, principally throughoutthe United States.

**INCOME TAXES**

The Company accounts for income taxes in accordance with SFAS No. 109,“Accounting for Income Taxes”. Deferred income taxes are provided for temporarydifferences between the amounts of assets and liabilities for financial and taxreporting purposes. Deferred tax assets are reduced by a valuation allowancewhen it is estimated to be more likely than not that some portion of thedeferred tax assets will not be realized. Accounting for income taxes arefurther explained in Note 5.

**STOCK-BASEDCOMPENSATION**

The Company accounts for stock-based compensation inaccordance with Accounting Principles Board (APB) Opinion No. 25, “Accountingfor Stock Issued to Employees”, and related interpretations. The Companyfollows the pro forma disclosure requirements of SFAS No. 123, “Accountingfor Stock-Based Compensation”, which require presentation of the pro formaeffect of the fair value based method on net income and net income per share inthe financial statement footnotes.

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If compensationexpense was determined based on the fair value method, the Company’s netearnings and net earnings per share would have resulted in the approximate proforma amounts indicated below for the years ended December 31, 2005, 2004and 2003 (*in thousands, except per share data*):

| ** **                                                                                       | ** ** | **2005**                                                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                       | ** ** | **(in thousands,**

**except for per share data)** | ** ** |
| Net earnings as  reported                                                                        |       | $                                                                           | 4,701      |     | $          | 2,701    |       | $ | 4,566 |   |
| Add: Stock-based  employee compensation expense included in reported net earnings                |       | —                                                                      |       | —   |       | —   |       |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  method |       | (63                                                                         | )          | (305     | )          | (298     | )          |
| Pro forma net earnings                                                                           |       | $                                                                           | 4,638      |     | $          | 2,396    |       | $ | 4,268 |   |
| Earnings per share:                                                                              |       |                                                                        |       |     |       |     |       |
| Basic—as reported                                                                           |       | $                                                                           | 0.30       |     | $          | 0.17     |       | $ | 0.29 |   |
| Basic—pro forma                                                                             |       | $                                                                           | 0.29       |     | $          | 0.15     |       | $ | 0.27 |   |
| Diluted—as reported                                                                         |       | $                                                                           | 0.30       |     | $          | 0.17     |       | $ | 0.29 |   |
| Diluted—pro forma                                                                           |       | $                                                                           | 0.29       |     | $          | 0.15     |       | $ | 0.27 |   |

 

The fair value of eachoption grant was estimated as of the grant date using the Black-Scholesoption-pricing model for the years ended December 31, 2005, 2004 and 2003,assuming risk-free interest rates of approximately 4.43 percent, 3.7 percent,and 1.9 percent, respectively; volatility of approximately 80 percent, 45percent, and 50 percent, respectively; zero dividend yield; and expected livesof five years for all periods.

**FAIR VALUE OFFINANCIAL INSTRUMENTS**

The Company’s balance sheets include the following financialinstruments: cash and cash equivalents, restricted cash, securitiesavailable-for-sale, accounts receivable, accounts payable, accrued liabilities,accrued commissions, and accrued bonuses. The Company considers the carryingvalue of these instruments to approximate fair value for these instrumentsbecause of the relatively short period of time between origination and theirexpected realization or settlement.

**COMPUTATION OF PERSHARE AMOUNTS**

Basic and diluted earnings per share are computedusing the methods prescribed by SFAS 128, “Earnings per Share.” Basic incomeper share is computed as net income divided by the weighted average number ofcommon shares outstanding during the period. Diluted earnings per share giveseffect to all potential dilutive common share equivalents outstanding duringthe period. The computation of diluted earnings per share does not assume theexercise of securities that would have an anti-dilutive effect.

F-9

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Thecomputation of basic and diluted earnings per common share for income fromcontinuing operations is as follows (*in thousands, except pershare data*):

| ** **                                                                                                                     | ** ** | **2005**                                                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                                     | ** ** | **(in thousands,**

**except for per share data)** | ** ** |
| Income available  to common shareholders—basic and diluted                                                                |       | $                                                                           | 4,701      |     | $          | 2,701    |       | $ | 4,566 |   |
| Basic weighted  average common shares                                                                                          |       | 15,751                                                                      |       | 15,738   |       | 15,613   |       |
| Incremental  shares related to stock options                                                                                   |       | 33                                                                          |       | 21       |       | 45       |       |
| Diluted weighted  average common shares                                                                                        |       | 15,784                                                                      |       | 15,759   |       | 15,658   |       |
| Net earnings per share:                                                                                                        |       |                                                                        |       |     |       |     |       |
| Basic earnings per common share                                                                                                |       | $                                                                           | 0.30       |     | $          | 0.17     |       | $ | 0.29 |   |
| Diluted earnings per common share                                                                                              |       | $                                                                           | 0.30       |     | $          | 0.17     |       | $ | 0.29 |   |
| Potential common shares  excluded from diluted earnings per share since their effect would be antidilutive—stock  options |       | 342                                                                         |       | 468      |       | 554      |       |

 

**IMPACT OF RECENTLY ADOPTED ACCOUNTINGPRONOUNCEMENTS**

In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and ErrorCorrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3.”This statement applies to all voluntary changes in accounting principle andchanges required by an accounting pronouncement where no specific transitionprovisions are included. SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. Retrospective application islimited to the direct effects of the change; the indirect effects should berecognized in the period of the change. This statement carries forward withoutchange the guidance contained in APB Opinion No. 20 for reporting thecorrection of an error in previously issued financial statements and a change inaccounting estimate. However, SFAS No. 154 redefines restatement asthe revising of previously issued financial statements to reflect thecorrection of an error. The provisions of SFAS No. 154 are effectivefor accounting changes and corrections of errors made in fiscal periods thatbegin after December 15, 2005, although early adoption is permitted. TheCompany does not anticipate that the implementation of this standard will havea material impact on its financial condition and results of operations.

In December 2004,the FASB issued SFAS No. 123R (revised 2004), “Share-Based Payment.”SFAS No. 123R addresses the accounting for share-based paymenttransactions in which a company receives employee services in exchange foreither equity instruments of the company or liabilities that are based on thefair value of the company’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS No. 123R eliminates theability to account for share-based compensation transactions using theintrinsic method that is currently used and requires that such transactions beaccounted for using a fair value-based method and recognized as expense in theconsolidated statement of operations. SFAS No. 123R is effective for theCompany on January 1, 2006. Accordingly, the Company will adopt SFAS No. 123Rin our first quarter of 2006. See Note 1 Summary of Business Description andSignificant Accounting Policies—Stock-Based Compensation for the pro formaeffects of how SFAS No. 123R would have affected results of operations in2005, 2004 and 2003. We are currently assessing the impact this prospectivechange in accounting guidance will have on our financial condition and resultsof operations, but we believe that the impact will not be material.

In November 2004,the FASB issued SFAS No. 151, “Inventory Costs, an amendment ofAccounting Research Bulletin No. 43, Chapter 4.” SFAS No. 151requires that abnormal amounts of idle facility 

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expense, freight, handling costs and wasted materials(spoilage) be recorded as current period charges and that the allocationof fixed production overhead to inventory be based on the normal capacity ofthe production facilities. SFAS No. 151 is effective for the Companyon January 1, 2006. The Company does not believe that the adoption ofSFAS No. 151 will have a material impact on its consolidatedfinancial statements.

In November 2002, the FASB issued FASB Interpretation No. 45(“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others”. This interpretationclarifies the requirements of a guarantor in accounting for and disclosingcertain guarantees issued and outstanding. The initial recognition andmeasurement provisions of this interpretation are applicable on a prospectivebasis to guarantees issued after December 31, 2002. The Company licensesits trademarks, provides design services and has approval rights for productdesign, marketing and advertising materials under licensing and design serviceagreements which include certain provisions for indemnifying the licensee. Asan element of its standard commercial terms, the Company includes anindemnification clause in its licensing and design services agreements thatindemnifies the licensee against liability and damages arising from any claims,suits, damages, or costs relating to the breach of any warranty,representation, term or condition made or agreed to by its licensees involvingthe manufacture, packaging, distribution, promotion, sale, marketing,advertising or other use of the trademarks under license. We believe that ourpolicies and practices limit our exposure related to the indemnificationprovisions of the license and design services agreements. For several reasons,including the lack of prior indemnification claims and the lack of monetaryliability limit for certain infringement cases under the license and designservices agreements, we cannot determine the maximum amount of potential futurepayments, if any, related to such indemnification provisions.

**RECLASSIFICATIONS**

Certain reclassifications have been made to conform to currentyear presentation. These reclassifications have no impact on reported netearnings.

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**2.**                 BUSINESS ACQUISITION

On January 16, 2004,Mossimo, Inc. acquired substantially all the assets of Modern AmusementLLC through a wholly owned subsidiary, Modern Amusement for cash. ModernAmusement designs, merchandises, sources, markets, sells and distributeswholesale apparel and related accessories for young men and young women. The“Modern Amusement” registered brand is principally focused on premium westcoast-lifestyle apparel and related accessories. The products are offered atmoderate to upper price points through traditional specialty store andhigher-end department store distribution channels. The purpose of theacquisition was to diversify the Company’s current design and licensingbusiness of its Mossimo brand product through mass retail distributionchannels. The acquisition was accounted for as a purchase whereby the purchaseprice was allocated to the assets acquired based on fair values. The excesspurchase price over the amount allocated to the assets acquired has beenallocated to goodwill, in the accompanying consolidated balance sheet atDecember 31, 2005. In the fourth quarter of 2004, the Company completedthe appraisal of Modern Amusement, and allocated $112,000 of the purchase priceto tradename, an amortizable intangible asset with a 10-year life. Theamortization will be recorded ratably over the 10-year period. Thefollowing table summarizes the fair values of the assets acquired at the dateof acquisition. Pro forma information is not presented as the impact of thisacquisition on the consolidated financial statements is not material.

| Net current  assets     |   | $   | 25     |   |
|-------------------------|--------|-----|--------|--------|
| Property and  equipment |   | 20  |   |
| Goodwill                |   | 212 |   |
| Trade Name              |   | 112 |   |
| Other assets            |   | 6   |   |
| Assets acquired         |   | $   | 375    |   |

 

The ModernAmusement segment is tested for goodwill impairment on an annual basis at theend of the fourth quarter. Due to the expected continuing investment in theModern Amusement brand, the cash flow from this reporting segment is expectedto be negative until 2008. In December 2005, a goodwill impairment loss of$212,000 was recognized in the Modern Amusement reporting segment. The fairvalue of that reporting segment was estimated using the expected present valueof future cash flows.

The Company also tested the Modern Amusement tradename for impairment.Based on our testing in accordance with FASB Statement No. 144, thetradename was not deemed impaired. The tradename will continue to be amortizedover its remaining useful life.

**3.**                 MAJOR CUSTOMER AND ACCOUNTSRECEIVABLE

A substantialamount of the Company’s revenue and accounts receivable are derived under theTarget Agreement. The accounts receivable are held without collateral, and aresubject to normal credit risk assumed by the Company. Revenue from licenseroyalties and design service fees from Target were approximately 69% in 2005,79% in 2004, and 88% in 2003, of total revenue. Accounts receivable from targetfor 2005 and 2004 were 58% and 59%, respectively, of total accounts receivable.

Modern Amusement extends credit to customers in the normal courseof business, subject to established credit limits. Accounts receivable, net, inthe consolidated balance sheets, consists of amounts due from customers net ofallowance for doubtful accounts. The allowance for doubtful accounts isdetermined by reviewing accounts receivable aging and evaluating individualcustomer receivables, considering customers’ financial condition, credithistory and current economic conditions.  The write-off for bad debts in 2005 wasapproximately $88,000.

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**4.**                 CREDIT FACILITY WITH BANK

The Company established a revolving line of credit with a bank inthe amount of $300,000 in February 2004. The line of credit wasestablished to open letters of credit with foreign suppliers for finished goodsfor Modern Amusement. The line of credit was increased to $400,000 in June of2004, and subsequently increased to $500,000 in January of 2005 andincreased again to $900,000 in May of 2005. The line of credit is securedby three certificates of deposit totaling approximately $726,000. There is noexpiration date for this line, and there are no covenants. There is a feecharged per letter of credit opened and closed. Open letters of credit at December 31,2005 were approximately $875,000.

**5.**                 INCOME TAXES

The provision for income taxes consists ofthe following for the years ended December 31:

| ** **                        | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                        | ** ** | **(IN THOUSANDS)** | ** ** |
| Current:                          |       |                    |       |     |       |     |       |
| Federal                           |       | $                       | 209        |     | $          | 40       |       | $ | 162 |   |
| State                             |       | 581                     |       | 572      |       | 604      |       |
|                              |       | 790                     |       | 612      |       | 766      |       |
| Deferred:                         |       |                    |       |     |       |     |       |
| Federal                           |       | 1,502                   |       | 1,481    |       | 1,032    |       |
| State                             |       | (44                     | )          | (310     | )          | 77       |       |
|                              |       | 1,458                   |       | 1,171    |       | 1,109    |       |
| Total provision  for income taxes |       | $                       | 2,248      |     | $          | 1,783    |       | $ | 1,875 |   |

 

The provision for income taxes may differfrom the amount of tax determined by applying the federal statutory rate of 34%to pretax earnings. The components of this difference consist of the followingfor the years ended December 31:

| ** **                                           | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                           | ** ** | **(IN THOUSANDS)** | ** ** |
| Provision on  earnings at federal statutory tax rate |       | $                       | 2,380      |     | $          | 1,518    |       | $ | 2,198 |   |
| State tax  provision, net of federal tax effect      |       | 705                     |       | 260      |       | 375      |       |
| Decrease in  valuation allowance                     |       | (862                    | )          | —   |       | —   |       |
| Other, including  alternative minimum tax            |       | 25                      |       | 5        |       | (698     | )          |
| Total provision  for income taxes                    |       | $                       | 2,248      |     | $          | 1,783    |       | $ | 1,875 |   |

 

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Significant components of the Company’sdeferred income taxes are as follows as of December 31, 2005 and 2004:

| ** **                        | ** ** | **2005**                | ** ** | **2004** | ** ** |
|-----------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                        | ** ** | **(IN THOUSANDS)** | ** ** |
| Deferred income  tax assets:      |       |                    |       |     |       |
| Net operating loss carry-forwards |       | $                       | 3,947      |     | $          | 7,631 |   |
| Related party accrued salary      |       | 665                     |       | —   |       |
| Foreign tax credits               |       | 371                     |       | 314      |       |
| Alternative minimum tax credit    |       | 718                     |       | 521      |       |
| State minimum tax credit          |       | 66                      |       | 20       |       |
| Other                             |       | 405                     |       | 6        |       |
| Total                             |       | 6,172                   |       | 8,492    |       |
| Less valuation  allowance         |       | (245                    | )          | (555     | )          |
| Total net deferred tax asset      |       | $                       | 5,927      |     | $          | 7,937 |   |
| Current portion                   |       | $                       | 4,004      |     | $          | 1,869 |   |
| Long-term portion                 |       | 1,923                   |       | 6,068    |       |
| Total net deferred tax  asset     |       | $                       | 5,927      |     | $          | 7,937 |   |

 

The Companyconsiders projected taxable income from the Target Agreement and otheragreements in deriving its estimate of deferred tax asset recoverability. As aresult of the extension of the Target Agreement through January 31, 2008,the reevaluation of its forecasted operating results and resultant taxableincome during the extended term of the Target Agreement, management believesrealization of its net deferred tax assets is more likely than not.

As ofDecember 31, 2005, the Company has approximately $10.2 million, and $8.2million of federal and state income tax net operating loss carry forwards,respectively, available to offset future taxable income, which expire invarious years through 2022.

In accordance withthe Tax Reform Act of 1986, the benefits from net operating losses carriedforward may be impaired or limited in certain circumstances. Events which maycause limitations in the amount of net operating losses that the Company mayutilize in any one year include, but are not limited to, a cumulative ownershipchange of more than 50 percent over a three-year period. The impact oflimitations, if any that may be imposed upon future issuances of equitysecurities cannot be determined at this time.

In addition to theCompany’s taxable income being subject to federal, state and local incometaxes, the Company may be classified as a “personal holding company” from timeto time. Personal holding company status results from more than 50 percent ofthe value of outstanding stock being owned directly or indirectly by five orfewer individuals, and more than 60 percent of the Company’s income, asdefined, being derived from royalties. Personal holding companies are subjectto an additional federal tax at a 15 percent tax rate on undistributedafter tax earnings.

Over 50 percent of the value of the Company’s outstanding stock isowned by one stockholder. In 2005, 2004 and 2003, less than 60 percent of theCompany’s income as defined was derived from license royalties, accordingly theCompany is not classified as a personal holding company and is not subject tothe personal holding company tax. The Company intends to continue to take appropriatemeasures to avoid being classified as a personal holding company in futureyears. However, there can be no assurance that the Company will be successfulin its efforts to avoid classification as a personal holding company in thefuture.

F-14

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**6.**                 PROPERTY AND EQUIPMENT

Property and equipment consists of thefollowing at December 31:

| ** **                                 | ** ** | **2005**                | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                 | ** ** | **(IN THOUSANDS)** | ** ** |
| Furniture and  fixtures                    |       | $                       | 486        |     | $          | 420 |   |
| Leasehold  improvements                    |       | 1,365                   |       | 1,282    |       |
| Equipment                                  |       | 454                     |       | 422      |       |
|                                       |       | 2,305                   |       | 2,124    |       |
| Accumulated  depreciation and amortization |       | 1,412                   |       | 1,007    |       |
|                                       |       | $                       | 893        |     | $          | 1,117 |   |

 

**7.**                 EMPLOYEE BENEFIT PLANS

The Company has a defined contribution plan under Section 401(k) ofthe Internal Revenue Code covering all full-time employees, and providing formatching contributions by the Company, as defined in the plan. Contributionsmade to the plan were $13,600 in 2005, $13,300 in 2004 and $14,000 in 2003.

**8.**                 COMMITMENTS AND CONTINGENCIES

The Company leasesits office and design studio under an operating lease agreement effective throughJuly 2009, providing for annual lease payments of approximately $315,000in 2006, $324,000 in 2007, $334,000 in 2008, and $196,000 in 2009. Rent expensewas approximately $380,000 in 2005, $384,000 in 2004 and $260,000 in 2003.

The Company has a bonus program with its two top executives. Underthis program bonuses payable to the Co-Chief Executive Officers’ are determinedat the discretion of the Compensation Committee of the Board of Directors, aresubject to approval by the Board of Directors, and can not exceed a formulabased on a percentage of fees paid by Target to the Company, as defined in therespective bonus plans of these two officers. Bonus expense in connection withthe bonus plans of these two officers was $3,340,000 in 2005, $607,000 in 2004and $1,854,000 in 2003.

We had a dispute over thecommissions payable to a third party which relate to our agreement with Target.In June 2003, we had deposited with the court approximately $4,585,000which was classified as restricted cash. The dispute was resolved in the secondquarter of 2004, and the funds were distributed to the third party. As part ofthe settlement the Company is required to pay a fee to the third party offifteen percent of applicable revenues from the Target agreement. Fees incurredunder this arrangement were $3.2 million in 2005, $2.6 million in 2004 and $2.6million in 2003. Under this agreement, we have a commission obligation for 15%of fees received from Target for the duration of the Target agreement thru January 2008,and for subsequent extensions if they are exercised by Target. The futurecommissions are based on the minimum royalty and design fee payment from targetof approximately $9.6 million through January 2008.

**9.**                 STOCKHOLDERS’ EQUITY

The Company adopted the Mossimo, Inc. 1995 StockOption Plan (the “1995 Plan”), which provides for the grant of stock options,stock appreciation rights and other stock awards to certain officers and keyemployees of the Company and to certain advisors or consultants to the Company.A total of 1,500,000 shares have been reserved for issuance under the 1995Plan. Options granted thereunder have an exercise price equal to the fairmarket value of the common stock on the date of grant. In April 2000, theCompany amended the 1995 Plan so that an optionee’s vesting in such optionsautomatically terminates when the optionee’s employment with the Company isterminated for reasons other than retirement, disability or 

F-15

----

death. As of December 31,2005 there were no shares of common stock under the 1995 Plan that wereavailable for future grant.

The Company’s Non-Employee Directors Stock Option Plan(the “Directors Plan”) provides for the automatic grant to each of the Company’snon-employee directors of (i) an option to purchase 30,000 shares ofcommon stock on the date of such director’s initial election or appointment tothe Board of Directors and (ii) an option to purchase 3,000 shares ofcommon stock on each anniversary thereof on which the director remains on theBoard of Directors. A total of 250,000 shares have been reserved under theDirectors Plan. Options granted thereunder have an exercise price equal to thefair market value of the common stock on the date of grant. As of December 31,2005 there were no shares of common stock under the Directors Plan that wereavailable for future grant.

Changesin shares under option for the 1995 Plan and the Directors Plan (the “Plans”)are summarized as follows for the years ended December 31,

| ** **                                                      | ** ** | **2005**   | ** ** | **2004**                             | ** ** | **2003**   | ** ** |                                 |
|-----------------------------------------------------------------|------------|------------|------------|--------------------------------------|------------|------------|------------|--------------------------------------|
| ** **                                                      | ** ** | **Shares** | ** ** | **Weighted**

**Average**

**Price** | ** ** | **Shares** | ** ** | **Weighted**

**Average**

**Price** | ** ** | **Shares** | ** ** | **Weighted**

**Average**

**Price** | ** ** |   |
| Outstanding,  beginning of year                                 |       | 685,310    |       |                                 | $          | 5.90       |       |                                 | 625,310 |   |   | $ | 7.23 |   |   | 992,075 |   |   | $ | 7.34 |   |   |
| Granted                                                         |       | 36,000     |       |                                 | 5.43       |       |       | 210,000                              |   |   | 3.77 |   |   | 549,000 |   |   | 4.13 |   |   |
| Exercised                                                       |       | (90,312    | )          |                                 | 4.60       |       |       | —                               |   |   | — |   |   | (250,400 | ) |   | 3.40 |   |   |
| Canceled/forfeited                                              |       | (81,667    | )          |                                 | 4.15       |       |       | (150,000                             | ) |   | 8.43 |   |   | (665,365 | ) |   | 6.06 |   |   |
| Outstanding, end  of year                                       |       | 549,331    |       |                                 | 6.41       |       |       | 685,310                              |   |   | 5.90 |   |   | 625,310 |   |   | 7.23 |   |   |
| Options  exercisable, end of year                               |       | 423,331    |       |                                 |       |       |       | 475,310                              |   |   |   |   |   | 281,000 |   |   |   |   |   |
| Weighted average fair  value of options granted during the year |       |       |       |                                 | $          | 3.88       |       |                                 |   |   |   | $ | 1.80 |   |   |   |   |   | $ | 2.18 |   |   |

 

Outstandingstock options for the Plans at December 31, 2005 consist of the following:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | ** **             | ** ** |
|---------------------------------------------|------------|------------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | ** **                   | ** ** | **Weighted**           | ** ** | ** ** | ** ** | **Options Exercisable** | ** ** |
| ** **                                  | ** ** | ** **                   | ** ** | **Average**            | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                  | ** ** | **Number**                   | ** ** | **Remaining**          | ** ** | **Average** | ** ** | **Number** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | **Outstanding**              | ** ** | **Contractual**        | ** ** | **Exercise** | ** ** | **Exercisable** | ** ** | **Exercise** | ** ** |
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **at 12/31/2005** | ** ** | **Life** | ** ** | **Price** | ** ** | **at 12/31/2005** | ** ** | **Price** | ** ** |
| $0.88 - $1.88                               |       |                         | 36,000     |                   |       |   | 4.32 |   |   |   | $ | 1.71 |   |   |   | 36,000 |   |   |   | $ | 1.71 |   |   |
| $2.50 - $3.50                               |       |                         | 60,000     |                   |       |   | 7.69 |   |   |   | 3.24 |   |   |   | 36,667 |   |   |   | 3.14 |   |   |
| $3.80 - $5.43                               |       |                         | 313,021    |                   |       |   | 6.84 |   |   |   | 4.63 |   |   |   | 210,354 |   |   |   | 4.75 |   |   |
| $6.42 - $9.61                               |       |                         | 100,000    |                   |       |   | 5.55 |   |   |   | 8.35 |   |   |   | 100,000 |   |   |   | 8.35 |   |   |
| $10.63 - $25.38                             |       |                         | 40,310     |                   |       |   | 0.64 |   |   |   | 23.43 |   |   |   | 40,310 |   |   |   | 23.43 |   |   |
|                                        |       |                         | 549,331    |                   |       |   | 6.08 |   |   |   | 6.34 |   |   |   | 423,331 |   |   |   | 6.98 |   |   |
|                                             |            |                              |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Company adopted theMossimo, Inc 2005 stock Option Plan (the “2005 Plan) to replace the 1995 Planand the Directors Plan both of which terminated as of December 31, 2005.The 2005 Plan provides for the grant of stock options to certain officers, keyemployees and non-employee directors. A total of 1,500,000 shares have beenreserved for issuance under the 2005 Plan. Options granted under the 2005 Planwill have an exercise price equal to the fair market value of the common stockon the date of grant. Options will be exercisable in accordance with vestingschedules to be established by the Compensation Committee. As of December 31,2005, no options have been granted under the 2005 Plan.

F-16

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**10.**          SEGMENT INFORMATION

The Company operates in two businesssegments: Mossimo (design and licensing service) and Modern Amusement (Modern)(wholesale men’s apparel). The following tables summarize various financialamounts for each of our business segments (in thousands):

| **Year ended December 31, 2005** | ** ** | ** ** | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|------------------------------------------------------|------------|------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                             |       | $          | 24,298     |        | $          | 6,730      |       | $         | 31,028     |   |
| Gross Profit                                         |       | —     |       | 2,737       |       | 2,737      |       |
| Depreciation and  Amortization                       |       | 186        |       | 241         |       | 427        |       |
| Selling, general  and administrative expenses        |       | 16,315     |       | 3,979       |       | 20,294     |       |
| Goodwill  impairment loss                            |       | —     |       | 212         |       | 212        |       |
| Operating Income  (loss)                             |       | 7,983      |       | (1,454      | )          | 6,529      |       |
| Interest Income                                      |       | 420        |       | —      |       | 420        |       |
| Total Assets                                         |       | 29,280     |       | 2,954       |       | 32,234     |       |
|                                                      |            |            |            |             |            |            |            |           |            |  |  |  |

 

| **Year ended December 31, 2004** | ** ** | ** ** | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|------------------------------------------------------|------------|------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                             |       | $          | 18,714     |        | $          | 1,821      |       | $         | 20,535     |   |
| Gross Profit                                         |       | —     |       | 580         |       | 580        |       |
| Depreciation and  Amortization                       |       | 229        |       | 100         |       | 329        |       |
| Selling, general  and administrative expenses        |       | 12,041     |       | 2,802       |       | 14,843     |       |
| Operating Income  (loss)                             |       | 6,601      |       | (2,221      | )          | 4,380      |       |
| Interest Income                                      |       | 104        |       | —      |       | 104        |       |
| Total Assets                                         |       | 20,753     |       | 2,720       |       | 23,473     |       |
|                                                      |            |            |            |             |            |            |            |           |            |  |  |  |

 

The following information should be considered when reading theabove table (in thousands):

·       The Company has no inter-segmentrevenue or expense.

·       Corporate overhead has beenallocated to the Mossimo segment.

·       The provision for income tax is notallocated to business segments.

·       All long-lived assets weregeographically located in the United States.

·       Revenue from countries other thanthe United States did not account for 10% or more of total revenue.

·       During 2003, the Company operatedonly the Mossimo segment.

·       Gross profit is derived by reducingsales of the Modern segment of $6,730 by $3,993 of cost of sales to arrive at agross profit of approximately $2,737 for 2005. For 2004, sales of the Modernsegment were $1,821 reduced by cost of sales of $1,241 to arrive at a grossprofit of approximately $580.

·       Operating expenses that have a direct correlation to each segmenthave been recorded in each respective segment.

F-17

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**11.**          VALUATION AND QUALIFYING ACCOUNTS

As of December 31, 2005 and 2004there is no allowance for doubtful accounts or sales returns recorded for theMossimo segment. Changes in the allowances for doubtful accounts, and for salesreturns and markdowns for 2002 were as follows:

| ** **                                        | ** ** | ** **              | ** ** | **ADDITIONS**       | ** ** | ** **     | ** ** | ** **              | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|---------------------|------------|----------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **BALANCE AT**     | ** ** | **CHARGED TO** | ** ** | ** **     | ** ** | **BALANCE**             | ** ** |
| ** **                                        | ** ** | **BEGINNING**           | ** ** | **COSTS AND**  | ** ** | ** **     | ** ** | **AT END OF** | ** ** |
| ** **                                        | ** ** | **PERIOD**              | ** ** | **EXPENSES**        | ** ** | **DEDUCTIONS** | ** ** | **PERIOD**              | ** ** |
| ** **                                        | ** ** | **(IN THOUSANDS)** | ** ** |
| Year ended  December 31, 2002—Note (a): |       |                    |       |                |       |           |       |                    |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts                   |       |                    | $          | 207                 |       |           |       | $                       | —     |   |   |   | $ | (207 | ) |   |   | $ | — |   |   |
| Allowance for  sales returns and markdowns        |       |                    | 6,229      |                |       |           | —     |                    |       |   | (6,229 | ) |   |   | — |   |   |
|                                                   |            |                         |            |                     |            |                |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

Note (a):Deductions reflect the write-off of accounts previously reserved.

As of December 31, 2005 and 2004there was an allowances for doubtful accounts for the Modern segment. Changesin the allowances for doubtful accounts for 2005 for the Modern segment were asfollows:

| ** **                          | ** ** | **BALANCE AT**     | ** ** | **ADDITIONS**       | ** ** | ** **     | ** ** | **BALANCE**             | ** ** |
|-------------------------------------|------------|-------------------------|------------|---------------------|------------|----------------|------------|-------------------------|------------|
| ** **                          | ** ** | **BEGINNING**           | ** ** | **CHARGED TO** | ** ** | ** **     | ** ** | **AT END OF** | ** ** |
| ** **                          | ** ** | **PERIOD**              | ** ** | **EXPENSE**         | ** ** | **DEDUCTIONS** | ** ** | **PERIOD**              | ** ** |
| ** **                          | ** ** | **(IN THOUSANDS)** | ** ** |
| Year ended  December 31, 2004: |       |                    |       |                |       |           |       |                    |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts     |       |                    | $          | —              |       |           |       | $                       | 22         |   |   |   | $ | — |   |   |   | $ | 22 |   |   |
| Year ended  December 31, 2005: |       |                    |       |                |       |           |       |                    |       |   |   |   |   |   |   |   |   |
| Allowance for  doubtful accounts    |       |                    | $          | 22                  |       |           |       | $                       | 88         |   |   |   | $ | — |   |   |   | $ | 110 |   |   |

 

**12.**          UNAUDITED INTERIM FINANCIALINFORMATION

The following tables set forth certainselected interim financial data for the Company by quarter for the years ended December 31,2005 and 2004.

| ** **                       | ** ** | **YEAR ENDED DECEMBER 31, 2005**               | ** ** |
|----------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                       | ** ** | **FIRST**                                                          | ** ** | **SECOND** | ** ** | **THIRD** | ** ** | **FOURTH** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **QUARTER**                                                        | ** ** | **QUARTER** | ** ** | **QUARTER** | ** ** | **QUARTER** | ** ** | **YEAR** | ** ** |
| ** **                       | ** ** | **(IN THOUSANDS, EXCEPT PER SHARE DATA)** | ** ** |
| INCOME STATEMENT DATA:           |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                   |       |                                                               | $          | 8,664 |   |   |   | $ | 9,045 |   |   |   | $ | 6,771 |   |   |   | $ | 6,548 |   |   | $ | 31,028 |   |
| Earnings before  income taxes(b) |       |                                                               | 3,081      |   |   |   | 3,076 |   |   |   | 755 |   |   |   | 37 |   |   | 6,949 |   |
| Provision for  income taxes      |       |                                                               | 1,260      |   |   |   | 848 |   |   |   | 118 |   |   |   | 22 |   |   | 2,248 |   |
| Net earnings                     |       |                                                               | 1,821      |   |   |   | 2,228 |   |   |   | 637 |   |   |   | 15 |   |   | 4,701 |   |
| Net earnings per share:          |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                            |       |                                                               | $          | 0.12 |   |   |   | $ | 0.14 |   |   |   | $ | 0.04 |   |   |   | $ | 0.00 |   |   | $ | 0.30 |   |
| Diluted                          |       |                                                               | 0.12       |   |   |   | 0.14 |   |   |   | 0.04 |   |   |   | 0.00 |   |   | 0.30 |   |

 

F-18

----

 

| ** **                              | ** ** | **YEAR ENDED DECEMBER 31, 2004**               | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                              | ** ** | **FIRST**                                                          | ** ** | **SECOND** | ** ** | **THIRD** | ** ** | **FOURTH** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **QUARTER**                                                        | ** ** | **QUARTER** | ** ** | **QUARTER** | ** ** | **QUARTER** | ** ** | **YEAR** | ** ** |
| ** **                              | ** ** | **(IN THOUSANDS, EXCEPT PER SHARE DATA)** | ** ** |
| INCOME STATEMENT DATA:                  |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                          |       |                                                               | $          | 6,236 |   |   |   | $ | 6,208 |   |   |   | $ | 4,934 |   |   |   | $ | 3,157 |   |   | $ | 20,535 |   |
| Earnings (loss)  before income taxes(b) |       |                                                               | 2,037      |   |   |   | 1,687 |   |   |   | (175 | ) |   |   | 935 |   |   | 4,484 |   |
| Provision  (benefit) for income taxes   |       |                                                               | 847        |   |   |   | 680 |   |   |   | (50 | ) |   |   | 306 |   |   | 1,783 |   |
| Net earnings  (loss)                    |       |                                                               | 1,190      |   |   |   | 1,007 |   |   |   | (125 | ) |   |   | 629 |   |   | 2,701 |   |
| Net earnings (loss) per  share:         |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                   |       |                                                               | $          | 0.08 |   |   |   | $ | 0.06 |   |   |   | $ | (0.01 | ) |   |   | $ | 0.04 |   |   | $ | 0.17 |   |
| Diluted                                 |       |                                                               | 0.08       |   |   |   | 0.06 |   |   |   | (0.01 | ) |   |   | 0.04 |   |   | 0.17 |   |

----

Note (a): Includedin the fourth quarter of 2005 is an impairment loss of goodwill in the amountof $212,000.

Note (b): Earnings(loss) before income taxes in the fourth quarter of 2004 reflects a reversal ofaccrued bonuses of $1.13 million.

F-19

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**EXHIBIT INDEX**
| 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            |            |       | Mossimo License Agreement, dated as of March 28, 2000,  between Mossimo, Inc. and Target Stores, a division of Target  Corporation(2) |   |
|             | 10.3.1          |            |       | Amendment to License and Design Services Agreement, dated  February 1, 2002(7) |   |
|             | 10.3.2          |            |       | Consent of Assignment and Amendment to License and Design  Services Agreement dated February 2, 2003(8) |   |
|             | 10.3.3          |            |       | Amendment to License and Design Services Agreement dated  June 20, 2003(9) |   |
|             | 10.5            |            |       | Cherokee-Mossimo Finders Agreement dated March 27, 2000  between Mossimo, Inc. and Cherokee Inc.(2) |   |
|             | 10.6            |            |       | Lease, dated June 29, 2000, between the Registrant and  Lexington-Broadway Place, LLC(3) |   |
|             | 10.6.1          |            |       | First Amendment to Office Lease dated June 26, 2002(9) |   |
|             | 10.6.2          |            |       | Second Amendment to Office Lease dated January 1, 2004(10) |   |
|             | 10.7            |            |       | Sunglasses Agreement, dated as of December 1, 2000, between  Mossimo, Inc., Marcolin S.P.A. and Target Stores(4) |   |
|             | 10.8*           |            |       | Amended and Restated Employment Agreement between the Registrant  and Mossimo Giannulli dated February 1, 2002(7) |   |
|             | 10.8.1*         |            |       | Amendment Number One to the Mossimo Giannulli Employment  Agreement, dated September 23, 2002(6) |   |
|             | 10.8.2          |            |       | Amendment Number Two to the Mossimo Giannulli Employment  Agreement, dated March 18, 2002(8) |   |
|             | 10.9            |            |       | Amended and Restated Mossimo Giannulli Bonus Plan(11) |   |
|             | 10.10           |            |       | Amended and Restated Edwin Lewis Bonus Plan(11) |   |
|             | 10.11           |            |       | 2005 Stock Option Plan(11) |   |
|             | 10.12           |            |       | Form of Stock Option Agreement for 2005 Stock Option Plan(11) |   |
|             | 14.1            |            |       | Code of Ethics |   |
|             | 21              |            |       | Subsidiaries of Registrant |   |
|             | 23              |            |       | Consent of Independent Registered Public Accounting Firm - KPMG  LLP |   |
|             | 31.1            |            |       | Certification of Principal Executive Officer as required by  Rule 13a - 14(a) of the Securities Act of 1934 |   |
|             | 31.2            |            |       | Certification of Principal Executive Officer as required by  Rule 13a - 14(a) of the Securities Act of 1934 |   |

----

 
|        | 31.3 |   |   | Certification of Principal Financial Officer as required by  Rule 13a - 14(a) of the Securities Act of 1934 |   |
|--------|------|--------|--------|-----------------------------------------------------------------------------------------------------------------------|--------|
|   | 32.1 |   |   | Certification of Principal Financial Officer as required by  Rule 13a - 14(a) of the Securities Act of 1934 |   |
|   | 32.2 |   |   | Certification of Principal Executive Officer as required by  Rule 13a - 14(b) of the Securities Act of 1934 |   |
|   | 32.3 |   |   | Certification of Principal Financial Officer as required by  Rule 13a - 14(b) of the Securities Act of 1934 |   |

----

NOTES:

(1)          Incorporated by reference from the Registrant’s RegistrationStatement on Form S-1 (No. 33-80597), as amended, which becameeffective February 22, 1996.

(2)          Incorporated by reference from the Registrant’s Current Report on Form 8-K,dated March 28, 2000.

(3)          Incorporated by reference from the Registrant’s Quarterly Reporton Form 10-Q for the Quarter ended September 30, 2000.

(4)          Incorporated by reference from the Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2000.

(5)          Incorporated by reference from the Registrant’s Quarterly Reporton Form 10-Q for the Quarter ended June 30, 2002.

(6)          Incorporated by reference from the Registrant’s Quarterly Reporton Form 10-Q for the Quarter ended September 30, 2002.

(7)          Incorporated by reference from the Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2002.

(8)          Incorporated by reference from the Registrant’s Quarterly Reporton Form 10-Q for the Quarter ended March 31, 2003.

(9)          Incorporated by reference from the Registrant’s Quarterly Reporton Form 10-Q for the Quarter ended June 30, 2003.

(10)   Incorporated by reference from the Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

(11)   Incorporated by reference from the Registrant’s Form 8-Kdated December 15, 2005.

*                    Indicates a management contract orcompensatory plan or arrangement.

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