**SECURITIES ANDEXCHANGE COMMISSION**

** **

**WASHINGTON, D.C.20549**

** **

**FORM 10-Q**

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

** **

** **

**FOR THE QUARTERLYPERIOD ENDED SEPTEMBER 30, 2004**

** **

**OR**

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

** **

**FOR THE TRANSITIONPERIOD FROM ____________ TO _____________**

** **

**COMMISSION FILENUMBER: 1-14208**

** **

**MOSSIMO, INC.**

(Exact name of Registrant as specified inits 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, includingarea code)

 

                Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor any shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

 

                Indicateby check mark whether the Registrant is an accelerated filer (as determined byExchange Act Rule 12b-2). Yes o No ý

 

                Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock as of the latest practicable date.

 

                Asof November 5, 2004, 15,738,442 shares of the Registrant’s Common Stock, $0.001par value, were outstanding.

 

 

 

**MOSSIMO, INC.**

** **

**INDEX TO FORM 10-Q**

 
|                                                                                                            | **Page** |
|-----------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                            |     |
| PART I - FINANCIAL  INFORMATION                                                                                 |     |   |
|                                                                                                            |     |
| ITEM 1 - Financial  Statements (Unaudited):                                                                     |     |
|                                                                                                            |     |
| Condensed  consolidated balance sheets as of September 30, 2004 and December 31, 2003                           | 2        |
|                                                                                                            |     |
| Condensed  consolidated statements of earnings for the three and nine months ended  September 30, 2004 and 2003 | 3        |
|                                                                                                            |     |
| Condensed  consolidated statements of cash flows for the nine months ended September 30,  2004 and 2003         | 4        |
|                                                                                                            |     |
| Notes  to condensed consolidated financial statements                                                           | 5        |
|                                                                                                            |     |
| ITEM  2 - Management’s Discussion and Analysis of Financial Condition and Results  of Operations           | 11       |
|                                                                                                            |     |
| ITEM  3 - Quantitative and Qualitative Disclosure about Market Risk                                             | 19       |
|                                                                                                            |     |
| ITEM 4 - Controls and  Procedures                                                                               | 19       |
|                                                                                                            |     |
| PART II - OTHER  INFORMATION                                                                                    |     |   |
|                                                                                                            |     |
| ITEM 1 - Legal Proceedings                                                                                      | 21       |
|                                                                                                            |     |
| ITEM 6 - Exhibits and Reports on  Form 8-K                                                                      | 22       |
|                                                                                                            |     |
| SIGNATURES                                                                                                      | 22       |

 

 

1

----

 

**PARTI - FINANCIAL INFORMATION**

 

**ITEM1. FINANCIAL STATEMENTS**

 

**MOSSIMO, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(IN THOUSANDS, EXCEPTSHARE DATA)**

**(UNAUDITED)**

 
| ** **                                                                                                                                   | ** ** | **SEPTEMBER 30,** | ** ** | **DECEMBER 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                                   | ** ** | **2004**          | ** ** | **2003**         | ** ** |
| **ASSETS**                                                                                                                                   |       |              |       |             |       |
| **CURRENT ASSETS**:                                                                                                                          |       |              |       |             |       |
| Cash and cash equivalents                                                                                                                    |       | $                 | 9,829      |             | $          | 9,707 |   |
| Restricted cash                                                                                                                              |       | —            |       | 4,585            |       |
| Accounts receivable                                                                                                                          |       | 3,554             |       | 2,007            |       |
| Merchandising inventories                                                                                                                    |       | 235               |       | —           |       |
| Deferred income taxes                                                                                                                        |       | 2,460             |       | 3,071            |       |
| Prepaid expenses and other  current assets                                                                                                   |       | 460               |       | 282              |       |
| Total current assets                                                                                                                         |       | 16,538            |       | 19,652           |       |
|                                                                                                                                         |       |              |       |             |       |
| Property and equipment, net                                                                                                                  |       | 1,104             |       | 480              |       |
| Deferred income taxes                                                                                                                        |       | 5,265             |       | 6,037            |       |
| Goodwill                                                                                                                                     |       | 324               |       | —           |       |
| Other assets                                                                                                                                 |       | 68                |       | 244              |       |
|                                                                                                                                         |       | $                 | 23,299     |             | $          | 26,413 |   |
|                                                                                                                                         |       |              |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                |       |              |       |             |       |
|                                                                                                                                         |       |              |       |             |       |
| **CURRENT  LIABILITIES:**                                                                                                                    |       |              |       |             |       |
| Accounts payable                                                                                                                             |       | $                 | 305        |             | $          | 525 |   |
| Accrued liabilities                                                                                                                          |       | 432               |       | 1,513            |       |
| Accrued commissions                                                                                                                          |       | 347               |       | 5,251            |       |
| Accrued bonuses                                                                                                                              |       | 1,131             |       | 112              |       |
| Total current liabilities                                                                                                                    |       | 2,215             |       | 7,401            |       |
|                                                                                                                                         |       |              |       |             |       |
| **COMMITMENTS AND  CONTINGENCIES**                                                                                                           |       |              |       |             |       |
|                                                                                                                                         |       |              |       |             |       |
| **STOCKHOLDERS’  EQUITY:**                                                                                                              |       |              |       |             |       |
| Preferred stock, par value $.001;  authorized shares 3,000,000; no shares issued or outstanding                                              |       | —            |       | —           |       |
| Common stock, par value $.001;  authorized shares 30,000,000; issued and outstanding 15,738,442 at September  30, 2004 and December 31, 2003 |       | 15                |       | 15               |       |
| Additional paid-in capital                                                                                                                   |       | 39,763            |       | 39,763           |       |
| Accumulated deficit                                                                                                                          |       | (18,694           | )          | (20,766          | )          |
| Stockholders’ equity                                                                                                                    |       | 21,084            |       | 19,012           |       |
|                                                                                                                                         |       | $                 | 23,299     |             | $          | 26,413 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

 

2

----

 

**MOSSIMO, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS**

**(IN THOUSANDS, EXCEPTPER SHARE DATA)**

**(UNAUDITED)**

 
| ** **                                              | ** ** | **THREE MONTHS**        | ** ** | **NINE MONTHS**         | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                              | ** ** | **ENDED SEPTEMBER 30,** | ** ** | **ENDED SEPTEMBER 30,** | ** ** |
| ** **                                              | ** ** | **2004**                | ** ** | **2003**                | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue from license royalties  and design service fees |       | $                       | 4,187      |                    | $          | 4,176 |   | $ | 16,181 |   | $ | 16,902 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Product Sales                                           |       | 747                     |       | —                  |       | 1,197 |   | — |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Total revenues                                          |       | 4,934                   |       | 4,176                   |       | 17,378 |   | 16,902 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Operating expenses:                                     |       |                    |       |                    |       |   |   |   |   |
| Cost of product sales                                   |       | 665                     |       | —                  |       | 889 |   | — |   |
| Selling, general and  administrative                    |       | 4,470                   |       | 3,144                   |       | 13,014 |   | 10,444 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Operating earnings (loss)                               |       | (201                    | )          | 1,032                   |       | 3,475 |   | 6,458 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Interest income (expense), net                          |       | 26                      |       | 18                      |       | 73 |   | (4 | ) |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Earnings (loss) before income  taxes                    |       | (175                    | )          | 1,050                   |       | 3,548 |   | 6,454 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Provision for income taxes                              |       | (50                     | )          | 420                     |       | 1,476 |   | 2,580 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Net earnings (loss)                                     |       | $                       | (125       | )                       | $          | 630 |   | $ | 2,072 |   | $ | 3,874 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Earnings (loss) per share:                              |       |                    |       |                    |       |   |   |   |   |
| Basic                                                   |       | $                       | (0.01      | )                       | $          | 0.04 |   | $ | 0.13 |   | $ | 0.25 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Diluted                                                 |       | $                       | (0.01      | )                       | $          | 0.04 |   | $ | 0.13 |   | $ | 0.25 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Shares used in computing earnings  (loss) per share:    |       |                    |       |                    |       |   |   |   |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Basic                                                   |       | 15,738                  |       | 15,500                  |       | 15,738 |   | 15,495 |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |
| Diluted                                                 |       | 15,738                  |       | 15,782                  |       | 15,777 |   | 15,734 |   |

 

See accompanying notes to condensed consolidated financialstatements.

 

3

----

 

 

 

**MOSSIMO, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(IN THOUSANDS)**

**UNAUDITED**

 
| ** **                                                                          | ** ** | **FOR THE NINE MONTHS** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                          | ** ** | **ENDED SEPTEMBER 30,** | ** ** |
| ** **                                                                          | ** ** | **2004**                | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM  OPERATING ACTIVITIES:**                                          |       |                    |       |   |   |
| Net earnings                                                                        |       | $                       | 2,072      |   | $ | 3,874 |   |
| Adjustment to reconcile net  earnings to net cash provided by operating activities: |       |                    |       |   |   |
| Depreciation and amortization                                                       |       | 237                     |       | 205 |   |
| Deferred income taxes                                                               |       | 1,383                   |       | 2,580 |   |
| Changes in:                                                                         |       |                    |       |   |   |
| Restricted cash                                                                     |       | 4,585                   |       | (4,585 | ) |
| Accounts receivable                                                                 |       | (1,535                  | )          | (142 | ) |
| Inventories                                                                         |       | (222                    | )          | — |   |
| Prepaid expenses and other  current assets                                          |       | (178                    | )          | (624 | ) |
| Other assets                                                                        |       | 182                     |       | (152 | ) |
| Accounts payable                                                                    |       | (220                    | )          | (375 | ) |
| Accrued liabilities                                                                 |       | (1,081                  | )          | (402 | ) |
| Accrued commissions                                                                 |       | (4,904                  | )          | (512 | ) |
| Accrued bonuses                                                                     |       | 1,019                   |       | 2,235 |   |
| Net cash provided by operating  activities                                          |       | 1,338                   |       | 2,102 |   |
|                                                                                |       |                    |       |   |   |
| **CASH FLOWS FROM  INVESTING ACTIVITITES:**                                         |       |                    |       |   |   |
| Payment for acquisition of a  business                                              |       | (375                    | )          | — |   |
| Payments for acquisition of  property and equipment                                 |       | (841                    | )          | (107 | ) |
| Net cash used in investing  activities                                              |       | (1,216                  | )          | (107 | ) |
|                                                                                |       |                    |       |   |   |
| **CASH FLOWS FROM  FINANCING ACTIVITIES:**                                          |       |                    |       |   |   |
| Payments of loan payable                                                            |       | —                  |       | (1,066 | ) |
| Proceeds from issuance of common  stock                                             |       | —                  |       | 52 |   |
| Net cash used in financing  activities                                              |       | —                  |       | (1,014 | ) |
|                                                                                |       |                    |       |   |   |
| **NET INCREASE IN  CASH AND CASH EQUIVALENTS**                                      |       | 122                     |       | 981 |   |
| Cash and cash equivalents,  beginning of period                                     |       | 9,707                   |       | 7,786 |   |
| Cash and cash equivalents, end of  period                                           |       | $                       | 9,829      |   | $ | 8,767 |   |
|                                                                                |       |                    |       |   |   |
| **SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:**                              |       |                    |       |   |   |
| Cash paid during the period for interest                                            |       | $                       | —     |   | $ | 10 |   |
|                                                                                |       |                    |       |   |   |
| Cash paid during the period for  income taxes                                       |       | $                       | 58         |   | $ | — |   |

 

See accompanying notes to condensed consolidated financialstatements.

 

 

4

----

 

**MOSSIMO, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(UNAUDITED)**

 

**1.BASIS OF PRESENTATION**

 

       The condensedconsolidated financial statements presented herein have not been audited byindependent auditors, but include all material adjustments (consisting ofnormal recurring adjustments), which are, in the opinion of management,necessary for a fair presentation of the financial condition, results ofoperations and cash flows for the periods presented. However, these results arenot necessarily indicative of results for any other interim period or for thefull year. The condensed consolidated balance sheet data presented herein forDecember 31, 2003 was derived from the Company’s audited financial statementsfor the year then ended, but does not include all disclosures required byaccounting principles generally accepted in the United States of America.

 

       On January 16, 2004,Mossimo, Inc. acquired substantially all the assets of Modern Amusement LLCthrough a wholly owned subsidiary, Modern Amusement, Inc. (“Modern Amusement”).The accompanying condensed consolidated financial statements include theaccount balances of Modern Amusement as of September 30, 2004 and the resultsof operations of Modern Amusement for the three months ended September 30, 2004and for the period from January 16, 2004 to September 30, 2004. Allintercompany accounts and transactions have been eliminated in consolidation.

 

       The preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States of America requires the Company to make certainestimates and assumptions for the reporting periods covered by the financialstatements. These estimates and assumptions affect the reported amounts ofassets, liabilities, revenues and expenses. Actual amounts could differ fromthese estimates.

 

       Certain informationand footnote disclosures normally included in annual financial statements inaccordance with accounting principles generally accepted in the United Statesof America have been omitted pursuant to the Regulations of the Securities andExchange Commission. The Company believes the disclosures included in theaccompanying interim condensed consolidated financial statements and notesthereto are adequate to make the information not misleading, but should be readin conjunction with the financial statements and notes thereto included in ourForm 10-K for the year ended December 31, 2003.

 

**2.DESCRIPTION OF BUSINESS**

 

       In 2000, the Companychanged its business operating strategy from a traditional apparel and relatedproducts wholesale company, to a designer and licensor of apparel and relatedproducts. The Company entered into a multi-year licensing and design servicesagreement with Target Corporation (“Target”) in March 2000, subsequentlyamended in April 2002 and in February 2003, (herein after referred to as the “TargetAgreement”). Under the terms of the Target Agreement, Target has the exclusivelicense for production and distribution through Target stores of substantiallyall Mossimo products sold in the United States, other than those covered underother existing Mossimo licensing arrangements at the time the Company enteredinto the Target Agreement.

 

       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, with minimum total guaranteed fees of approximately$9.6 million payable in each of the contract years after January 31, 2002.Target fees are based on net sales achieved multiplied by a rate, as defined inthe Target Agreement. The Company pays a 15 percent commission, based on feesreceived from Target, to a third party who assisted the Company in connectionwith entering into the initial agreement with Target.

 

5

----

 

 The Target Agreement issubject to early termination under certain circumstances. If Target is currentwith payments of its obligations under the Target Agreement, Target has theright to renew the Target Agreement on the same terms and conditions foradditional terms of two years each. In January 2003, Target exercised its firstrenewal option extending the Target Agreement through January 31, 2006. Thenext renewal option could be exercised by Target in or before January 2005.This renewal option could extend the Target Agreement through January 2008.

 

       In addition to theTarget Agreement, the Company also licenses its trademarks and provides designservices outside of the United States. The Company also licenses its trademarksfor use in collections of eyewear and women’s swimwear and body-wear sold inTarget stores in the United States.

 

       In May 2002, theCompany entered into an agreement with Hudson’s Bay Company whereby the Companyprovides product design services, and has licensed the Mossimo trademark toHudson’s Bay Company exclusively in Canada. The Company receives licenseroyalties and design service fees. Hudson’s Bay Company collaborates on productdesign, and is responsible for manufacturing, importing, marketing,advertising, selling and distributing merchandise bearing the Mossimotrademark. The initial term of the agreement is three years beginning in May2002, with a five-year extension at the option of Hudson’s Bay Company. Hudson’sBay Company fully launched the Mossimo product line in March 2003 fordistribution through its Zellers stores in Canada.

 

       On January 16, 2004, the Company acquiredsubstantially all the assets of Modern Amusement LLC through a wholly ownedsubsidiary, Modern Amusement for aggregate consideration of $375,000. ModernAmusement designs, merchandises, sources, markets, sells and distributeswholesale apparel and related accessories for young men and young women. The “ModernAmusement” registered brand is principally focused on premium westcoast-lifestyle apparel and related accessories. The products are offered atmoderate to upper price points through traditional specialty store andhigher-end department store distribution channels. This line of business isexpected to diversify the Company’s current design and licensing business ofits Mossimo brand product through mass retail distribution channels. Theaccompanying condensed consolidated financial statements include the accountbalances of Modern Amusement as of September 30, 2004 and the results ofoperations of Modern Amusement for the three months ended September 30, 2004 andfor the period from January 16, 2004 to September 30, 2004. Pro formainformation is not presented for the three and nine month periods endedSeptember 30, 2003 as the account balances and results of operations of ModernAmusement are not considered material to the Company’s results of operationsfor those periods.

 

**3.REVENUE RECOGNITION**

 

       Revenue from licenseroyalties and design service fees are recognized in accordance with the termsof the underlying agreements, which is generally after the design services areperformed, and as the licensee achieves sales of the Company’s products. Duringthe periods presented herein, a substantial amount of the Company’s revenuefrom license royalties and design fees were generated under the TargetAgreement under a rate of 1% to 4% that declines as the contract yearprogresses and Target achieves certain levels of retail sales. Accordingly, theCompany’s revenues from Target decrease as the year progresses. The decliningrate is reset each contract year beginning on February 1. Revenue recognized inthe first and second quarters of the Company’s fiscal year in connection withthe Target Agreement is significantly higher than in the third and fourthquarters of the Company’s fiscal year due to the declining rates in the TargetAgreement. Royalties from Target are receivable 30 days after the end of Target’sfiscal year quarters. Revenue from license royalties and design service feesunder license agreements other than the Target Agreement are generallycollected on a quarterly basis, and they range from 1% to 3% of sales, asdefined in the respective agreements.

 

       Revenue from productsales is recognized when merchandise is sold to customers. An allowance formerchandise returns is estimated and recorded at the time of sale.

 

6

----

 

**4.BONUS PLANS**

 

       The Company has bonusplans covering two executive officers which are administered by theCompensation Committee of the Board of Directors, and that provide for discretionarybonuses based on the Company’s overall performance, with the total amount ofthe bonuses not to exceed a percent (as defined) of the excess over the minimumtotal guaranteed fees, if any, of license royalties paid to the Company underthe Target Agreement, and as defined in each of the respective bonus plans. TheCompany has expensed approximately $465,000 and $407,000 under these agreementsfor the three month periods ended September 30, 2004 and 2003, respectively;and $1,739,000 and $1,870,000 for the nine month periods ended September 30,2004 and 2003, respectively.

 

**5.INCOME TAXES**

 

       The Company accountsfor income 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 recordeda provision for income taxes of ($50,000) and $1,476,000 for the three and ninemonth periods ended September 30, 2004, respectively. Both provisions reflectthe Company’s consolidated effective tax rate expected to apply to full yearearnings.

 

       At September 30,2004, the Company has recorded a total net deferred tax asset of $7.7 million,with $2.5 million classified as current in the accompanying condensedconsolidated balance sheet, as a result of the extension of the TargetAgreement through January 31, 2006, management’s discussions with Target priorto the end of 2003 which resulted in management considering that it is morelikely than not that Target would extend the agreement through 2008, thereevaluation of its forecasted operating results and resultant taxable incomeduring the extended term of the Target Agreement, and the consequent expectedutilization of available net operating losses during the extended term of theTarget Agreement. The Company has considered the projected taxable income fromthe Target Agreement and other agreements in its estimate of deferred tax assetrecoverability and has recorded a valuation allowance for its net deferred taxassets of $1.1 million.

 

       As of December 31,2003, the Company had approximately $22 million and $18 million of federal andstate income tax net operating loss carry forwards, respectively, available tooffset future taxable income which expire in various years through 2022. TheCompany expects that future taxable income will be offset in the near-term, forthe most part, by its net operating tax loss carry forwards.

 

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

 

       Over 50 percent ofthe value of the Company’s outstanding stock is owned by one stockholder,however it is presently anticipated that in 2004, no more than 60 percent ofthe Company’s income, as defined, would be derived from license royalties.Accordingly, at this time the Company is not anticipating to be classified as apersonal holding company at the end of 2004 and the Company intends to continueto take appropriate measures to avoid being classified as a personal holdingcompany at the end of 2004 and beyond. However, there can be no assurance thatthe Company will be successful in its efforts to avoid classification as apersonal holding company at the end of 2004 or in future years.

 

7

----

 

**6.BUSINESS ACQUISITION**

 

       On January 16, 2004,Mossimo, Inc. acquired substantially all the assets of Modern Amusement LLCthrough a wholly owned subsidiary, Modern Amusement. Modern Amusement designs,merchandises, sources, markets, sells and distributes wholesale apparel andrelated accessories for young men and young women. The “Modern Amusement”registered brand is principally focused on premium west coast-lifestyle appareland related accessories. The products are offered at moderate to upper pricepoints through traditional specialty store and higher-end department storedistribution channels. This line of business is expected to diversify theCompany’s current design and licensing business of its Mossimo brand productthrough mass retail distribution channels. The acquisition was accounted for as a purchase whereby the purchaseprice was allocated to the assets acquired based on fair values. The excesspurchase price over the amount allocated to the assets acquired has beenrecorded as goodwill in the accompanying condensed consolidated balance sheetat September 30, 2004. The following table summarizes the fair values of theassets acquired at the date of acquisition. Pro forma information is notpresented as the impact of this acquisition on the consolidated financialstatements is not material.

 

| Net current assets     |   | $   | 25     |   |
|------------------------|--------|-----|--------|--------|
| Property and equipment |   | 20  |   |
| Goodwill               |   | 324 |   |
| Other assets           |   | 6   |   |
| Assets acquired        |   | $   | 375    |   |

 

      The preliminary allocation of thepurchase price is pending completion of several elements, including thefinalization of our valuation of acquired intangible assets.  We do not expect future adjustments to thepurchase price to be material. However, there may be material adjustments tothe allocation of the purchase price.

 

**7.EARNINGS PER SHARE AND STOCK OPTION PLANS**

 

       Basic earnings pershare is computed by dividing net earnings available to common stockholders bythe weighted average number of common shares outstanding during the relevantperiod. Diluted earnings per share includes the effect of potential sharesoutstanding, including dilutive stock options, using the treasury stock method.Stock options excluded from diluted weighted average shares outstanding wereapproximately 656,300 and 400,000 for the three months ended September 30, 2004and 2003, respectively; and approximately 424,300 and 550,000 for the ninemonths ended September 30, 2004 and 2003, respectively; as they were antidilutive.

 

       The reconciliationbetween net earnings and weighted average shares outstanding for basic anddiluted earnings per share is as follows (amounts in thousands, except pershare data):

 
| ** **                                     | ** ** | **Three Months**        | ** ** | **Nine Months**         | ** ** |
|------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                     | ** ** | **Ended September 30,** | ** ** | **Ended September 30,** | ** ** |
| ** **                                     | ** ** | **2004**                | ** ** | **2003**                | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net earnings (loss)                            |       | $                       | (125       | )                       | $          | 630 |   | $ | 2,072 |   | $ | 3,874 |   |
| Weighted average shares  outstanding - Basic   |       | 15,738                  |       | 15,500                  |       | 15,738 |   | 15,495 |   |
| Basic earnings (loss) per share                |       | $                       | (0.01      | )                       | $          | 0.04 |   | $ | 0.13 |   | $ | 0.25 |   |
|                                           |       |                    |       |                    |       |   |   |   |   |
| Add: Dilutive effect of stock  options         |       | —                  |       | 282                     |       | 39 |   | 239 |   |
| Weighted average shares  outstanding - Diluted |       | 15,738                  |       | 15,782                  |       | 15,777 |   | 15,734 |   |
| Diluted earnings (loss) per share              |       | $                       | (0.01      | )                       | $          | 0.04 |   | $ | 0.13 |   | $ | 0.25 |   |

 

       The Company adoptedthe Mossimo, Inc. 1995 Stock Option Plan (the “1995 Plan”), which provides forthe grant of stock options, stock appreciation rights and other stock awards tocertain officers and key employees of the Company and to certain advisors orconsultants to the Company. In addition, the Company adopted a Non-EmployeeDirectors Stock Option Plan (the “Directors Plan”) that provides for the grantof stock options to non-employee directors.

 

       The Company accountsfor stock-based compensation in accordance with Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees”, and relatedinterpretations. The Company follows the pro forma disclosure requirements ofSFAS No. 123, “Accounting for Stock-Based Compensation”, which requirepresentation of the pro forma effect of the fair value based method on netearnings and earnings per share in the financial statement footnotes.

 

8

----

 

        The fair value ofeach option grant was estimated as of the grant date using the Black-Scholesoption-pricing model for the three and nine month periods ended September 30,2004 and 2003, assuming risk-free interest rates in the range of approximately1.9 to 6.7 percent; volatility in the range of approximately 40 to 202 percent;zero dividend yield; and expected lives of five years. In accordance with APBOpinion No. 25, no compensation expense has been recognized related to stockoptions granted with an option price at or above the fair market value of theCompany’s stock on the date of issuance.

 

       If compensationexpense was determined based on the fair value method beginning with grants inthe year ended December 31, 1996, the Company’s net earnings (loss) andearnings (loss) per share would have resulted in the approximate pro formaamounts indicated below for the three and nine month periods ended September30, 2004 and 2003 (in thousands, except per share data):

 
| ** **                                                                        | ** ** | **Three Months**        | ** ** | **Nine Months**         | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                        | ** ** | **Ended September 30,** | ** ** | **Ended September 30,** | ** ** |
| ** **                                                                        | ** ** | **2004**                | ** ** | **2003**                | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net earnings as reported                                                          |       | $                       | (125       | )                       | $          | 630 |   | $ | 2,072 |   | $ | 3,874 |   |
| Less: Total compensation as if  the fair value method was used, net of tax effect |       | (213                    | )          | (238                    | )          | (360 | ) | (606 | ) |
| Pro forma net earnings (loss)                                                     |       | $                       | (338       | )                       | $          | 392 |   | $ | 1,712 |   | $ | 3,268 |   |
|                                                                              |       |                    |       |                    |       |   |   |   |   |
| Net earnings (loss) per share:                                                    |       |                    |       |                    |       |   |   |   |   |
| Basic - as reported                                                               |       | $                       | (0.01      | )                       | $          | 0.04 |   | $ | 0.13 |   | $ | 0.25 |   |
| Basic - pro forma                                                                 |       | $                       | (0.02      | )                       | $          | 0.03 |   | $ | 0.11 |   | $ | 0.21 |   |
|                                                                              |       |                    |       |                    |       |   |   |   |   |
| Diluted - as reported                                                             |       | $                       | (0.01      | )                       | $          | 0.04 |   | $ | 0.13 |   | $ | 0.25 |   |
| Diluted - pro forma                                                               |       | $                       | (0.02      | )                       | $          | 0.02 |   | $ | 0.11 |   | $ | 0.21 |   |
|                                                                                   |            |                         |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

**8.IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS**

 

       In May 2003, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 150, “Accountingfor Certain Financial Instruments With Characteristics of Both Liabilities andEquity.” SFAS No. 150 changes the classification in the statement of financialposition of certain common financial instruments from either equity ormezzanine presentation to liabilities and requires an issuer of those financialstatements to recognize changes in fair value or redemption amount, asapplicable, in earnings. SFAS No. 150 is effective for financial instrumentsentered into or modified after May 31, 2003, and with one exception relating tocertain mandatorily redeemable financial instruments, is effective at thebeginning of the first interim period beginning after June 15, 2003. Theimplementation of SFAS No. 150 did not have an impact on the Company’sfinancial position or results of operations.

 

       In January 2003, the FASB issued FASBInterpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities”.In December 2003, the FASB issued “Summary of Interpretation No. 46 (RevisedDecember 2003)” (“FIN 46R”) which replaced FIN 46. FIN 46R clarifies theapplication of Accounting Research Bulletin No. 51 “Consolidated FinancialStatements”, and requires companies to evaluate variable interest entities forspecific characteristics to determine whether additional consolidation anddisclosure requirements apply. Certain special effective date provisions applyto companies that fully or partially applied FIN 46 prior to the issuance ofFIN 46R. Otherwise, application of FIN 46R is required in financial statementsof public companies that have interests in variable interest entities orpotential variable interest entities, commonly referred to as special-purposeentities, for periods ending after December 15, 2003. Application by publiccompanies (other than small business issuers) for all other types of entitiesis required in financial statements for periods ending after March 15, 2004.Neither the initial adoption of FIN 46 nor the adoption of FIN 46R had amaterial impact on the Company’s financial position or results of operations.

 

9

----

 

        In December 2003,the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”,which codifies, revises and rescinds certain sections of SAB No. 101, “RevenueRecognition”, in order to make this interpretive guidance consistent withcurrent authoritative accounting and auditing guidance and SEC rules andregulations. The changes noted in SAB No. 104 did not have a material effect onthe Company’s results of operations, financial position or cash flows.

 

**9.LITIGATION**

 

       In May 2002, theCompany made a demand for arbitration in connection with a claim foroverpayment of commissions paid to a third party who assisted the Company inconnection with entering into the initial agreement with Target. Thearbitration hearing was completed in October 2002. In November 2002, thearbitration hearing panel issued a preliminary award in favor of the thirdparty, which became final in January 2003 and awarded the third party thecommissions owed, interest on the amounts due which had been withheld by theCompany, and the recovery of the third party’s legal fees.

 

       In January 2003, theCompany filed a petition to vacate the award, including commissions, thirdparty legal fees, and interest, on the basis that the evidence received duringthe arbitration hearing demonstrated that the finder’s agreement between theCompany and the third party was illegal under certain applicable Californialaw. In January 2003, the third party filed a petition to confirm the award,including commissions, the third party’s legal fees, and interest.

 

       In June 2003, theaward was confirmed and a judgment entered in favor of the third party, and thethird party was awarded additional interest. In June 2003, the Company filed anappeal to the judgment and in connection therewith deposited with the courtapproximately $4,585,000. The $4,585,000 deposited with the courts wasclassified as restricted cash on the Company’s balance sheet as of December 31,2003. The deposit secured 150% of the judgment amount. In January 2004, theappeal decision was rendered in favor of the third party, and the Companyproceeded with an appeal to the Supreme Court of the State of California.

 

       In March 2004, theCalifornia Supreme Court denied the Company’s appeal. The California SupremeCourt’s decision not to review the trial court judgment reaffirms the validityof the original finder’s agreement between the third party and Mossimo and thethird party‘s right to be paid all amounts currently due, including interest atthe legal rate and all post-judgment amounts as well as attorney’s fees.

 

       Prior to June 30,2004, the Company paid all unpaid commissions, legal fees and interest payableto the third party in connection with this litigation. The Company had accruedfor the full amount each quarter under the original agreement with the thirdparty, including estimated penalties and interest.

 

10

----

 

 

 
| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS** |
|-------------|------------|-------------------------------------------------------------------------------------------------|

 

         The followingdiscussion includes the consolidated operations of Mossimo, Inc., and itswholly-owned subsidiary Modern Amusement, Inc. for each of the periodsdiscussed. This discussion and analysis should be read in conjunction with theCompany’s financial statements for the year ended December 31, 2003 on Form10-K.

 

**RESULTSOF OPERATIONS**

 

**DESCRIPTIONOF BUSINESS**

 

         In 2000, theCompany changed its business operating strategy from a traditional apparel andrelated products wholesale company, to a designer and licensor of apparel andrelated products. The Company entered into a multi-year licensing and designservices agreement with Target Corporation (“Target”) in March 2000,subsequently amended in April 2002 and in February 2003, (herein after referredto as the “Target Agreement”). Under the terms of the Target Agreement, Targethas the exclusive license, for production and distribution through Targetstores, of substantially all Mossimo products sold in the United States, otherthan those covered under other existing Mossimo licensing arrangements at thetime the Company entered into the Target Agreement.

 

         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, with minimum total guaranteed fees ofapproximately $9.6 million payable in each of the contract years after January31, 2002. Target fees are based on net sales achieved multiplied by a rate, asdefined in the Target Agreement. The Company pays a 15 percent commission,based on fees received from Target, to a third party who assisted the Companyin connection with entering into the initial agreement with Target. The TargetAgreement is subject to early termination under certain circumstances. IfTarget is current with payments of its obligations under the Target Agreement,Target has the right to renew the Target Agreement on the same terms andconditions for additional terms of two years each. In January 2003, Targetexercised its first renewal option extending the Target Agreement throughJanuary 31, 2006. The next renewal option could be exercised by Target in orbefore January 2005. This renewal option could extend the Target Agreementthrough January 2008.

 

         In addition to theTarget Agreement, the Company also licenses its trademarks and provides designservices outside of the United States. The Company also licenses its trademarksfor use in collections of eyewear and women’s swimwear and body-wear sold inTarget stores in the United States.

 

         In May 2002, theCompany entered into an agreement with Hudson’s Bay Company whereby the Companyprovides product design services, and has licensed the Mossimo trademark toHudson’s Bay Company exclusively in Canada. The Company receives licenseroyalties and design service fees. Hudson’s Bay Company collaborates on productdesign, and is responsible for manufacturing, importing, marketing,advertising, selling and distributing merchandise bearing the Mossimotrademark. The initial term of the agreement is three years beginning in May2002, with a five-year extension at the option of Hudson’s Bay Company. Hudson’sBay Company fully launched the Mossimo product in mid-March 2003 fordistribution through its Zellers stores in Canada.

 

       On January 16, 2004,the Company acquired substantially all the assets of Modern Amusement LLCthrough a wholly owned subsidiary, Modern Amusement for aggregate considerationof $375,000. Modern Amusement designs, merchandises, sources, markets, sellsand distributes wholesale apparel and related accessories for young men andyoung women. The “Modern Amusement” registered brand is principally focused onpremium west coast-lifestyle apparel and related accessories. The products areoffered at moderate to upper price points through traditional specialty storeand higher-end department store distribution channels. This line of business isexpected to diversify the Company’s current design and licensing business ofits Mossimo brand product through mass retail distribution channels.

 

11

----

 

** THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003**

** **

**     REVENUES**

 

         Revenue fromlicense royalties and design service fees are recognized in accordance with theterms of the underlying agreements, which is generally after the designservices are performed, and as the licensee achieves sales of the Company’sproducts. For the three months ended September 30, 2004, a substantial amountof the Company’s revenue from license royalties and design fees were generated underthe Target Agreement. The royalty rate under the Target Agreement declines, asthe contract year progresses and Target achieves certain levels of retailsales, from 4% to 1%. The declining royalty rate is reset each contract yearbeginning on February 1. Accordingly, revenue recognized in the first andsecond quarters of the Company’s fiscal year is significantly higher than inthe third and fourth quarters due to the declining rates in the TargetAgreement. Royalties from Target are receivable 30 days after the end of Target’sfiscal year quarters. Revenue from license royalties and design service feesunder license agreements other than the Target Agreement are generallycollected on a quarterly basis, and they range from 1% to 3% of sales, asdefined in the respective agreements.

 

         Total revenue fromlicense royalties and design service fees in the third quarter of 2004 and 2003were consistent at $4.2 million.

 

         Design service feesand royalties recognized under the Target Agreement remained stable at $3.8million for the third quarter of 2004 compared to $3.7 million for the thirdquarter 2003. Royalties and design service fees from customers other thanTarget decreased to $420,000 in the third quarter of 2004 from $521,000 in the thirdquarter of 2003. The decrease was primarily due to a decrease in design servicefees received from Zellers to $27,000 in the third quarter of 2004 from$141,000 in the third quarter of 2003.

 

         Modern Amusementrealized product sales of $747,000 in the third quarter of 2004.

 

**     OPERATING EXPENSES**

 

         Total operatingexpenses is comprised of the cost of product sales and selling, general andadministrative expenses. Selling, general and administrative expenses increasedto $4.5 million in the third quarter of 2004 from $3.1 million for thecomparable period in 2003. Selling, general and administrative expenses wereapproximately 107% of revenues from license royalties and design service feesfor the third quarter of 2004, as compared to approximately 75% for thecomparable period of 2003. This increase was primarily due to $858,000 ofselling, general and administrative expenses incurred in the third quarter of2004 attributable to the operations of Modern Amusement. Operating expenses forMossimo, Inc., as a stand-alone operation, as a percent of revenues fromroyalties and design service fees, increased to 86% for the third quarter of2004 compared to 55% for the comparable period of 2003, primarily as a resultof the increases in salary and related expense and travel expense discussedbelow. Cost of product sales incurred by Modern Amusement were $665,000 on$747,000 in revenue recognized on product sales for the third quarter of2004.  The cost of the product wasnegatively impacted by markdowns taken on outdated merchandise.

 

         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$561,000 in the third quarter of 2004 from $540,000 in the third quarter of2003, due to the slight increase in design service fees and royalties receivedfrom Target.

 

12

----

 

          General andadministrative expenses include payroll for the Company’s officers and itsdesign staff, travel, facilities, insurance, legal and professional fees, andother design related expenses for purchased services and artwork used in thedesign process. Salaries and related costs for Mossimo, Inc., as a stand-aloneoperation, increased to $1.1 million in the third quarter of 2004 from $1million in the third quarter of 2003 as a result of an increase in remunerationpayable to the Company’s Chief Executive Officer-Operations and Finance, Mr.Edwin Lewis.

 

         On July 30, 2004, the Board of Directors, uponthe recommendation of the Compensation Committee of the Board of Directors,approved an employment agreement for Edwin Lewis. Under the agreement Mr. Lewiswas elevated to Co-Chief Executive Officer-Operations and Finance.Additionally, under his agreement Mr. Lewis is entitled to an increased basesalary of $900,000 per annum which became effective from January 1, 2004.

 

         Also included ingeneral and administrative expenses are bonuses of $465,000 accrued in thethird quarter of 2004, and $509,000 accrued in the third quarter of 2003, whichare due under bonus plans covering two executive officers of the Company.Design, artwork and sample costs remained consistent at $220,000 in the thirdquarter of 2004 compared to $197,000 in the third quarter of 2003. Travelexpenses increased to $520,000 in the third quarter of 2004 from $253,000 inthe third quarter of 2003 as a result of the increased amount and costs ofexecutive officers’ travel and costs incurred for two tradeshows attendedduring the third quarter 2004.

 

         Legal expenses inthe third quarter of 2004 remained consistent at $95,000 between the thirdquarter 2004 and 2003.

 

         Selling, generaland administrative expenses incurred by Modern Amusement were $858,000 in thethird quarter of 2004. These costs consisted primarily of salary and relatedcosts of $299,000, consulting and outsourcing fees of $149,000, tradeshow costsof $69,000 and sample design costs of $89,000.

 

**     INTEREST INCOME (EXPENSE) NET**

 

         The Company earned$26,000 in interest income in the third quarter of 2004, compared to $18,000 inthe third quarter of 2003. The Company maintained a higher interest-earningcash balance in third quarter 2004 compared to 2003.

 

**     INCOME TAXES**

 

         The Companyrecorded a benefit for income taxes of ($50,000) in the third quarter of 2004compared to a provision for income taxes of $420,000 in the third quarter of2003. Both provisions reflect the Company’s estimated effective tax rate forthe full year.

 

         At December 31,2003, the Company had approximately $22 million and $18 million of federal andstate income tax net operating loss carry forwards, respectively, available tooffset future taxable income which expire in various years through 2022. TheCompany expects that future taxable income will be offset in the near-term, forthe most part, by its net operating tax loss carry forwards.

 

**     NET EARNINGS**

 

         The Company’s netloss for the third quarter of 2004 was $125,000, or $0.01 per diluted share,compared to net earnings of $630,000, or $0.04 per diluted share for the thirdquarter of 2003 due to the factors discussed above, which was primarily drivenby the loss of $776,000 by Modern Amusement.

 

13

----

 

** NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003**

** **

**     REVENUES**

 

         Total revenue fromlicense royalties and design service fees in the nine months ended September30, 2004 were $16.2 million compared to $16.9 million in the nine months endedSeptember 30, 2003.

 

         Design service feesand royalties recognized under the Target Agreement were $14.4 million in thenine months ended September 30, 2004 compared to $15.1 million in the ninemonths ended September 30, 2003. The decrease is due to reduced consumerspending in the second quarter of 2004 at Target stores. Royalties and designservice fees from customers other than Target remained consistent at $1.8million in the nine months ended September 30, 2004 and 2003. The Company’srevenues generated under the Target Agreement are expected to increase modestlyduring the remainder of 2004 as Target adds new stores, the Company continuesto maximize its opportunities with Target and consumer spending increases.

 

         Modern Amusementrealized product sales of $1.2 million in the nine months ended September 30,2004.

 

**     OPERATING EXPENSES**

 

         Total operatingexpenses is comprised of the cost of product sales and selling, general andadministrative expenses. Selling, general and administrative expenses increasedto $13.0 million in the nine months ended September 30, 2004, from $10.4million for the comparable period in 2003. Selling, general and administrativeexpenses were approximately 81% of revenues from royalties and design servicefees in the nine months ended September 30, 2004, as compared to approximately62% for the comparable period of 2003. This increase was primarily due to $1.9million of selling, general and administrative expenses incurred in the ninemonths ended September 30, 2004 by the operations of Modern Amusement.Operating expenses for Mossimo, Inc., as a stand-alone operation, as a percentof revenues from royalties and design service fees, increased to 69% for the ninemonths ended September 30, 2004 compared to 62% for the comparable period of2003, primarily as a result of the aforementioned decrease in design servicefees and royalties received from Target and the increase in salary and relatedexpense and travel expense discussed below. Cost of product sales incurred byModern Amusement were $889,000 on $1.2 million in revenue recognized on productsales for the nine months ended September 30, 2004.

 

          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$2.3 million in the nine months ended September 30, 2004 from $2.2 million inthe nine months ended September 30, 2003. Despite the decrease in designservice fees and royalties received from Target in the nine months endedSeptember 30, 2004 compared with the comparable period in 2003, commissionshave increased as a result of an adjustment in the interest owed on the unpaidcommissions to the third party that occurred in the first quarter of 2004.

 

14

----

 

          General andadministrative expenses include payroll for the Company’s officers and itsdesign staff, travel, facilities, insurance, legal and professional fees, andother design related expenses for purchased services and artwork used in thedesign process. Salaries and related costs for Mossimo, Inc., as a stand-aloneoperation, increased to $3.3 million in the nine months ended September 30,2004 from $3.1 million in the nine months ended September 30, 2003, primarilyas a result of an increase in remuneration payable to the Company’s Co-ChiefExecutive Officer-Operations and Finance, Mr. Edwin Lewis.

 

         Also included ingeneral and administrative expenses are bonuses of $1.7 million in the ninemonths ended Septebmer 30, 2004, and $1.9 million in the nine months endedSeptember 30, 2003, which are due under bonus plans covering two executiveofficers of the Company. Design, artwork and sample costs decreased to $503,000in the nine months ended September 30, 2004, from $697,000 in the nine monthsended September 30, 2003, primarily due to costs incurred in 2003 relating tothe launch of the Company’s product line with Zellers. Travel expensesincreased to $1.0 million in the nine months ended September 30, 2004, from$658,000 in the nine months ended September 30, 2003, as a result of theincreased amount and costs of executive officers’ travel.

 

         Selling, generaland administrative expenses incurred by Modern Amusement were $1.9 million inthe nine months ended September 30, 2004. These costs consisted primarily ofsalary and related costs of $723,000, consulting and outsourcing fees of$343,000, and tradeshow costs of $139,000 and sample design costs of $106,000.

 

**     INTEREST INCOME (EXPENSE),NET**

 

         The Company earned$73,000 in interest income in the nine months ended September 30, 2004,compared to $66,000 in the nine months ended September 30, 2003. As a result ofthe repayment of the Company’s outstanding balance of a loan payable to a bankin June 2003 no interest expense was incurred in the nine months endedSeptember 30, 2004. The Company incurred interest expense in the nine monthsended September 30, 2003 of $70,000.

 

**     INCOME TAXES**

 

         The Companyrecorded a provision for income taxes of $1,476,000 in the nine months endedSeptember 30, 2004 compared to a provision for income taxes of $2,580,000 inthe nine months ended September 30, 2003. Both provisions reflect the Company’sconsolidated effective tax rate expected to apply to the full year.

 

         At December 31,2003, the Company had approximately $22 million and $18 million of federal andstate income tax net operating loss carry forwards, respectively, available tooffset future taxable income which expire in various years through 2022. TheCompany expects that future taxable income will be offset in the near-term, forthe most part, by its net operating tax loss carry forwards.

 

**     NET EARNINGS**

 

         The Company’s netearnings for the nine months ended September 30, 2004 were $2.1 million, or$0.13 per diluted share, compared to net earnings of $3.9 million, or $0.25 perdiluted share for the nine months ended September 30, 2003 due to the factorsdiscussed above, which was primarily driven by the loss of $1.6 million byModern Amusement.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

         Net cash providedby operating activities was approximately $1.3 million for the nine monthsended September 30, 2004. Cash provided by operating activities primarilyincludes $2.1 million provided by net earnings, plus a decrease in restrictedcash of $4.6 million, partially offset by an increase in accounts receivable of$1.5 million and decreases in accrued liabilities of $1.1 million, whichincludes bonuses paid of $601,000, and accrued commissions of $4.9 million.

 

 

15

----

 

          The changes inaccrued commissions and restricted cash resulted from a dispute with a thirdparty that was resolved. Prior to September 30, 2004 the Company paid allpreviously accrued and unpaid commissions, legal fees and interest payable tothe third party in connection with this matter. This resulted in a decrease inrestricted cash of $4.6 million which was offset by a decrease in accruedcommissions of $4.9 million. The dispute is further discussed in Part II, ItemI - Legal Proceedings in this quarterly report.

 

         Net cash used ininvesting activities was $1.2 million in the nine months ended September 30,2004 and was comprised of the purchase price for the business of ModernAmusement of $375,000 and purchase of additional property and equipment of$841,000 primarily relating to additional property and equipment for Modern Amusement.

 

         As a result of theacquisition in January 2004, of the Modern Amusement, we amended our facilitylease to increase our space from approximately 6,000 square feet toapproximately 9,000 square feet, and extend the lease term through July 2009.The future annual obligation under the amended lease varies each year. Itcommences at approximately $290,000 in 2004 and increases to $334,000 in 2008.The required cash and liquidity resources for Modern Amusement are not expectedto have a significant impact on our liquidity and capital resources in 2004.Future cash and liquidity resources required beyond 2004 will depend in part onour planned expansion of the Modern Amusement business.

 

         The Company isapproached from time to time by parties seeking to sell their brands andrelated trademarks. Should an established marketable brand become available onfavorable terms, the Company may be interested in pursuing such an acquisitionand may elect to fund such acquisition, in whole or in part, with availablecash.

 

         The Companybelieves that its available cash balances at September 30, 2004, and itsexpected net operating cash inflows from operations during 2004, will beadequate to meet the Company’s anticipated liquidity needs in 2004.

 

         From time to time,the Company also considers a number of different financing alternatives,including the issuance of equity securities, and debt instruments as sources ofliquidity or as consideration for potential acquisitions. These financingsources may not be available on acceptable terms to the Company.

 

**CRITICALACCOUNTING POLICIES**

** **

**         REVENUE RECOGNITION**

 

         Revenue fromlicense royalties and design service fees are recognized in accordance with theterms of the underlying agreements, which is generally after the designservices are performed, and as the licensee achieves sales of the Company’sproducts. During the periods presented herein, a substantial amount of theCompany’s revenue from license royalties and design fees were generated underthe Target Agreement under a rate of 1% to 4% that declines as the contractyear 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 onFebruary 1. Revenue recognized in the first and second quarters of the Company’sfiscal year in connection with the Target Agreement is significantly higherthan in the third and fourth quarters of the Company’s fiscal year due to thedeclining rates in the Target Agreement. Royalties from Target are receivable30 days after the end of Target’s fiscal year quarters. Revenue from licenseroyalties and design service fees under license agreements other than the TargetAgreement are generally collected on a quarterly basis, and they range from 1%to 3% of sales, as defined in the respective agreements.

 

         Revenue fromproduct sales is recognized when merchandise is sold to customers. An allowancefor merchandise returns is estimated and recorded at the time of sale.

 

**     INCOME TAXES**

 

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

 

16

----

 

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

 

         Over 50 percent ofthe value of the Company’s outstanding stock is owned by one stockholder,however it is presently anticipated that in 2004, no more than 60 percent ofthe Company’s income, as defined, would be derived from license royalties.Accordingly, at this time the Company is not anticipated to be classified as apersonal holding company at the end of 2004 and the Company intends to continueto take appropriate measures to avoid being classified as a personal holdingcompany at the end of 2004 and beyond. However, there can be no assurance thatthe Company will be successful in its efforts to avoid classification as apersonal holding company at the end of 2004 or in future years.

 

**     IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS**

 

         In May 2003, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 150, “Accountingfor Certain Financial Instruments With Characteristics of Both Liabilities andEquity.” SFAS No. 150 changes the classification in the statement of financialposition of certain common financial instruments from either equity ormezzanine presentation to liabilities and requires an issuer of those financialstatements to recognize changes in fair value or redemption amount, as applicable,in earnings. SFAS No. 150 is effective for financial instruments entered intoor modified after May 31, 2003, and with one exception relating to certainmandatorily redeemable financial instruments, is effective at the beginning ofthe first interim period beginning after June 15, 2003. The implementation ofSFAS No. 150 did not have an impact on the Company’s financial position orresults of operations.

 

         In January 2003,the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities”. In December 2003, the FASB issued “Summary ofInterpretation No. 46 (Revised December 2003)” (“FIN 46R”) which replaced FIN46. FIN 46R clarifies the application of Accounting Research Bulletin No. 51 “ConsolidatedFinancial Statements”, and requires companies to evaluate variable interestentities for specific characteristics to determine whether additionalconsolidation and disclosure requirements apply. Certain special effective dateprovisions apply to companies that fully or partially applied FIN 46 prior tothe issuance of FIN 46R. Otherwise, application of FIN

 

17

----

 

 46R is required infinancial statements of public companies that have interests in variableinterest entities or potential variable interest entities, commonly referred toas special-purpose entities, for periods ending after December 15, 2003.Application by public companies (other than small business issuers) for allother types of entities is required in financial statements for periods endingafter March 15, 2004. Neither the initial adoption of FIN 46 nor the adoptionof FIN 46R had a material impact on the Company’s financial position or resultsof operations.

 

         In December 2003,the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”,which codifies, revises and rescinds certain sections of SAB No. 101, “RevenueRecognition”, in order to make this interpretive guidance consistent withcurrent authoritative accounting and auditing guidance and SEC rules andregulations. The changes noted in SAB No. 104 did not have a material effect onthe Company’s results of operations, financial position or cash flows.

 

**     CONTINGENCIES AND LITIGATION**

 

         Managementevaluates contingent liabilities including pending or threatened litigation inaccordance with SFAS No. 5 “Accounting for Contingencies”, and records accrualswhen the outcome of these matters is deemed probable and the amount of theliability is subject to reasonable estimation. Management makes theseassessments based on the facts and circumstances available at the time, and insome instances based in part on the advice of outside counsel.

 

**     INFLATION**

 

         The Company doesnot believe that the relatively moderate rates of inflation experienced in theUnited States over the last three years have had a significant effect on itsoperations. Since the Company’s future revenues are based on a percentage ofsales of licensed products by licensees, the Company does not anticipate thatinflation will have a material impact on future operations.

 

**     EXCHANGE RATES**

 

         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.

 

18

----

 

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

 

         The Company doesnot use interest rate swaps, futures contracts or options on futures, or othertypes of derivative financial instruments. Further, the Company does not facethe risk of exposure to adverse movements in foreign currency. The Company doesnot currently rely upon credit agreements for financing, which could have anadverse impact upon the Company should interest rates rise.

 

**ITEM4. CONTROLS AND PROCEDURES**

 

         Based on theirevaluation as of September 30, 2004, our Principal Executive Officer and actingChief Financial Officer have concluded that our internal Controls anddisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934, as amended) were sufficientlyeffective to ensure that the information required to be disclosed by us in thisreport on Form 10-Q was recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and instructions for Form 10-Q.

 

         There have not beenany changes in our internal control over financial reporting (as defined inRules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) duringthe period covered by this report that have materially affected, or arereasonably likely to materially affect our internal controls over financialreporting.

 

         Our management,including our Principal Executive Officer and acting Chief Financial Officer,does not expect that our internal controls and disclosure controls andprocedures will prevent all errors and all fraud. A control system, no matterhow well conceived and operated, can provide only reasonable, not absoluteassurance that the objectives of the control system are met. Further, thedesign of the control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the Company have been detected.

 

**FORWARD-LOOKINGSTATEMENTS AND RISK FACTORS**

 

         Certain informationincluded in this Form 10-Q and other materials filed or to be filed by us withthe Securities and Exchange Commission (as well as information included in oralor written statements made by us or on our behalf), may contain forward-lookingstatements about our current and expected performance trends, growth plans,business goals and other matters. These statements may be contained in ourfilings with the Securities and Exchange Commission, in our press releases, inother written communications, and in oral statements made by or with theapproval of one of our authorized officers. Words or phrases such as “believe,”“plan,” “will likely result,” “expect,” “intend,” “will continue,” “isanticipated,” “estimate,” “project,” “may,” “could,” “would,” “should” andsimilar expressions are intended to identify forward-looking statements. Thesestatements, and any other statements that are not historical facts, areforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995, as codified in Section 27A of the Securities Actof 1933 and Section 21E of the Securities Exchange Act of 1934, as amended fromtime to time (the “Act”).

 

         In connection withthe “safe harbor” provisions of the Act, we are filing the following summary toidentify important factors, risks and uncertainties that could cause our actualresults to differ materially from those projected in forward-looking statementsmade by us, or on our behalf. These cautionary statements are to be used as areference in connection with any forward-looking statements. The factors, risksand uncertainties identified in these cautionary statements are in addition tothose contained in any other cautionary statements, written or oral, which maybe made or otherwise addressed in connection with a forward-looking statementor contained in any of our subsequent filings with the Securities and ExchangeCommission. Because of these

 

19

----

 

factors, risks and uncertainties, we caution against placing unduereliance on forward-looking statements. Although we believe that theassumptions underlying forward-looking statements are reasonable, any of theassumptions could be incorrect, and there can be no assurance thatforward-looking statements will prove to be accurate. Forward-lookingstatements speak only as of the date on which they are made. We do notundertake any obligation to modify or revise any forward-looking statement totake into account or otherwise reflect subsequent events, or circumstancesarising after the date that the forward-looking statement was made.

 

         The following riskfactors may affect our operating results and the environment within which weconduct our business. If our projections and estimates regarding these factorsdiffer materially from what actually occurs, our actual results could varysignificantly from any results expressed or implied by forward-lookingstatements. These risk factors include, but are not limited to, a terminationor adverse modification of the Company’s license relationships with Target andothers, the success of its licensing program with Target and The Hudson BayCompany and other licensees, the integration of Modern Amusement and itssuccess in growing its business, changes in consumer demands and preferences,competition from other lines, risks generally associated with productintroductions and shifting trends in the overall retail and apparel retailingmarkets and the other factors described in “Business-Risk Factors” in theCompany’s Form 10-K filing for the year ended December 31, 2003.

 

20

----

 

 

 

**PARTII - OTHER INFORMATION**

 

**ITEM  1 - LEGAL PROCEEDINGS**

 

         In May 2002, theCompany made a demand for arbitration in connection with a claim foroverpayment of commissions paid to a third party who assisted the Company inconnection with entering into the initial agreement with Target. Thearbitration hearing was completed in October 2002. In November 2002, thearbitration hearing panel issued a preliminary award in favor of the thirdparty, which became final in January 2003 and awarded the third party thecommissions owed, interest on the amounts due which had been withheld by theCompany, and the recovery of the third party’s legal fees.

 

         In January 2003,the Company filed a petition to vacate the award, including commissions, thirdparty legal fees, and interest, on the basis that the evidence received duringthe arbitration hearing demonstrated that the finder’s agreement between theCompany and the third party was illegal under certain applicable Californialaw. In January 2003 the third party filed a petition to confirm the award,including commissions, the third party’s legal fees, and interest.

 

         In June 2003, theaward was confirmed and a judgment entered in favor of the third party, and thethird party was awarded additional interest. In June 2003 the Company filed anappeal to the judgment and in connection therewith deposited with the courtapproximately $4,585,000. The $4,585,000 deposited with the courts wasclassified as restricted cash on the Company’s balance sheet as of December 31,2003. The deposit secured 150% of the judgment amount. In January 2004 theappeal decision was rendered in favor of the third party, and the Companyproceeded with an appeal to the Supreme Court of the State of California.

 

         In March 2004, theCalifornia Supreme Court denied the Company’s appeal. The California SupremeCourt’s decision not to review the trial court judgment reaffirms the validityof the original finder’s agreement between the third party and Mossimo and thethird party ‘s right to be paid all amounts currently due, including interestat the legal rate and all post-judgment amounts as well as attorney’s fees.

 

         Prior to June 30,2004 the Company paid all unpaid commissions, legal fees and interest payableto the third party in connection with this litigation. The Company had accruedfor the full amount each quarter under the original agreement with the thirdparty, including estimated penalties and interest. Accordingly, this settlementdid not have a material impact on the Company’s results of operations,financial position or cash flows.

 

21

----

 

 

**ITEM  6 - EXHIBITS**

 

 
| 31.1   |   | Certification of Principal Executive Officer as required by Rule  13a - 14(a) of the Securities Exchange Act of 1934                                 |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                 |
| 31.2   |   | Certification of Principal Financial Officer as required by Rule  13a - 14(a) of the Securities Exchange Act of 1934                                 |
|   |   |                                                                                                                                                 |
| 32.1   |   | Certification of Principal Executive Officer Pursuant to 18 USC  Section 1350 as adopted pursuant to Section 906 of the Sarbanes Oxley Act of  2002. |
|   |   |                                                                                                                                                 |
| 32.2   |   | Certification of Principal Financial Officer Pursuant to 18 USC  Section 1350 as adopted pursuant to Section 906 of the Sarbanes Oxley Act of  2002. |

 

**SIGNATURES**

 

         Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized on the eleventh day of November 2004.

 
|   | **MOSSIMO, INC.**     |
|--------|-----------------------|
|   |                  |   |
|   | /s/ MOSSIMO GIANNULLI |
|   |                  | Mossimo Giannulli |
|   |                  | Chairman and Co-Chief Executive Officer |
|   |                  | (Principal Executive Officer) |
|   |                  |   |
|   | /s/ EDWIN LEWIS       |
|   |                  | Edwin Lewis |
|   |                  | President, Co-Chief Executive Officer |
|   |                  | and Acting Chief Financial Officer |
|   |                  | (Principal Financial and Accounting Officer) |

 

 

22

----

 

Exhibit Index

 
| 31.1   |   | Certification of Principal Executive Officer as required by Rule  13a - 14(a) of the Securities Exchange Act of 1934                                 |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                 |
| 31.2   |   | Certification of Principal Financial Officer as required by Rule  13a - 14(a) of the Securities Exchange Act of 1934                                 |
|   |   |                                                                                                                                                 |
| 32.1   |   | Certification of Principal Executive Officer Pursuant to 18 USC  Section 1350 as adopted pursuant to Section 906 of the Sarbanes Oxley Act of  2002. |
|   |   |                                                                                                                                                 |
| 32.2   |   | Certification of Principal Financial Officer Pursuant to 18 USC  Section 1350 as adopted pursuant to Section 906 of the Sarbanes Oxley Act of  2002. |

 

 

23

----