**SECURITIESAND EXCHANGE COMMISSION**

 

**WASHINGTON,D.C. 20549**

 

### **FORM 10-Q**

 

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

 

**For theQuarterly Period Ended September 30, 2005**

 

**or**

 

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

 

**For theTransition Period From                to                **

 

##### **Commission File Number: 1-14208**

##### ** **

**MOSSIMO, INC.**

(Exact name of Registrant asspecified in its charter)

 
| **Delaware**                    | ** ** | **33-0684524**           |
|---------------------------------|------------|--------------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer ID No.) |
| incorporation or organization)  |       |                     |
|                            |       |                     |
| **2016  Broadway**              |       |                     |
| **Santa Monica, California**    | ** ** | **90404**                |
| (Address of principal           |       | (Zip Code)               |
| executive  offices)             |       |                     |

 

**(310) 460-0040**

(Registrant’s telephone number,including area code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for anyshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes   ý  No   o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes   o  No   ý

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   o  No   ý

 

As of September 30, 2005, the Registrant had15,748,442 shares of Common Stock, $0.001 par value, outstanding.

 

 

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**MOSSIMO,INC.**

 

**FORM 10-Q**

For the Six Months Ended June 30,2005

 
| PART I  – FINANCIAL INFORMATION                                                                           |   |
|---------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                |   |
| ITEM 1 – Financial Statements (Unaudited):                                                                     |   |
|                                                                                                                |   |
| Condensed consolidated balance sheets as of September 30, 2005  and December 31, 2004                     |   |
|                                                                                                                |   |
| Condensed consolidated statements of earnings for the three and nine  months ended September 30, 2005 and 2004 |   |
|                                                                                                                |   |
| Condensed consolidated statements of cash flows for the nine months  ended September 30, 2005 and 2004         |   |
|                                                                                                                |   |
| Notes to condensed consolidated financial statements                                                                |   |
|                                                                                                                |   |
| ITEM 2 – Management’s Discussion and Analysis of Financial Condition  and Results of Operations           |   |
|                                                                                                                |   |
| ITEM 3 – Quantitative and Qualitative Disclosure about Market Risk                                             |   |
|                                                                                                                |   |
| ITEM 4 – Controls and Procedures                                                                               |   |
|                                                                                                                |   |
| PART II  - OTHER INFORMATION                                                                                   |   |
|                                                                                                                |   |
| ITEM  1 – Legal Proceedings                                                                                    |   |
|                                                                                                                |   |
| ITEM 6  – Exhibits                                                                                             |   |
|                                                                                                                |   |
| SIGNATURES                                                                                                          |   |
|                                                                                                                |   |
| CERTIFICATIONS                                                                                                      |   |

 

----

 

MOSSIMO, INC.

CONDENSEDCONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

(Unaudited)

 
| ** **                                                                                                                                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ASSETS                                                                                                                                                               |       |                   |       |                  |       |
| CURRENT ASSETS:                                                                                                                                                      |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                            |       | $                      | 17,884     |                  | $          | 4,903 |   |
| Restricted cash                                                                                                                                                      |       | 722                    |       | 413                   |       |
| Investments                                                                                                                                                          |       | —                 |       | 4,800                 |       |
| Accounts receivable                                                                                                                                                  |       | 4,551                  |       | 2,908                 |       |
| Merchandise inventory                                                                                                                                                |       | 1,009                  |       | 539                   |       |
| Deferred income taxes                                                                                                                                                |       | 2,952                  |       | 1,739                 |       |
| Prepaid expenses and other current assets                                                                                                                            |       | 302                    |       | 436                   |       |
| Total current assets                                                                                                                                                 |       | 27,420                 |       | 15,738                |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| PROPERTY AND EQUIPMENT, at cost, net of  accumulated depreciation and amortization                                                                                   |       | 923                    |       | 1,117                 |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| DEFERRED INCOME TAXES                                                                                                                                                |       | 3,022                  |       | 5,646                 |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| GOODWILL                                                                                                                                                             |       | 212                    |       | 212                   |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| TRADENAME, net                                                                                                                                                       |       | 92                     |       | 112                   |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| OTHER ASSETS                                                                                                                                                         |       | 37                     |       | 96                    |       |
|                                                                                                                                                                 |       | $                      | 31,706     |                  | $          | 22,921 |   |
|                                                                                                                                                                 |       |                   |       |                  |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                                           |       |                   |       |                  |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| CURRENT LIABILITIES:                                                                                                                                                 |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                     |       | $                      | 1,556      |                  | $          | 352 |   |
| Accrued liabilities                                                                                                                                                  |       | 645                    |       | 257                   |       |
| Accrued commissions                                                                                                                                                  |       | 382                    |       | 258                   |       |
| Accrued bonuses                                                                                                                                                      |       | 2,568                  |       | 206                   |       |
| Total current liabilities                                                                                                                                            |       | 5,151                  |       | 1,073                 |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| DEFERRED RENT                                                                                                                                                        |       | 132                    |       | 135                   |       |
| Total liabilites                                                                                                                                                     |       | 5,283                  |       | 1,208                 |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| COMMITMENTS, CONTINGENCIES, AND SUBSEQUENT  EVENTS                                                                                                                   |       |                   |       |                  |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| 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 15,748,442 at September 30, 2005 and  15,738,442 at December 31, 2004 |       | 15                     |       | 15                    |       |
| Additional paid-in capital                                                                                                                                           |       | 39,788                 |       | 39,763                |       |
| Accumulated deficit                                                                                                                                                  |       | (13,380                | )          | (18,065               | )          |
| Net stockholders’ equity                                                                                                                                        |       | 26,423                 |       | 21,713                |       |
|                                                                                                                                                                 |       | $                      | 31,706     |                  | $          | 22,921 |   |

 

See accompanying notes to condensed consolidated financial statements

 

2

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MOSSIMO, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF EARNINGS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(Unaudited)

 
| ** **                                              | ** ** | **For the Three Months  September 30,** | ** ** | **For the Nine Months  September 30,** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                              | ** ** | **2005**                                     | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Revenue from license royalties and design  service fees |       | $                                            | 4,238      |                                        | $          | 4,187 |   | $ | 19,705 |   | $ | 16,181 |   |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Product sales                                           |       | 2,533                                        |       | 747                                         |       | 4,775 |   | 1,197 |   |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Total revenues                                          |       | 6,771                                        |       | 4,934                                       |       | 24,480 |   | 17,378 |   |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Operating expenses:                                     |       |                                         |       |                                        |       |   |   |   |   |
| Cost of product sales                                   |       | 1,204                                        |       | 665                                         |       | 2,937 |   | 889 |   |
| Selling, general and administrative                     |       | 4,935                                        |       | 4,470                                       |       | 14,864 |   | 13,014 |   |
| Total operating expenses                                |       | 6,139                                        |       | 5,135                                       |       | 17,801 |   | 13,903 |   |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Earnings (loss) from operations                         |       | 632                                          |       | (201                                        | )          | 6,679 |   | 3,475 |   |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Interest income                                         |       | 123                                          |       | 26                                          |       | 232 |   | 73 |   |
| Earnings (loss) before income taxes                     |       | 755                                          |       | (175                                        | )          | 6,911 |   | 3,548 |   |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Income taxes                                            |       | 118                                          |       | (50                                         | )          | 2,226 |   | 1,476 |   |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Net earnings (loss)                                     |       | $                                            | 637        |                                        | $          | (125 | ) | $ | 4,685 |   | $ | 2,072 |   |
|                                                    |       |                                         |       |                                        |       |   |   |   |   |
| Earnings (loss) per common share:                       |       |                                         |       |                                        |       |   |   |   |   |
| Basic                                                   |       | $                                            | 0.04       |                                        | $          | (0.01 | ) | $ | 0.30 |   | $ | 0.13 |   |
| Diluted                                                 |       | $                                            | 0.04       |                                        | $          | (0.01 | ) | $ | 0.30 |   | $ | 0.13 |   |
| Weighted average common shares outstanding:             |       |                                         |       |                                        |       |   |   |   |   |
| Basic                                                   |       | 15,748                                       |       | 15,738                                      |       | 15,742 |   | 15,738 |   |
| Diluted                                                 |       | 15,785                                       |       | 15,738                                      |       | 15,770 |   | 15,777 |   |

 

See accompanying notes to condensed consolidated financial statements

 

3

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MOSSIMO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(Unaudited)

 
| ** **                                                                           | ** ** | **FOR THE NINE MONTHS  ENDED SEPTEMBER 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
|                                                                                 |       |                                              |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                |       |                                              |       |   |   |
| Net earnings                                                                         |       | $                                                 | 4,685      |   | $ | 2,072 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                        |       | 346                                               |       | 237 |   |
| Inventory write-down                                                                 |       | 255                                               |       | — |   |
| Deferred rent                                                                        |       | (3                                                | )          | — |   |
| Provision for bad debt                                                               |       | 49                                                |       | — |   |
| Deferred income taxes                                                                |       | 1,411                                             |       | 1,383 |   |
| Changes in:                                                                          |       |                                              |       |   |   |
| Restricted Cash                                                                      |       | —                                            |       | 4,585 |   |
| Accounts receivable                                                                  |       | (1,692                                            | )          | (1,535 | ) |
| Merchandise inventory                                                                |       | (725                                              | )          | (222 | ) |
| Prepaid expenses and other current assets                                            |       | 134                                               |       | (178 | ) |
| Other assets                                                                         |       | 59                                                |       | 182 |   |
| Accounts payable                                                                     |       | 1,204                                             |       | (220 | ) |
| Accrued liabilities                                                                  |       | 388                                               |       | (1,081 | ) |
| Accrued commissions                                                                  |       | 124                                               |       | (4,904 | ) |
| Accrued bonuses                                                                      |       | 2,362                                             |       | 1,019 |   |
| Net cash provided by operating activities                                            |       | 8,597                                             |       | 1,338 |   |
|                                                                                 |       |                                              |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                |       |                                              |       |   |   |
| Proceeds from sale of available-for-sale  securities                                 |       | 4,800                                             |       | — |   |
| Payments for acquisition of property and  equipment                                  |       | (132                                              | )          | (841 | ) |
| Acquisition of Modern Amusement                                                      |       | —                                            |       | (375 | ) |
| Net cash provided by (used in) investing  activities                                 |       | 4,668                                             |       | (1,216 | ) |
|                                                                                 |       |                                              |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                |       |                                              |       |   |   |
| Proceeds from issuance of common stock                                               |       | 25                                                |       | — |   |
| Restricted cash – certificates of deposit                                       |       | (309                                              | )          | — |   |
| Net cash used in financing activities                                                |       | (284                                              | )          | — |   |
|                                                                                 |       |                                              |       |   |   |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                            |       | 12,981                                            |       | 122 |   |
| CASH AND CASH EQUIVALENTS, beginning of  period                                      |       | 4,903                                             |       | 9,707 |   |
| CASH AND CASH EQUIVALENTS, end of period                                             |       | $                                                 | 17,884     |   | $ | 9,829 |   |
|                                                                                 |       |                                              |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:                                   |       |                                              |       |   |   |
| Cash paid during the year for state income  taxes                                    |       | $                                                 | 195        |   | $ | 58 |   |

 

See accompanying notes to condensed consolidatedfinancial statements

 

4

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**MOSSIMO,INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

1.  BASIS OF PRESENTATION

 

The condensed consolidated financialstatements presented herein have not been audited, but include all materialadjustments (consisting of normal recurring adjustments), which are, in theopinion of management, necessary for a fair statement of the financialcondition, results of operations and cash flows for the periods presented.However, these results are not necessarily indicative of results for any otherinterim period or for the full year. The condensed consolidated balance sheetdata presented herein for December 31, 2004 was derived from the Company’saudited consolidated financial statements for the year then ended, but does notinclude all disclosures required by accounting principles generally accepted inthe United States of America.

 

On January 16,2004, Mossimo, Inc. acquired substantially all the assets of ModernAmusement LLC through a wholly owned subsidiary, Modern Amusement, Inc. (“ModernAmusement”). The accompanying consolidated financial statements as of and forthe three and nine months ended September 30, 2004 include the accountbalances and results of operations of Modern Amusement as of September 30,2004 and for the period from January 16, 2004 to September 30, 2004,respectively. All inter-company accounts and transactions have been eliminatedin consolidation.

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedamounts of 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.

 

Certain information and footnote disclosuresnormally included in annual financial statements in accordance with accountingprinciples generally accepted in the United States of America have been omittedpursuant to the Regulations of the Securities and Exchange Commission. TheCompany believes the disclosures included in the accompanying interim condensedconsolidated financial statements and notes thereto are adequate to make theinformation not misleading, but should be read in conjunction with thefinancial statements and notes thereto included in our Form 10-K for theyear ended December 31, 2004.

 

Certain prior year balances have beenreclassified to conform to the current year presentation.

 

2.  REVENUERECOGNITION

 

Revenue from license royalties and designservice fees are recognized in accordance with the terms of the underlyingagreements, which is generally after the design services are performed, and asthe licensee achieves sales of the Company’s products. During the periodspresented herein, a substantial amount of the Company’s revenue from licenseroyalties and design fees were generated under the Target Agreement under arate of 1% to 4% that declines as the contract year progresses and Targetachieves certain levels of retail sales. Accordingly, the Company’s revenuesfrom Target decreases as the year progresses. The declining rate is reset eachcontract year beginning on February 1. Revenue recognized in the first andsecond quarters of the Company’s calendar year in connection with the TargetAgreement is significantly higher than in the third and fourth quarters of theCompany’s calendar year due to the declining rates in the Target Agreement.Revenues from license royalties and design service fees under licenseagreements other than the Target Agreement are generally collected on aquarterly basis, and they range from 1% to 5% of sales, as defined in therespective agreements.

 

5

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Modern Amusement recognizes wholesaleoperations revenue from the sale of merchandise when products are shipped, FOBModern Amusement’s distribution facilities, and the customer takes title andassumes risk of loss, collection is reasonably assured, pervasive evidence ofan arrangement exists, and the sales price is fixed or determinable.

 

3. INVENTORY

 

The Companymaintains inventories for the Modern Amusement segment.   Inventories are valued at the lower of cost(first-in, first-out) or market and are made up primarily of finished goods.  The Company continually evaluates its inventoriesby assessing slow moving current product as well as prior seasons’ remaininginventory.  Market value of non-currentinventory is estimated based on the impact of market trends, an evaluation ofeconomic conditions and the value of current orders relating to the futuresales of this type of inventory. Management makes reserves against such inventory as seen appropriate,which reduces our gross margin, operating income and carrying value ofinventories.

 

The Companyhas adopted SFAS No. 151, “Inventory Costs: an amendment of ARB No. 43,Chapter 4,” to clarify the accounting for abnormal amounts of idle facilityexpense, freight, handling costs and wasted material.  The adoption of SFAS No. 151 did nothave a significant impact on the Company’s financial position, results ofoperations or cash flows.

 

4.  EXECUTIVEBONUS PLANS

 

The Company has bonus plans covering two executiveofficers which are administered by the Compensation Committee of the Board ofDirectors, and that provide for discretionary bonuses based on the Company’soverall performance, with the total amount of the bonuses not to exceed apercent (as defined) of the excess over the minimum total guaranteed fees, ifany, of license royalties paid to the Company under the Target Agreement, andas defined in each of the respective bonus plans. The Company has expensedapproximately $721,000 and $465,000 under these agreements for the three monthperiods ended September 30, 2005 and 2004, respectively; and $2,382,000and $1,131,000 for the nine month periods ended September 30, 2005 and2004, respectively.

 

5.  INCOME TAXES

 

The Company accounts forincome taxes in accordance with Statement of Financial Accounting Standard (“SFAS”)No. 109, “Accounting for Income Taxes”. Deferred taxes result from therecognition of the income tax benefit to be derived from the Company’s netoperating loss carry forward for income taxes purposes.

 

The Company recorded aprovision for income taxes of $118,000 and $2,226,000 for the three and ninemonths ended September 30, 2005, respectively, compared to a benefit forincome taxes of $50,000 for the three months ended September 30, 2004 andprovision for income taxes of $1,477,000 for the nine months ended September 30,2004. Both provisions approximate the Company’s combined effective rate asestimated for the entire fiscal year, for Federal and California state incometaxes.  The income tax rate for the ninemonths ended September 30, 2005 is 32% compared to 41% for the comparableperiod of the prior year.  The decreaseis due to a reduction in the valuation allowance as described below.

 

At September 30, 2005, the Company has recorded a total netdeferred tax asset of $5.97 million, with $2.95 million classified as currentin the accompanying condensed consolidated balance sheet, primarily reflectingthe extension of the Target Agreement through January 31, 2008. TheCompany has considered the projected taxable income from the Target Agreementand other agreements in its estimate of deferred tax asset recoverability andhas recorded a valuation allowance for its net deferred tax assets of $306,000as of September 30, 2005 compared to $1.1 million as of December 31,2004.  The reduction is primarily due tothe increased future utilization of foreign tax credits and alternative minimumtax credits.

 

6

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The Company has approximately $10 million and$7.3 million of federal and state income tax net operating loss carry forwards,respectively, available to offset future taxable income which expire in variousyears through 2022. The Company expects that future taxable income will be offset inthe near-term, for the most part, by its net operating tax loss carryforwards.

 

In addition to the Company’s taxable incomebeing subject to federal, state and local income taxes, the Company may beclassified as a “personal holding company” from time to time. Personal holdingcompany status results from more than 50 percent of the value of outstandingstock being owned directly or indirectly by five or fewer individuals, and morethan 60 percent of the Company’s income, as defined, being derived fromroyalties. Personal holding companies are subject to an additional federal taxat the highest personal income tax rate on undistributed after tax earnings.

 

Over 50 percent of the value of the Company’soutstanding stock is owned by one stockholder, however it is presentlyanticipated that in 2005, no more than 60 percent of the Company’s income, asdefined, would be derived from license royalties. Accordingly, at this time theCompany is not anticipating being classified as a personal holding company atthe end of 2005 and the Company intends to continue to take appropriatemeasures to avoid being classified as a personal holding company at the end of2005 and beyond. However, there can be no assurance that the Company will besuccessful in its efforts to avoid classification as a personal holding companyat the end of 2005 or in future years.

 

6.  EARNINGS PERSHARE AND STOCK OPTION PLANS

 

Basic earningsper share is computed by dividing net earnings available to common stockholdersby the weighted average number of common shares outstanding. Diluted earningsper share includes the effect of potential shares outstanding, includingdilutive stock options, using the treasury stock method. Securities excludedfrom diluted weighted average shares outstanding are comprised of stockoptions.

 

The reconciliation between earnings andweighted average shares outstanding for basic and diluted earnings per share isas follows (amounts in thousands, except per share data):

 
| ** **                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                        |       |                                       |       |                                      |       |   |   |   |   |
| Net earnings (loss)                         |       | $                                          | 637        |                                      | $          | (125 | ) | $ | 4,685 |   | $ | 2,072 |   |
| Weighted average number of common shares:   |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                       |       | 15,748                                     |       | 15,738                                    |       | 15,742 |   | 15,738 |   |
| Effect of dilutive securities-stock options |       | 37                                         |       | —                                    |       | 28 |   | 39 |   |
| Diluted                                     |       | 15,785                                     |       | 15,738                                    |       | 15,770 |   | 15,777 |   |
|                                        |       |                                       |       |                                      |       |   |   |   |   |
| Earnings (loss) per share:                  |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                       |       | $                                          | 0.04       |                                      | $          | (0.01 | ) | $ | 0.30 |   | $ | 0.13 |   |
| Effect of dilutive securities-stock options |       | —                                     |       | —                                    |       | — |   | — |   |
| Diluted                                     |       | $                                          | 0.04       |                                      | $          | (0.01 | ) | $ | 0.30 |   | $ | 0.13 |   |
|                                        |       |                                       |       |                                      |       |   |   |   |   |
| Excluded securities - antidilutive          |       | 394                                        |       | 656                                       |       | 399 |   | 424 |   |

 

The Company adopted the Mossimo, Inc.1995 Stock Option Plan (the “1995 Plan”), which provides for the grant of stockoptions, stock appreciation rights and other stock awards to certain officersand key employees of the Company and to certain advisors or consultants to theCompany. In addition, the Company

 

7

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adopted a Non-EmployeeDirectors Stock Option Plan (the “Directors Plan”) that provides for the grantof stock options to non-employee directors.

 

The Companyaccounts for stock-based compensation in accordance with Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”,and related interpretations. The Company follows the pro forma disclosurerequirements of SFAS No. 123, “Accounting for Stock-Based Compensation”,which requires presentation of the pro forma effect of the fair value basedmethod on net earnings and net earnings per share in the financial statementfootnotes.

 

If compensation expensewas determined based on the fair value method, the Company’s net earnings andearnings per share would have resulted in the approximate pro forma amountsindicated below for the three and nine month periods ended September 30,2005 and 2004 (in thousands, except per share data):

 
| ** **                                                                                                                                   | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Net earnings (loss) as reported                                                                                                              |       | $                                          | 637        |                                      | $          | (125 | ) | $ | 4,685 |   | $ | 2,072 |   |
|                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Deduct:                                                                                                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Total stock-based employee compensation expense  determined under fair market value based method for all awards, net of  related tax effects |       | (16                                        | )          | (213                                      | )          | (48 | ) | (360 | ) |
| Pro forma net earnings (loss)                                                                                                                |       | $                                          | 621        |                                      | $          | (338 | ) | $ | 4,637 |   | $ | 1,712 |   |
|                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Earnings (loss) per share – basic and  diluted                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| As reported – basic                                                                                                                     |       | $                                          | 0.04       |                                      | $          | (0.01 | ) | $ | 0.30 |   | $ | 0.13 |   |
| As reported – diluted                                                                                                                   |       | $                                          | 0.04       |                                      | $          | (0.01 | ) | $ | 0.30 |   | $ | 0.13 |   |
|                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Pro forma – basic                                                                                                                       |       | $                                          | 0.04       |                                      | $          | (0.02 | ) | $ | 0.29 |   | $ | 0.11 |   |
| Pro forma – diluted                                                                                                                     |       | $                                          | 0.04       |                                      | $          | (0.02 | ) | $ | 0.29 |   | $ | 0.11 |   |

 

7.  IMPACT OF RECENT ACCOUNTINGPRONOUNCEMENTS

 

SFAS No. 123R- In December 2004, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 123R, “Share-Based Payment: an amendment of FASBStatements No. 123 and 95,” which requires companies to recognize in theirincome statement the grant-date fair value of stock options and otherequity-based compensation issued to employees. That cost will be recognized over the period during which an employee isrequire to provide service in exchange for the award.  Additionally, liability awards will beremeasured each reporting period.  SFAS No. 123Ris effective for the Company on January 1, 2006.  Accordingly, the Company will adopt SFAS No. 123Rin our first quarter of 2006. See Note 6 “Earnings Per Share and Stock OptionPlans,” for the pro forma effects of how SFAS No. 123R would have affectedthe results of earnings in the nine month period ended September 30, 2005and 2004.  We are currently assessing theimpact this prospective change in accounting guidance will have on ourfinancial condition and results of operations, but we believe that the impactwill not be material.

 

8. LITIGATION

 

On October 10,2005, the Company and other defendants entered intoa Memorandum of Understanding (“MOU”) to settle the pending consolidated classaction lawsuit styled *In Re Mossimo, Inc.Shareholder Litigation*, Delaware Chancery Court Case No.1246-N.  The litigation was filedfollowing the announcement by Mossimo Giannulli (“Giannulli”) ofhis intention to acquire all outstanding shares of the Company that he doesnot already own for a price of $4.00 per share. Under the terms of the MOU, Giannulli agreed that hisproposal to acquire all of the Company’s outstanding shares would bepriced at $5.00 per share and that the tender offer pursuantto which the acquisition is proposed to be consummated would be conditionedupon no less than 50 percent of all public stockholders of the Companyunaffiliated with Giannulli accepting or approving the tender offer.  The MOU further provided that plaintiffs’lead counsel will be afforded the opportunity to comment on and suggestinclusions to the disclosures made to the Company’s public stockholders inconjunction with the acquisition.  Inaddition, the Company agreed to negotiate in good faith with the plaintiffs’lead counsel concerning the amount of attorney fees and expenses to be paid,subject to Delaware Chancery Court approval. The Company has agreed to pay whatever fee and expense amount theDelaware Chancery Court may award to plaintiffs’ lead counsel.  In consideration of these terms, the partieswill fully and finally release and discharge all claims against eachother.  The settlement isconditioned the consummation of the acquisition by Giannulli, the negotiationof a definitive stipulation of settlement and the entry of aFinal Order and Judgment approving the settlement by the Delaware ChanceryCourt.  On November 12, 2005, Giannulli terminatedhis proposal to acquire the outstanding shares of the Company that he does not alreadyownafter the Company’s special committee withdrew its recommendation of theproposal. The parties have not proceeded with the further negotiations requiredto finalize the settlement.

 

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9. SEGMENT INFORMATION

 

The Companyoperates in two business segments: Mossimo (design and licensing services) andModern Amusement (Modern) (wholesale). The following tables summarize various financial amounts for each of ourbusiness segments (in thousands):

 
| **Three months ended  September 30, 2005** | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                        |       | $           | 4,238      |       | $          | 2,533     |       | $ | 6,771 |   |
| Gross Profit                                    |       | —      |       | 1,329      |       | 1,329     |       |
| Depreciation and Amortization                   |       | 38          |       | 55         |       | 93        |       |
| Selling, general and administrative  expenses   |       | 3,753       |       | 1,182      |       | 4,935     |       |
| Operating Income (loss)                         |       | 485         |       | 147        |       | 632       |       |
| Interest Income                                 |       | 123         |       | —     |       | 123       |       |
| Total Assets                                    |       | 27,875      |       | 3,831      |       | 31,706    |       |
| Capital Expenditures                            |       | 26          |       | 3          |       | 29        |       |
|                                                 |            |             |            |            |            |           |            |  |  |  |

 
| **Three months ended  September 30, 2004** | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                        |       | $           | 4,187      |       | $          | 747       |       | $ | 4,934 |   |
| Gross Profit                                    |       | —      |       | 82         |       | 82        |       |
| Depreciation and Amortization                   |       | 58          |       | 38         |       | 96        |       |
| Selling, general and administrative  expenses   |       | 3,611       |       | 859        |       | 4,470     |       |
| Operating Income (loss)                         |       | 575         |       | (776       | )          | (201      | )          |
| Interest Income                                 |       | 26          |       | —     |       | 26        |       |
| Total Assets                                    |       | 21,075      |       | 2,224      |       | 23,299    |       |
| Capital Expenditures                            |       | 33          |       | 113        |       | 146       |       |
|                                                 |            |             |            |            |            |           |            |  |  |  |

 

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| **Nine months ended  September 30, 2005** | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                       |       | $           | 19,705     |       | $          | 4,775     |       | $ | 24,480 |   |
| Gross Profit                                   |       | —      |       | 1,838      |       | 1,838     |       |
| Depreciation and Amortization                  |       | 158         |       | 188        |       | 346       |       |
| Selling, general and administrative  expenses  |       | 11,790      |       | 3,074      |       | 14,864    |       |
| Operating Income (loss)                        |       | 7,915       |       | (1,236     | )          | 6,679     |       |
| Interest Income                                |       | 232         |       | —     |       | 232       |       |
| Total Assets                                   |       | 27,875      |       | 3,831      |       | 31,706    |       |
| Capital Expenditures                           |       | 54          |       | 78         |       | 132       |       |
|                                                |            |             |            |            |            |           |            |  |  |  |

 
| **Nine months ended  September 30, 2004** | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                       |       | $           | 16,181     |       | $          | 1,197     |       | $ | 17,378 |   |
| Gross Profit                                   |       | —      |       | 308        |       | 308       |       |
| Depreciation and Amortization                  |       | 167         |       | 70         |       | 237       |       |
| Selling, general and administrative expenses   |       | 11,084      |       | 1,930      |       | 13,014    |       |
| Operating Income (loss)                        |       | 5,091       |       | (1,616     | )          | 3,475     |       |
| Interest Income                                |       | 73          |       | —     |       | 73        |       |
| Total Assets                                   |       | 21,075      |       | 2,224      |       | 23,299    |       |
| Capital Expenditures                           |       | 82          |       | 759        |       | 841       |       |
|                                                |            |             |            |            |            |           |            |  |  |  |

 

The following information should beconsidered when reading the above table:

 

•      The Company has no inter-segment revenue or expense.

•      Corporate overhead has been allocated to the Mossimo segment.

•      The provision for income tax is not allocated to businesssegments.

•      All long-lived assets were geographically located in the UnitedStates.

•      Revenue from countries other than the United States did notaccount for 10% or more of total revenue.

•      Gross profit is derived by reducing sales of the Modern segment of$4.78 million by $2.94 million of cost of sales for the ninemonths ended September 30, 2005 toarrive at a gross profit of approximately $1.84 million.  For the three months ended September 30,2005 sales of the Modern segment were $2.53 million reduced by cost of sales of$1.20 million to arrive at a gross profit of approximately $1.33 million.

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

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**FORWARDLOOKING INFORMATION**

 

This report on Form 10-Q containscertain forward-looking statements within the meaning of Section 27A ofthe Securities 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 other things,statements regarding or expectations about our future revenues and earnings.Forward

 

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looking statements includeknown or unknown risks and uncertainties that may cause our results,performance and stock price to be materially different from the forward lookingstatements. Such statements are based on management’s current expectations andare subject to certain risks, uncertainties and assumptions, including thosedescribed in our Form 10-K for the year ended December 31, 2004 under“Business—Risk Factors”. Should one or more risks or uncertainties materialize,or should underlying assumptions prove incorrect, the Company’s actual results,performance or achievements could differ materially from those expressed in, 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 our Form 10-K for the year ended December 31,2004 under “Business—Risk Factors.” Accordingly, undue reliance should not beplaced on these forward-looking statements.

 

This discussion and analysis should be readin conjunction with the Company’s financial statements for the year ended December 31,2004 in our annual report on Form 10-K.

 

**Overview**

 

Mossimo, Inc.presently 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 andinternationally.  Our primary domesticlicensee is Target Corporation.  Inaddition to the Target Agreement, the Company also licenses its Mossimotrademarks and provides design services outside of the United States, and alsolicenses its Mossimo trademarks for use in collections of eyewear and women’sswimwear and body-wear sold in Target stores in the United States.

 

The Company entered intoa multi-year licensing and design services agreement with Target in March 2000which was subsequently amended in April 2002, and in February and June 2003(hereinafter referred to as the “Target Agreement”). Under the terms of theTarget Agreement, Target has the exclusive license, for production anddistribution 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 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 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’s fees are based on net sales achieved multipliedby a rate, as defined in the Target Agreement. The Company pays a 15%commission, based on fees received from Target, to a third party who assistedthe Company in connection with entering into the initial agreement with Target.The Target Agreement is subject to early termination under certaincircumstances. 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 2005, Target exercised itssecond renewal options extending the Target Agreement through January 31,2008.

 

The Company has licensedthe exclusive right to manufacture and distribute eyewear bearing its Mossimotrademarks through specialty retail stores such as opticians, optical chainsand specialty eyeglass and sunglass stores pursuant to a license agreement withthe Marcolin Group. This agreement

 

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ended on December 31,2004 and we currently not generating revenue in this area. The Company in theprocess of negotiating a new agreement.

 

The Company has licensedthe exclusive right to manufacture and distribute women’s swimwear and bodywearbearing its Mossimo trademarks through Target stores in the United Statespursuant to a license agreement with The Lunada Bay Corporation. This agreementextends through September 30, 2007, and is renewable annually.

 

In May 2002,the Company 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 has expired, and there are no plans torenew the agreement.

 

The Company enters intoother International licensing agreements of its Mossimo branded products forcertain geographical territories when the Company believes such arrangementsprovide effective manufacturing, distribution and marketing of suchproducts.  Historically, very littleactivity has occurred outside the United States.

 

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 businessincludes sourcing manufactured products, wholesale distribution, inventory management,marketing, promoting, and advertising of apparel and related accessories underthe Modern Amusement brand. While the Modern Amusement business is relativelysmall, as the Company expands into the wholesale products business, it willencounter increased exposure to excess and obsolete inventories, potentialdelays and cancellations from sourcing manufactured products domestically andinternationally, and product returns and allowances from retail customers, aswell as marketing, promotion and advertising expenditures that may not resultin successful campaigns.

 

The Company’sstrategy in developing Modern Amusement is to diversify the Company’s currentdesign and licensing businesses through the development of mass wholesaledistribution channels.

 

Net salesfor Modern Amusement for the quarter ended September 30, 2005 were $2.53million with a gross profit margin of 52.5%. Selling, general and administrative expense for Modern Amusement for thequarter ended September 30, 2005 was $1.18 million.  For quarter ended September 30, 2005, ModernAmusement had operating income of $147,000. Modern Amusement’s total assets as of September 30, 2005 were $3.83million.  Net sales for the nine monthsended September 30, 2005 were $4.78 million with a gross profit margin of38%.  Selling, general and administrativeexpenses for Modern Amusement for the nine months ended September 30, 2005 was$3.07 million.  For the nine months endedSeptember 30, 2005, Modern Amusement had operating loss of $1.24 million.

 

***Results of Operations***

 

# *ThreeMonths Ended September 30, 2005 and 2004*

# * *

*Revenues*

 

Total revenue from license royalties anddesign service fees in the third quarter of 2005 remained constant at $4.2million compared to the third quarter of 2004. For the third quarter of 2005, 85% of the Company’s revenue from licenseroyalties and design fees were generated under the Target Agreement, comparedto 90% for the same period in 2004. The royalty rate under the Target Agreementdeclines, as the contract year progresses and Target achieves certain levels ofretail sales, from 4% to 1%. The declining royalty rate is reset each contractyear beginning on February 1. Accordingly, revenue

 

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recognized in the first andsecond quarters of the Company’s calendar year is significantly higher than inthe third and fourth quarters due to the declining rates in the TargetAgreement.  In 2005, the 1% rate wasreached in June compared to August in 2004.  Revenues from license royalties and designservice fees under license agreements other than the Target Agreement aregenerally collected on a quarterly basis, and they range from 1% to 5% ofsales, as defined in the respective agreements.

 

Design service fees and royalties recognized under theTarget Agreement were $3.6 million in the third quarter of 2005 compared to$3.8 million in the third quarter of 2004. The 5% decrease was due reaching alower royalty rate in June of 2005 compared to August of 2004.  Royalties and design service fees fromcustomers other than Target increased to $658,000 in the third quarter of 2005compared to $420,000 in the third quarter of 2004.  The increase was due mainly to an additionalroyalties received from Australia, Canada, and Mexico.  The Company’s revenues generated under theTarget Agreement are expected to increase modestly as Target adds new storesand the Company continues to maximize its opportunities with Target.

 

Modern Amusement achieved gross retail sales of$2.53 million in the third quarter of 2005 compared to $747,000 for the thirdquarter of 2004.  These sales generated agross profit of approximately $1.33 million for the third quarter of 2005compared to $82,000 for the third quarter of 2004.  We experienced a higherprofit margin due to better buying and a proportionality smaller amount of offprice sales compared to regular priced sales.

 

*Cost of product sales*

 

Cost ofsales in the third quarter of 2005 resulted entirely from Modern Amusementproduct sales.  Cost of salesapproximated 47.5% of sales.  Cost ofsales includes 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.

 

*Selling, general and administrative expenses(S, G & A)*

 

Selling, general and administrative expenses increasedto $4.93 million for the third quarter of 2005 from $4.47 million for the thirdquarter of 2004.  This increase wasprimarily due to (i) $324,000 increase in selling, general andadministrative expenses incurred by the operations of Modern Amusement, (ii) increasesin accrued executive officer bonuses of $261,000, (iii) $625,000 in costsincurred for legal and financial advisor expenses for the Company and itsspecial committee associated with the review and consideration of thetransaction proposed by Mossimo Giannulli for the acquisition of all of thecompanies remaining outstanding shares and pending litigation relating to theproposal.  The increase was offset byoperational improvements in the Mossimo segment, although operating expensesfor the Mossimo segment, as a percent of revenues from royalties and designservice fees, increased to 89% in the third quarter of 2005 compared to 86% forthe third quarter of 2004, primarily as a result of the expenses associatedwith the Mossimo Giannulli proposal.

 

Selling expenses, comprised of commissions due to athird party who assisted the Company in connection with entering into theinitial agreement with Target, remained relatively constant at $537,000 in thethird quarter of 2005 compared to $561,000 in the third quarter of 2004.

 

General and administrative expenses include payrollfor the Company’s officers and its design staff, travel, facilities, insurance,legal and professional fees, and other design related expenses for purchasedservices and artwork used in the design process. Salaries and related costs forthe Mossimo segment decreased to $914,000 for the third quarter of 2005,compared to $1.15 million for the third quarter of 2004 due to additionalsalary and bonus accruals in the third quarter of 2004. Also included ingeneral and administrative expenses are accruals for bonuses of $726,000 forthe third quarter of 2005, compared to $465,000 for the third quarter of 2004,which are due under bonus plans covering the Company’s co-chief executiveofficers.

 

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Selling, general and administrative expenses incurredby Modern Amusement were $1.18 million in the third quarter of 2005 compared to$859,000 in the third quarter of 2004. These increases resulted from commissions of $175,000 compared to$12,000 in the third quarter of 2004, consulting fees of $75,000 compared to$42,000 in the third quarter of 2004, advertising cost of $91,000 compared to$4,000 in the third quarter of 2004, outsourcing costs of $131,000 compared to$106,000 for the third quarter of 2004, and samples costs of $66,000 comparedto $37,000 in the second quarter of 2004. These increases are associated with the anticipated growth of the ModernAmusement brand.

 

*Interest income*

 

As a result ofhigher average cash balances of $17.88 million for the period ended September 30,2005 compared to average cash and investment balance of $9.70 million for thesame period in 2004, the Company earned $124,000 in interest income the thirdquarter of 2005, compared to $26,000 in the third quarter of 2004. $4,300 ofinterest expense was incurred in the three month period ended September 30,2005.

 

*Income taxes*

 

The Company recorded aprovision for income taxes of $118,000 in the third quarter of 2005 compared toa benefit for income taxes of $50,000 in the third quarter of 2004. Bothprovisions approximate the Company’s effective tax rate for Federal andCalifornia state income taxes.

 

The Company has approximately $10 million and$7.3 million of federal and state income tax net operating loss carry forwards,respectively, available to offset future taxable income which expire in variousyears through 2022. The Company expects that future taxable income will be offset inthe near-term, for the most part, by its net operating tax loss carryforwards.

 

*Net earnings*

 

The Company’s net earnings for the second quarter of2005 were $637,000, or $0.04 per diluted share, compared to a net loss of$125,000, or $0.01 per diluted share for the third quarter of 2004 due to thefactors discussed above.

 

# *NineMonths Ended September 30, 2005 and 2004*

# * *

*Revenues*

 

Total revenue from license royalties anddesign service fees for the nine months ended September 30, 2005 were$19.7 million compared to $16.2 million for the nine months ended September 30,2004.  For the nine months ended September 30,2005, 90% of the Company’s revenue from license royalties and design fees weregenerated under the Target Agreement, compared to 89% for the same period in2004. 

 

Design service fees and royalties recognized under theTarget Agreement were $17.6 million for the nine months ended September 30,2005 compared to $14.4 million for the nine months ended September 30,2004. The 22% increase reflects growth in sales of women’s apparel, accessoriesand shoes. Royalties and design service fees from customers other than Targetincreased to $2.1 million for the nine months ended September 30, 2005compared to $1.8 million for the nine months ended September 30,2004.  The increase was due mainly toadditional royalties received from Australia, Canada, and Mexico.

 

Modern Amusement achieved gross sales of $4.78million for the nine months ended September 30, 2005 compared to $1.20million for the period of January 16, 2004 to September 30,2004.  These sales generated a grossprofit of approximately $1.84 million for the nine months ended September 30,2005 compared to $308,000 for the period from January 16, 2004 to September 30,2004.

 

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*Cost of product sales*

 

Cost ofsales forthe nine months ended September 30, 2005 resulted entirely from Modern Amusement product sales.  Cost of sales approximated 62% of sales.  Cost of sales includes all costs and expensesincurred prior to the receipt of finished goods at the Company’s distributionfacilities. These costs include, but are not limited to, product cost, inboundfreight charges, purchasing and receiving costs, inspection costs, insurance,duty, and brokers’ fees.

 

*Selling, general and administrative expenses(S, G & A)*

 

Selling, general and administrative expenses increasedto $14.86 million for the nine months ended September 30, 2005 from $13.01million for the 2004 period.  Thisincrease was primarily due to: (i) $1.14 million increase in selling,general and administrative expenses incurred by the operations of ModernAmusement, (ii) increases in accrued executive officer bonuses of$643,000, (iii) increases in commissions of $297,000 and (iv) $975,000in costs incurred for legal and financial advisor expenses for the Company andits special committee associated with the review and consideration of the transactionproposed by Mossimo Giannulli for the acquisition of all of the Company’sremaining outstanding shares and pending litigation related to theproposal.  The increase was offset byoperational improvements in the Mossimo segment.  Operating expenses for the Mossimo segment,as a percent of revenues from royalties and design service fees, decreased to60% for the nine months ended September 30, 2005 compared to 68% for thenine months ended September 30, 2004. The decrease was primarily due to a disproportionate increase ofrevenues.

 

Selling expenses,comprised of commissions due to a third party who assisted the Company inconnection with entering into the initial agreement with Target, increased to$2.6 million for the nine months ended September 30, 2005 compared to $2.3million for the nine months ended September 30, 2004.  The increase was due to the increased revenuegenerated from Target for the nine months ended September 30, 2005.

 

General and administrative expenses include payrollfor the Company’s officers and its design staff, travel, facilities, insurance,legal and professional fees, and other design related expenses for purchasedservices and artwork used in the design process. Salaries and related costs forthe Mossimo segment decreased to $2.77 million for the nine months ended September 30,2005, compared to $3.34 million for the nine months ended September 30,2004 due to additional salary and bonus accruals for the nine months ended September 30,2004.  Also included in general andadministrative expenses are accruals for bonuses of $2.38 million for the ninemonths ended September 30, 2005, compared to $1.74 million for the ninemonths ended September 30, 2004, which are due under bonus plans coveringthe Company’s co-chief executive officers.

 

Selling, general and administrative expenses incurredby Modern Amusement were $3.07 million for the nine months ended September 30,2005 compared to $1.93 million for the period of January 16, 2004 to September 30,2004.  This increase was primarily dueto: (i) increases in salary and related costs of $222,000, (ii) commissionsof $154,000, (iii) outsourcing cost of $148,000, (iv) advertising andpromotion of $214,000, and (v) depreciation and amortization of$118,000.  These increases were associatedwith the anticipated growth of the Modern Amusement brand.

 

*Interest income*

 

As a result ofhigher average cash balances of $17.88 million for the period ended September 30,2005 compared to average cash and investment balance of $9.70 million for thesame period in 2004, the Company earned $232,000 in interest income for thenine months ended September 30, 2005, compared to $73,000 for the ninemonths ended September 30, 2004. $4,300 of interest expense was incurredin the nine month period ended September 30, 2005.

 

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*Income taxes*

 

The Company recorded aprovision for income taxes of $2.2 million for the nine months ended September 30,2005 compared to a provision for income taxes of $1.5 million for the ninemonths ended September 30, 2004. Both provisions approximate the Company’s effective tax rate for Federaland California state income taxes.  Forthe nine month period ended September 30, 2005, the valuation allowancewas reduced by $794,000.

 

The Company has approximately $10 million and$7.3 million of federal and state income tax net operating loss carry forwards,respectively, available to offset future taxable income which expire in variousyears through 2022. The Company expects that future taxable income will be offset inthe near-term, for the most part, by its net operating tax loss carryforwards.

 

*Net earnings*

 

The Company’s net earnings for the nine months ended September 30,2005 were $4.7 million, or $0.30 per diluted share, compared to net earnings of$2.1 million, or $0.13 per diluted for the nine months ended September 30,2004  due to the factors discussed above.

 

***Liquidity and Capital Resources***

* *

Our sourcesof liquidity and capital resources as of September 30, 2005 consisted of$17.9 million of cash and cash equivalents, and $0.7 million of short-termrestricted cash, as well as potential future cash flows from operationsprimarily resulting from the Target agreement. As of September 30, 2005 we had working capital of approximately$22.3 million compared to $14.7 million at December 31, 2004.  The increase in working capital is due toincreased earnings and associated collections of accrued revenues from Targetin nine months ended September 30, 2005.

 

The Companyestablished a revolving line of credit with a bank in the amount of $300,000 inFebruary 2004.  The line of creditwas established to open letters of credit with foreign suppliers for finishedgoods for Modern Amusement.  The line ofcredit 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 creditis secured by three certificates of deposit totaling approximately$722,000.  There is no expiration datefor this line, and there are no covenants. There is a fee charged per letter of credit opened and closed.  Open letters of credit at September 30,2005 were approximately $245,000.

 

We believethat the Company’s sources of liquidity and capital will be sufficient to meetour expected operational and capital needs for the next 12 months and likelywill be sufficient to meet our operating needs for the foreseeable future andat least through January 2008, which is the most recently extendedcontract term with Target.

 

During thenine months ended September 30, 2005, net cash provided by operatingactivities were $8.6 million.  Cashprovided in operating activities includes primarily $4.7 million of netearnings, accounts payable of $1.2 million, accrued commissions of $124,000,and accrued bonuses of $2.4 million, primarily offset by a change in accountsreceivable of $1.7 million.  The changewas primarily due to the increase in accrued revenue from Target, whichincreased accrued commissions payable to a third party and accrued bonuses.

 

Net cashprovided by investing activities was generated from the sale of securities of$4.8 million, classified as available-for-sale. Capital expenditures for the nine months ended September 30,2005  were $132,000 and are not expectedto be material for the balance of the 2005 year.

 

Net cashused by financing activities was primarily generated from obtaining additionalcertificates of deposits in the amount of $309,000 used to secure letters ofcredit with foreign supplies for finished goods of Modern Amusement.

 

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 incurred under this obligation were$537,000 in the third quarter of 2005, compared to $561,000 in the thirdquarter of 2004 and $2.6 million for the nine months ended September 30,2005 compared to $2.3 million for the nine months ended September 30,2004.

 

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In January 2004we completed the acquisition of the Modern Amusement and we amended ourfacility lease 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, initially atapproximately $290,000 in 2004, increasing to $334,000 in 2008. The purchaseprice of the Modern Amusement assets of $375,000 was funded with existingcash.  The expected cash requirements in2005 for Modern Amusement are approximately $1.4 million, and is comprisedprimarily of selling, general, and administrative expenses.  Most of this working capital will besatisfied through operating cash flows, and we do not expect to incur anysignificant capital expenditures.

 

The Companyis approached 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.

 

**Critical Accounting Policies**

 

REVENUE RECOGNITION

 

Revenue from license royalties and designservice fees are recognized in accordance with the terms of the underlyingagreements, which is generally after the design services are performed, and asthe licensee achieves sales of the Company’s products.  Revenue from license royalties and designservice fees are generally collected on a quarterly basis, and they range fromone percent to five percent of sales as defined in the respectiveagreements.  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 Mossimobranded products 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.

 

ModernAmusement extends credit to customers in the normal course of business, subjectto established 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 determined byreviewing accounts receivable aging and evaluating individual customerreceivables, considering customers’ financial condition, credit history andcurrent economic conditions.   Thewrite-off for bad debt for the current quarter was approximately $2,000, and$49,000 for the nine months ended September 30, 2005.

 

ModernAmusement recognizes wholesale operations revenue from the sale of merchandisewhen products are shipped, FOB Modern Amusement’s distribution facilities, andthe customer takes title and assumes risk of loss, collection is reasonablyassured, pervasive evidence of an arrangement exists, and the sales price isfixed or determinable.

 

INVENTORY

 

We maintaininventories for the Modern Amusement segment of our business.  Inventories are valued at the lower of cost(first-in, first-out) or market. The Company continually evaluates itsinventories by assessing slow moving current product as well as prior seasons’inventory.  Market value of non-

 

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current inventory is estimated based on the impact of markettrends, an evaluation of economic conditions and the value of current ordersrelating to the future sales of this type of inventory.

 

To theextent that management’s estimates of price reductions necessary to rapidlysell inventory differ from actual results, additional price reductions may berequired that could reduce our gross margin, operating income and the carryingvalue of inventories. Our success is largely dependent upon our ability toanticipate the changing fashion tastes of our customers and to respond to thosechanging tastes in a timely manner. If we fail to anticipate, identify or reactappropriately to changing styles, trends or brand preferences of our customers,we may experience lower sales, excess inventories and more frequent and extensivemarkdowns, which would adversely affect our operating results.

 

IMPAIRMENTOF LONG-LIVED ASSETS

 

The Companyaccounts for goodwill in accordance with SFAS No. 142, *“Goodwill and Other Intangible Assets,”*which is an impairment-only approach. Under SFAS No. 142, properaccounting treatment requires annual assessment for any impairment of thecarrying value of goodwill based upon an estimation of the fair value of thereporting unit.  As of June 30, 2005, recognized goodwill isallocated to the Modern Amusement segment. Acquired intangible assets withfinite lives are amortized over their estimated useful life.  Animpairment is indicated if the undiscounted future cash flows attributable tothe finite lived intangible asset is less than its carrying value.

 

We evaluatethe recoverability of our identifiable intangible assets and other long-livedassets in accordance with SFAS No. 144 that generally requires managementto assess these assets for recoverability when events or circumstances indicatea potential impairment by estimating the undiscounted cash flows to begenerated from the use and ultimate disposition of these assets.

 

The ModernAmusement trade name acquired during 2004 and valued at $112,000 is amortizedover its estimated useful life of 10 years.

 

DEFERRED TAX ASSET VALUATION

 

The Company accounts for income taxes inaccordance with Statement of Financial Accounting Standard (“SFAS”) No. 109,“Accounting for Income Taxes”. Deferred taxes result from the recognition ofthe income tax benefit to be derived from the Company’s net operating losscarry forward for income taxes purposes. As of September 30, 2005 the Company has approximately $10 millionand $7.3 million of federal and state income tax net operating loss carryforwards, respectively, available to offset future taxable income which expirein various years through 2022.  In accordance with the provisions of SFAS No. 109 the Companyrecords a valuation allowance to reduce deferred tax assets to the amountexpected 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 that we would not be ableto realize all or part of our net deferred tax assets in the future,adjustments to the valuation allowance for deferred tax assets may be required.

 

In addition to the Company’s taxable incomebeing subject to federal, state and local income taxes, the Company may beclassified as a “personal holding company” from time to time. Personal holdingcompany status results from more than 50 percent of the value of outstandingstock being owned directly or indirectly by five or fewer individuals, and morethan 60 percent of the Company’s income, as defined, being derived fromroyalties. Personal holding companies are subject to an additional federal taxat the highest personal income tax rate on undistributed after tax earnings.

 

Over 50 percent of the value of the Company’soutstanding stock is owned by one stockholder, however it is presentlyanticipated that in 2005, no more than 60 percent of the Company’s income, asdefined, would be derived from license royalties. Accordingly, at this time theCompany is not anticipated to be classified as a personal holding company atthe end of 2005 and the Company intends to continue to

 

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take appropriate measures toavoid being classified as a personal holding company at the end of 2005 andbeyond. However, there can be no assurance that the Company will be successfulin its efforts to avoid classification as a personal holding company at the endof 2005 or in future years.

 

IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS

 

SFAS No. 123R- In December 2004, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 123R, “Share-Based Payment: an amendment of FASBStatements No. 123 and 95,” which requires companies to recognize in theirincome statement the grant-date fair value of stock options and otherequity-based compensation issued to employees. That cost will be recognized over the period during which an employee isrequire to provide service in exchange for the award.  Additionally, liability awards will be remeasuredeach reporting period.  SFAS No. 123Ris effective for the Company on January 1, 2006.  Accordingly, the Company will adopt SFAS No. 123Rin our first quarter of 2006. See Note 6 “Earnings Per Share and Stock OptionPlans,” for the pro forma effects of how SFAS No. 123R would have affectedthe results of earnings in the nine month period ended September 30, 2005and 2004.  We are currently assessing theimpact this prospective change in accounting guidance will have on ourfinancial condition and results of operations, but we believe that the impactwill not be material.

 

INFLATION

 

The Companydoes not believe that the relatively moderate rates of inflation experienced inthe United States over the last three years have had a significant effect onits operations. Since the Company’s future revenues are based on a percentageof sales of licensed products by licensees, the Company does not anticipatethat inflation will have a material impact on future operations.

 

EXCHANGERATES

 

The Companyreceives United States dollars for all its revenue from license royalties anddesign service fees, other than from its business in Canada, which began in2003 and does not represent a substantial amount of revenue at this time.During the last three fiscal years, exchange rate fluctuations have not had amaterial impact on the Company’s operating results. The Company does not engagein hedging activities with respect to exchange rate risk.

 

**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

The Companymakes temporary investments of cash in liquid interest bearing accounts andmarketable securities. The Company does not use interest rate swaps, futurescontracts or options on futures, or other types of derivative financialinstruments. The Company does not believe that future market risks arising fromholdings of its financial instruments will have a material impact on itsfinancial position or results of operations.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

Based ontheir evaluation as of September 30, 2005, our Co-Chief Executive Officersand Chief 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) were effective toensure that the information required to be disclosed by us in this quarterlyreport on Form 10-Q was recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and instructions for Form 10-Q.

 

There are nochanges in our internal controls over financial reporting during the nine monthsended September 30, 2005  that have materially affected, or arereasonably likely to materially affect our internal controls over financialreporting.

 

Ourmanagement, including our Co-Chief Executive Officers and Chief FinancialOfficer, does not expect that our internal controls and disclosure controls andprocedures will prevent all error and all fraud.

 

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A control system, no matter how well conceived and operated, canprovide only reasonable, not absolute assurance that the objectives of thecontrol system are met. Further, the design of the control system must reflectthe fact that there are resource constraints, and the benefits of controls mustbe considered relative to their costs. Because of the inherent limitations inall control systems, no evaluation of controls can provide absolute assurancethat all control issues and instances of fraud, if any, within the Company havebeen detected.

 

**PART II – OTHER INFORMATION**

 

**ITEM 1. LEGALPROCEEDINGS**

 

On October10, 2005, the Company and other defendants entered into a Memorandum ofUnderstanding (“MOU”) to settle the pending consolidated class action lawsuitstyled In Re Mossimo, Inc. Shareholder Litigation, Delaware Chancery Court CaseNo. 1246-N.  The litigation was filedfollowing the announcement by Mossimo Giannulli (“Giannulli”) of his intentionto acquire all outstanding shares of the Company that he does not already ownfor a price of $4.00 per share.  Underthe terms of the MOU, Giannulli agreed that his proposal to acquire all of theCompany’s outstanding shares would be priced at $5.00 per share and that thetender offer pursuant to which the acquisition is proposed to be consummatedwould be conditioned upon no less than 50 percent of all public stockholders ofthe Company unaffiliated with Giannulli accepting or approving the tenderoffer.  The MOU further provided thatplaintiffs’ lead counsel will be afforded the opportunity to comment on andsuggest inclusions to the disclosures made to the Company’s public stockholdersin conjunction with the acquisition.  Inaddition, the Company agreed to negotiate in good faith with the plaintiffs’lead counsel concerning the amount of attorney fees and expenses to be paid,subject to Delaware Chancery Court approval. The Company has agreed to pay whatever fee and expense amount theDelaware Chancery Court may award to plaintiffs’ lead counsel.  In consideration of these terms, the partieswill fully and finally release and discharge all claims against eachother.  The settlement is conditioned theconsummation of the acquisition by Giannulli, the negotiation of a definitivestipulation of settlement and the entry of a Final Order and Judgment approvingthe settlement by the Delaware Chancery Court. On November 12, 2005, Giannulli terminated his proposal to acquire theoutstanding shares of the Company that he does not already own after the Company’s specialcommittee withdrew its recommendation of the proposal. The parties have not proceeded with the further negotiationsrequired to finalize the settlement.

 

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**ITEM6. EXHIBITS**

 

The following exhibits are included herein:

 
| 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 Executive  Officer as required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
| 32.2 |   | Certification of Principal Executive  Officer as required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
| 32.3 |   | Certification of Principal Financial  Officer as required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |

 

 

SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized on the 14thday of November 2005.

 

 

MOSSIMO, INC.

 
| /s/ MOSSIMO GIANNULLI                         |   |
|-----------------------------------------------|--------|
| Mossimo Giannulli                             |
| Chairman and Co-Chief Executive Officer       |
| November 14, 2005                        |
|                                          |
| /s/ EDWIN LEWIS                               |   |
| Edwin Lewis                                   |
| Vice-Chairman and Co-Chief Executive  Officer |
| November 14, 2005                        |
|                                          |
| /s/ VICKEN FESTEKJIAN                         |   |
| Vicken Festekjian                             |
| Chief Financial Officer                       |
| November 14, 2005                        |

 

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**Exhibit Index**

 

The following exhibits are included herein:

 
| 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 Executive  Officer as required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
| 32.2 |   | Certification of Principal Executive  Officer as required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
| 32.3 |   | Certification of Principal Financial  Officer as required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |

 

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