**SECURITIES AND EXCHANGE COMMISSION**

 

**WASHINGTON,D.C. 20549**

 

### **FORM 10-Q**

### ** **

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

 

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

 

**or**

 

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

 

**For theTransition Period From              to              **

 

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

##### ** **

**MOSSIMO, INC.**

(Exact name of Registrant asspecified in its charter)

 

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

 

**(310) 460-0040**

(Registrant’s telephone number,including area code)

 

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

 

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

 

As of June 30, 2005, the Registrant had15,738,442 shares of Common Stock, $0.001 par value, outstanding.

 

 

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**MOSSIMO,INC.**

 

**FORM 10-Q**

For the Six Months Ended June 30,2005

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

 

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MOSSIMO, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

(Unaudited)

 
| ** **                                                                                                                                        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                        | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ASSETS                                                                                                                                            |       |              |       |                  |       |
| CURRENT  ASSETS:                                                                                                                                  |       |              |       |                  |       |
| Cash and  cash equivalents                                                                                                                        |       | $                 | 14,688     |                  | $          | 4,903 |   |
| Restricted  cash                                                                                                                                  |       | 717               |       | 413                   |       |
| Investments                                                                                                                                       |       | —            |       | 4,800                 |       |
| Accounts  receivable                                                                                                                              |       | 6,448             |       | 2,908                 |       |
| Merchandise  inventory                                                                                                                            |       | 785               |       | 539                   |       |
| Deferred  income taxes                                                                                                                            |       | 2,376             |       | 1,739                 |       |
| Prepaid  expenses and other current assets                                                                                                        |       | 375               |       | 436                   |       |
| Total  current assets                                                                                                                             |       | 25,389            |       | 15,738                |       |
|                                                                                                                                              |       |              |       |                  |       |
| PROPERTY AND  EQUIPMENT, at cost, net of accumulated depreciation and amortization                                                                |       | 985               |       | 1,117                 |       |
|                                                                                                                                              |       |              |       |                  |       |
| DEFERRED  INCOME TAXES                                                                                                                            |       | 3,144             |       | 5,646                 |       |
|                                                                                                                                              |       |              |       |                  |       |
| GOODWILL                                                                                                                                          |       | 212               |       | 212                   |       |
|                                                                                                                                              |       |              |       |                  |       |
| TRADENAME,  net                                                                                                                                   |       | 95                |       | 112                   |       |
|                                                                                                                                              |       |              |       |                  |       |
| OTHER ASSETS                                                                                                                                      |       | 52                |       | 96                    |       |
|                                                                                                                                              |       | $                 | 29,877     |                  | $          | 22,921 |   |
|                                                                                                                                              |       |              |       |                  |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                        |       |              |       |                  |       |
|                                                                                                                                              |       |              |       |                  |       |
| CURRENT  LIABILITIES:                                                                                                                             |       |              |       |                  |       |
| Accounts  payable                                                                                                                                 |       | $                 | 1,113      |                  | $          | 352 |   |
| Accrued  liabilities                                                                                                                              |       | 307               |       | 257                   |       |
| Accrued  commissions                                                                                                                              |       | 778               |       | 258                   |       |
| Accrued  bonuses                                                                                                                                  |       | 1,780             |       | 206                   |       |
| Total  current liabilities                                                                                                                        |       | 3,978             |       | 1,073                 |       |
|                                                                                                                                              |       |              |       |                  |       |
| DEFERRED  RENT                                                                                                                                    |       | 137               |       | 135                   |       |
| Total  liabilites                                                                                                                                 |       | 4,115             |       | 1,208                 |       |
|                                                                                                                                              |       |              |       |                  |       |
| COMMITMENTS,  CONTINGENCIES, AND SUBSEQUENT EVENTS                                                                                                |       |              |       |                  |       |
|                                                                                                                                              |       |              |       |                  |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                       |       |              |       |                  |       |
| Preferred  stock, par value $.001; authorized shares 3,000,000; no shares issued or  outstanding                                                  |       | —            |       | —                |       |
| Common  stock, par value $.001; authorized shares 30,000,000; issued and outstanding  15,738,442 at June 30, 2005 and December 31, 2004 |       | 15                |       | 15                    |       |
| Additional  paid-in capital                                                                                                                       |       | 39,763            |       | 39,763                |       |
| Accumulated  deficit                                                                                                                              |       | (14,016           | )          | (18,065               | )          |
| Net  stockholders’ equity                                                                                                                    |       | 25,762            |       | 21,713                |       |
|                                                                                                                                              |       | $                 | 29,877     |                  | $          | 22,921 |   |

 

See accompanying notes tocondensed consolidated financial statements

 

2

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MOSSIMO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(Unaudited)

 
| ** **                                              | ** ** | **For the Three Months  June 30,** | ** ** | **For the Six Months  June 30,** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                              | ** ** | **2005**                                | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Revenue from  license royalties and design service fees |       | $                                       | 8,113      |                                  | $          | 5,784 |   | $ | 15,467 |   | $ | 11,994 |   |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Product  sales                                          |       | 932                                     |       | 424                                   |       | 2,242 |   | 450 |   |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Total  revenues                                         |       | 9,045                                   |       | 6,208                                 |       | 17,709 |   | 12,444 |   |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Operating  expenses:                                    |       |                                    |       |                                  |       |   |   |   |   |
| Cost of  product sales                                  |       | 695                                     |       | 211                                   |       | 1,734 |   | 224 |   |
| Selling,  general and administrative                    |       | 5,353                                   |       | 4,330                                 |       | 9,928 |   | 8,543 |   |
| Total  operating expenses                               |       | 6,048                                   |       | 4,541                                 |       | 11,662 |   | 8,767 |   |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Earnings  from operations                               |       | 2,997                                   |       | 1,667                                 |       | 6,047 |   | 3,677 |   |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Other income—Interest  income                      |       | 79                                      |       | 20                                    |       | 110 |   | 47 |   |
| Earnings  before income taxes                           |       | 3,076                                   |       | 1,687                                 |       | 6,157 |   | 3,724 |   |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Income taxes                                            |       | 848                                     |       | 680                                   |       | 2,108 |   | 1,527 |   |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Net earnings                                            |       | $                                       | 2,228      |                                  | $          | 1,007 |   | $ | 4,049 |   | $ | 2,197 |   |
|                                                    |       |                                    |       |                                  |       |   |   |   |   |
| Earnings per  common share:                             |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                   |       | $                                       | 0.14       |                                  | $          | 0.06 |   | $ | 0.26 |   | $ | 0.14 |   |
| Diluted                                                 |       | $                                       | 0.14       |                                  | $          | 0.06 |   | $ | 0.26 |   | $ | 0.14 |   |
| Weighted  average common shares outstanding:            |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                   |       | 15,738                                  |       | 15,738                                |       | 15,738 |   | 15,738 |   |
| Diluted                                                 |       | 15,768                                  |       | 15,768                                |       | 15,762 |   | 15,770 |   |

 

See accompanying notes tocondensed consolidated financial statements

 

3

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MOSSIMO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(Unaudited)

 
| ** **                                                                           | ** ** | **FOR THE SIX MONTHS**  | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                           | ** ** | **ENDED JUNE 30,** | ** ** |
| ** **                                                                           | ** ** | **2005**                | ** ** | **2004** | ** ** |
|                                                                                 |       |                    |       |   |   |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                               |       |                    |       |   |   |
| Net earnings                                                                         |       | $                       | 4,049      |   | $ | 2,197 |   |
| Adjustments  to reconcile net earnings to net cash provided by operating activities: |       |                    |       |   |   |
| Depreciation  and amortization                                                       |       | 252                     |       | 141 |   |
| Inventory  write-down                                                                |       | 189                     |       | — |   |
| Deferred  rent                                                                       |       | 2                       |       | — |   |
| Provision  for bad debt                                                              |       | 48                      |       | 22 |   |
| Deferred  income taxes                                                               |       | 1,865                   |       | 1,451 |   |
| Changes in:                                                                          |       |                    |       |   |   |
| Restricted  Cash                                                                     |       | —                  |       | 4,585 |   |
| Accounts  receivable                                                                 |       | (3,588                  | )          | (2,470 | ) |
| Merchandise  inventory                                                               |       | (435                    | )          | (394 | ) |
| Prepaid  expenses and other current assets                                           |       | 61                      |       | (279 | ) |
| Other assets                                                                         |       | 44                      |       | 188 |   |
| Accounts  payable                                                                    |       | 761                     |       | (407 | ) |
| Accrued  liabilities                                                                 |       | 50                      |       | (802 | ) |
| Accrued  commissions                                                                 |       | 520                     |       | (4,725 | ) |
| Accrued  bonuses                                                                     |       | 1,574                   |       | 555 |   |
| Net cash  provided by operating activities                                           |       | 5,392                   |       | 62 |   |
|                                                                                 |       |                    |       |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                               |       |                    |       |   |   |
| Proceeds  from sale of available-for-sale securities                                 |       | 4,800                   |       | — |   |
| Payments for  acquisition of property and equipment                                  |       | (103                    | )          | (697 | ) |
| Acquisition  of Modern Amusement                                                     |       | —                  |       | (375 | ) |
| Net cash  provided by (used in) investing activities                                 |       | 4,697                   |       | (1,072 | ) |
|                                                                                 |       |                    |       |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                               |       |                    |       |   |   |
| Restricted  cash—certificates of deposit                                        |       | (304                    | )          | — |   |
| Net cash  (used in) financing activities                                             |       | (304                    | )          | — |   |
|                                                                                 |       |                    |       |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                |       | 9,785                   |       | (1,010 | ) |
| CASH AND  CASH EQUIVALENTS, beginning of period                                      |       | 4,903                   |       | 9,707 |   |
| CASH AND  CASH EQUIVALENTS, end of period                                            |       | $                       | 14,688     |   | $ | 8,697 |   |
|                                                                                 |       |                    |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                   |       |                    |       |   |   |
| Cash paid  during the year for state income taxes                                    |       | $                       | 25         |   | $ | 58 |   |

 

See accompanying notes tocondensed consolidated financial statements

 

4

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**MOSSIMO,INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

1.  BASIS OF PRESENTATION

 

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

 

On January 16,2004, Mossimo, Inc. acquired substantially all the assets of ModernAmusement LLC through a wholly owned subsidiary, Modern Amusement, Inc. (“ModernAmusement”). The accompanying consolidated financial statements as of and forthe three and six months ended June 30, 2004 include the account balancesand results of operations of Modern Amusement as of June 30, 2004 and forthe period from January 16, 2004 to June 30, 2004, respectively. Allinter-company accounts and transactions have been eliminated in consolidation.

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amountsof revenues and expenses during the reporting period. Actual results coulddiffer from those estimates.

 

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

 

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

 

2.  REVENUERECOGNITION

 

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

 

5

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

 

3. INVENTORY

 

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

 

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

 

4.  EXECUTIVEBONUS PLANS

 

The Company has bonus plans covering two executiveofficers which are administered by the Compensation Committee of the Board ofDirectors, and that provide for discretionary bonuses based on the Company’soverall performance, with the total amount of the bonuses not to exceed apercent (as defined) of the excess over the minimum total guaranteed fees, ifany, of license royalties paid to the Company under the Target Agreement, andas defined in each of the respective bonus plans. The Company has accruedapproximately $1,037,000 and $667,000 under these agreements for the threemonth periods ended June 30, 2005 and 2004, respectively; and $1,656,000and $1,274,000 for the six month periods ended June 30, 2005 and 2004,respectively.

 

5.  INCOME TAXES

 

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

 

The Company recorded aprovision for income taxes of $848,000 and $2,108,000 for the three and sixmonths ended June 30, 2005, respectively, compared to a provision forincome taxes of $680,000  and $1,527,000for the three and six months ended June 30, 2004, respectively. Bothprovisions approximate the Company’s combined effective rate as estimated forthe entire fiscal year, for Federal and California state income taxes.  The income tax rate for the six months ended June 30,2005 is 34% compared to 41% for the comparable period of the prior year.  The decrease is due to a reduction in thevaluation allowance as described below.

 

At June 30, 2005, the Company has recorded a total netdeferred tax asset of $5.52 million, with $2.38 million classified as currentin the accompanying condensed consolidated balance sheet, primarily reflectingthe extension of the Target Agreement through January 31, 2008. TheCompany has considered the projected taxable income from the Target Agreementand other agreements in its estimate of deferred tax asset recoverability andhas recorded a valuation allowance for its net deferred tax assets of $710,000as of June 30, 2005 compared to $1.1 million as of December 31,2004.  The reduction is primarily due tothe change of anticipated use of federal and state alternative minimum taxcredits.

 

6

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The Company has approximately $11.6 millionand $7.2 million of federal and state income tax net operating loss carryforwards, respectively, available to offset future taxable income which expirein various years through 2022. The Company expects that future taxable income will be offset inthe near-term, for the most part, by its net operating tax loss carryforwards.

 

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

 

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

 

6.  EARNINGS PERSHARE AND STOCK OPTION PLANS

 

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

 

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

 
| ** **                                        | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                        | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                        | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings                                      |       | $                                     | 2,228      |                                | $          | 1,007 |   | $ | 4,049 |   | $ | 2,197 |   |
| Weighted  average number of common shares:        |       |                                  |       |                                |       |   |   |   |   |
| Basic                                             |       | 15,738                                |       | 15,738                              |       | 15,738 |   | 15,738 |   |
| Effect of  dilutive securities-stock options      |       | 30                                    |       | 30                                  |       | 24 |   | 32 |   |
|                                              |       |                                  |       |                                |       |   |   |   |   |
| Diluted                                           |       | 15,768                                |       | 15,768                              |       | 15,762 |   | 15,770 |   |
|                                              |       |                                  |       |                                |       |   |   |   |   |
| Earnings per  share:                              |       |                                  |       |                                |       |   |   |   |   |
| Basic                                             |       | $                                     | 0.14       |                                | $          | 0.06 |   | $ | 0.26 |   | $ | 0.14 |   |
| Effect of  dilutive securities—stock options |       | —                                |       | —                              |       | — |   | — |   |
|                                              |       |                                  |       |                                |       |   |   |   |   |
| Diluted                                           |       | $                                     | 0.14       |                                | $          | 0.06 |   | $ | 0.26 |   | $ | 0.14 |   |
|                                              |       |                                  |       |                                |       |   |   |   |   |
| Excluded  securities—antidilutive            |       | 394                                   |       | 441                                 |       | 394 |   | 441 |   |

 

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

 

7

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

 

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

 

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

 
| ** **                                                                                                                                   | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Net earnings  as reported                                                                                                                    |       | $                                     | 2,228      |                                | $          | 1,007 |   | $ | 4,049 |   | $ | 2,197 |   |
|                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Deduct:                                                                                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Total  stock-based employee compensation expense determined under fair market value  based method for all awards, net of related tax effects |       | (16                                   | )          | (73                                 | )          | (32 | ) | (147 | ) |
| Pro forma  net earnings                                                                                                                      |       | $                                     | 2,212      |                                | $          | 934 |   | $ | 4,017 |   | $ | 2,050 |   |
|                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Earnings per  share—basic and diluted                                                                                                   |       |                                  |       |                                |       |   |   |   |   |
| As reported—basic                                                                                                                       |       | $                                     | 0.14       |                                | $          | 0.06 |   | $ | 0.26 |   | $ | 0.14 |   |
| As reported—diluted                                                                                                                     |       | $                                     | 0.14       |                                | $          | 0.06 |   | $ | 0.26 |   | $ | 0.14 |   |
|                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Pro forma—basic                                                                                                                         |       | $                                     | 0.14       |                                | $          | 0.06 |   | $ | 0.26 |   | $ | 0.13 |   |
| Pro forma—diluted                                                                                                                       |       | $                                     | 0.14       |                                | $          | 0.06 |   | $ | 0.26 |   | $ | 0.13 |   |

 

7.  IMPACT OF RECENT ACCOUNTINGPRONOUNCEMENTS

 

SFAS No. 123R—InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 123R, “Share-Based Payment: an amendment of FASB Statements No. 123and 95,” which requires companies to recognize in their income statement thegrant-date fair value of stock options and other equity-based compensationissued to employees.  SFAS No. 123Ris effective for the Company on January 1, 2006.  Accordingly, the Company will adopt SFAS No. 123Rin our first quarter of 2006. See Note 1 “Earnings Per Share and Stock OptionPlans,” for the pro forma effects of how SFAS No. 123R would have affectedthe results of earnings in the six month period ended June 30, 2005 and2004.  We are currently assessing theimpact this prospective change in accounting will have but believe that it willnot have a material impact on our reported financial position or results ofoperations.

 

8. LITIGATION

 

On April 12,2005, Mossimo Giannulli offered to acquire all of the outstanding publicly heldcommon stock of the Company at a price of $4.00 per share.  Since then, six purported class actionlawsuits have been filed in the Court of Chancery of the State of Delaware. Eachof the complaints asserts

 

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that the Directors have breached theirfiduciary duties to the Company’s shareholders, and seeks an injunctionpreventing the acquisition.  On May 27,2005, the above referenced cases were consolidated under the following caption:In re Mossimo, Inc. Shareholder Litigation, Consolidated Civil ActionNo.1246-N.

 

The Companyand its Board of Directors intend to vigorously defend the lawsuits. On April 19,2005, the Board of Directors appointed a Special Committee to consider andevaluate Mr. Giannulli’s proposal. The Special Committee retained Houlihan Lokey and Gibson Dunn &Crutcher to serve as the Committee’s independent financial advisor and legalcounsel, respectively, with respect to the Committee’s evaluation of Mr. Giannulli’sproposal.  The Committee is currently inthe process of reviewing the terms of Mr. Giannulli’s proposal as well asany indications of interest expressed by other third-parties.

 

The Companyis involved in certain other legal and administrative proceedings andthreatened legal and administrative proceedings from time to time in the normalcourse of business. While the outcome of such proceedings and threatenedproceedings cannot be predicted with certainty, in the opinion of management,the ultimate resolution of these matters individually or in the aggregate isnot expected to have a material adverse effect on the Company’s business as awhole.

 

9. SEGMENT INFORMATION

 

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

 
| **Three months ended June 30, 2005**     | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                      |       | $           | 8,113      |       | $          | 932       |       | $ | 9,045 |   |
| Gross Profit                                  |       | —      |       | 237        |       | 237       |       |
| Depreciation  and Amortization                |       | 59          |       | 50         |       | 109       |       |
| Selling,  general and administrative expenses |       | 4,419       |       | 934        |       | 5,353     |       |
| Operating  Income (loss)                      |       | 3,694       |       | (697       | )          | 2,997     |       |
| Interest  Income                              |       | 79          |       | —     |       | 79        |       |
| Total Assets                                  |       | 26,979      |       | 2,898      |       | 29,877    |       |
| Capital  Expenditures                         |       | 21          |       | 29         |       | 50        |       |
|                                               |            |             |            |            |            |           |            |  |  |  |

 
| **Three months ended June 30, 2004**     | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                      |       | $           | 5,784      |       | $          | 424       |       | $ | 6,208 |   |
| Gross Profit                                  |       | —      |       | 213        |       | 213       |       |
| Depreciation  and Amortization                |       | 56          |       | 28         |       | 84        |       |
| Selling,  general and administrative expenses |       | 3,741       |       | 589        |       | 4,330     |       |
| Operating  Income (loss)                      |       | 2,043       |       | (376       | )          | 1,667     |       |
| Interest  Income                              |       | 20          |       | —     |       | 20        |       |
| Total Assets                                  |       | 21,422      |       | 1,810      |       | 23,232    |       |
| Capital  Expenditures                         |       | —      |       | 216        |       | 216       |       |
|                                               |            |             |            |            |            |           |            |  |  |  |

 

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| **Six months ended June 30, 2005**       | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                      |       | $           | 15,467     |       | $          | 2,242     |       | $ | 17,709 |   |
| Gross Profit                                  |       | —      |       | 508        |       | 508       |       |
| Depreciation  and Amortization                |       | 120         |       | 132        |       | 252       |       |
| Selling,  general and administrative expenses |       | 8,036       |       | 1,892      |       | 9,928     |       |
| Operating  Income (loss)                      |       | 7,430       |       | (1,383     | )          | 6,047     |       |
| Interest Income                               |       | 110         |       | —     |       | 110       |       |
| Total Assets                                  |       | 26,979      |       | 2,898      |       | 29,877    |       |
| Capital  Expenditures                         |       | 28          |       | 75         |       | 103       |       |
|                                               |            |             |            |            |            |           |            |  |  |  |

 
| **Six months ended June 30, 2004**       | ** ** | **Mossimo** | ** ** | **Modern** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|
| Revenues                                      |       | $           | 11,994     |       | $          | 450       |       | $ | 12,444 |   |
| Gross Profit                                  |       | —      |       | 226        |       | 226       |       |
| Depreciation  and Amortization                |       | 110         |       | 31         |       | 141       |       |
| Selling,  general and administrative expenses |       | 7,476       |       | 1,067      |       | 8,543     |       |
| Operating  Income (loss)                      |       | 4,518       |       | (841       | )          | 3,677     |       |
| Interest  Income                              |       | 47          |       | —     |       | 47        |       |
| Total Assets                                  |       | 21,422      |       | 1,810      |       | 23,232    |       |
| Capital  Expenditures                         |       | 49          |       | 648        |       | 697       |       |
|                                               |            |             |            |            |            |           |            |  |  |  |

 

The following information should beconsidered when reading the above table:

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

•                  Corporate overhead has been allocated to the Mossimo segment.

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

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

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

•                  Gross profit is derived by reducing sales of the Modern segment of$2.24 million by $1.73 million of cost of sales for the sixmonths ended June 30, 2005 toarrive at a gross profit of approximately $508,000.  For the three months ended June 30, 2005sales of the Modern segment were $932,000 reduced by cost of sales of $695,000to arrive at a gross profit of approximately $237,000.

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

 

**ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

**FORWARDLOOKING INFORMATION**

 

This report on Form 10-Q containscertain forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. These forward looking statements relate tomatters such as the Company’s future operating results, the success andlongevity of its licensing program with Target in the United States, Hudson’sBay Company in Canada, and other licensees, and the Company’s success inexecuting its business plan for Modern Amusement. Such forward-lookingstatements are based on the beliefs of the Company’s management as well asassumptions made by and information currently available to the Company’smanagement. The words “anticipate”, “believe”, “may”, “estimate”, “plan”, “expect”,“future”, “intend”, “will”, “should”, “continue” and similar expressions,variations of such terms or the negative of such terms as they relate to theCompany or its management when used in this document, are intended to identifysuch forward-looking statements. In particular, the forward looking statementsin this Form 10-K include, among other things, statements regarding orexpectations about our future revenues and earnings. Forward

 

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looking statements include known or unknown risks and uncertaintiesthat may cause our results, performance and stock price to be materiallydifferent from the forward looking statements. Such statements are based onmanagement’s current expectations and are subject to certain risks,uncertainties and assumptions, including those described in our Form 10-Kfor the year ended December 31, 2004 under “Business—Risk Factors”. Shouldone or more risks or uncertainties materialize, or should underlyingassumptions prove incorrect, the Company’s actual results, performance orachievements could differ materially from those expressed in, or implied bysuch forward-looking statements. The Company’s future operations, financialperformance, business and share price may be affected by a number of factors,including but not limited to the financial condition of the apparel industryand the retail industry, the overall level of consumer spending, the effect ofintense competition from other apparel lines, within and outside of TargetStores, adverse changes in licensee or consumer acceptance of products bearingthe Mossimo or Modern Amusement name as a result of fashion trends orotherwise, the ability and/or commitment of Target and our other licensees tomanufacture and market Mossimo branded products, our dependence on Target formost of our revenue, our dependence on key management personnel and the otherfactors described in our Form 10-K for the year ended December 31,2004 under “Business—Risk Factors.” Accordingly, undue reliance should not beplaced on these forward-looking statements.

 

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

 

**Overview**

 

Mossimo, Inc.presently operates as a designer and licensor of apparel and related productsunder the “Mossimo” brand and other brands it owns or may acquire. The Companylicenses the Mossimo brand to third parties domestically andinternationally.  Our primary domesticlicensee is Target Corporation.  Inaddition to the Target Agreement, the Company also licenses its Mossimo trademarksand provides design services outside of the United States, and also licensesits Mossimo trademarks for use in collections of eyewear and women’s swimwearand body-wear sold in Target stores in the United States.

 

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

 

Under the TargetAgreement the Company provides design services and has approval rights forproduct design, marketing and advertising materials. Target collaborates ondesign and is responsible for product development, sourcing, quality controland inventory management with respect to the Target licensed product line.Target is obligated to pay the Company design service fees and license royaltyfees. Total fees payable by Target are based upon a percentage of Target’s netsales of Mossimo brand products that varies according to the volume of sales ofmerchandise. Target has agreed to pay minimum guaranteed fees of approximately$9.6 million annually. Target’s fees are based on net sales achieved multipliedby a rate, as defined in the Target Agreement. The Company pays a 15%commission, based on fees received from Target, to a third party who assistedthe Company in connection with entering into the initial agreement with Target.The Target Agreement is subject to early termination under certaincircumstances. If Target is current with payments of its obligations under theTarget Agreement, Target has the right to renew the Target Agreement, on thesame terms and conditions, for additional terms of two years each.  In January 2005, Target exercised itssecond renewal options extending the Target Agreement through January 31,2008.

 

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

 

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ended on December 31, 2004 and we currently notgenerating revenue in this area. The Company in the process of negotiating anew agreement.

 

The Company has licensedthe exclusive right to manufacture and distribute women’s swimwear and bodywearbearing its Mossimo trademarks through Target stores in the United Statespursuant to a license agreement with The Lunada Bay Corporation. This agreementextends through September 30, 2006, and is renewable annually.

 

In May 2002, theCompany entered into an agreement with Hudson’s Bay Company. Under theagreement, the Company provides product design services, and has granted alicense for the Mossimo trademark to Hudson’s Bay Company exclusively inCanada, in return for license royalties and design service fees. Hudson’s BayCompany collaborates on product design, and is responsible for manufacturing,importing, marketing, advertising, selling and distributing merchandise bearingthe Mossimo trademark. The initial term of the agreement is three yearsbeginning in May 2002, with a five-year extension at the option of Hudson’sBay Company. Hudson’s Bay Company fully launched the Mossimo product in mid-March 2003for distribution through its Zellers stores in Canada.  We are currently negotiating an extension ofthe contract.

 

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

 

In January 2004,the Company acquired Modern Amusement, which is focused on design anddistribution of premium branded west coast-lifestyle casual sportswear appareland related accessories for young men and young women under the ModernAmusement brand. The products are offered at moderate to upper price pointsthrough traditional specialty stores and better department store distributionchannels.  The Modern Amusement businessincludes sourcing manufactured products, wholesale distribution, inventorymanagement, marketing, promoting, and advertising of apparel and relatedaccessories under the Modern Amusement brand. While the Modern Amusementbusiness is relatively small, as the Company expands into the wholesaleproducts business, it will encounter increased exposure to excess and obsoleteinventories, potential delays and cancellations from sourcing manufacturedproducts domestically and internationally, and product returns and allowancesfrom retail customers, as well as marketing, promotion and advertisingexpenditures that may not result in successful campaigns.

 

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

 

Net salesfor Modern Amusement for the quarter ended June 30, 2005 were $932,000with a gross profit margin of 25%. Selling, general and administrative expense for Modern Amusement for thequarter ended June 30, 2005 was $934,000. For quarter ended June 30, 2005, Modern Amusement had an operatingloss of $697,000.  Modern Amusement’stotal assets as of June 30, 2005 were $2.9 million.

 

***Results of Operations***

# *ThreeMonths Ended June 30, 2005 and 2004*

# * *

*Revenues*

 

Total revenue from license royalties anddesign service fees in the second quarter of 2005 were $8.1 million compared to$5.8 million in the second quarter of 2004. For the second quarter of 2005, 92% of the Company’s revenue fromlicense royalties and design fees were generated under the Target Agreement,compared to 89% for the same period in 2004. The royalty rate under the TargetAgreement declines, as the contract year progresses and Target achieves certainlevels of retail sales, from 4% to 1%. The declining royalty rate is reset eachcontract year beginning on February 1. Accordingly, revenue recognized inthe first and second quarters of the Company’s calendar year is significantlyhigher than in

 

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the third and fourth quarters due to the declining rates in the TargetAgreement.  In 2005, the 1% rate wasreached in June compared to August in 2004.  Revenues from license royalties and designservice fees under license agreements other than the Target Agreement aregenerally collected on a quarterly basis, and they range from 1% to 5% ofsales, as defined in the respective agreements.

 

Design service fees and royalties recognized under theTarget Agreement were $7.4 million in the second quarter of 2005 compared to$5.1 million in the second quarter of 2004. The 45% increase reflects growth insales of women’s apparel, accessories and shoes. Royalties and design servicefees from customers other than Target remained constant at $669,000 in thesecond quarter of 2005 and $664,000 in the second quarter of 2004.  The Company’s revenues generated under theTarget Agreement are expected to increase modestly as Target adds new storesand the Company continues to maximize its opportunities with Target.

 

Modern Amusement achieved gross retail sales of$932,000 in the second quarter of 2005 compared to $424,000 for the secondquarter of 2004.  These sales generated agross profit of approximately $237,000 for the second quarter of 2005 comparedto $213,000 for the second quarter of 2004.  We experienced a lowprofit margin due to off price sales and write down of old and slow movinginventory.  We expect margins to improveas regular price sales become a larger percentage of total sales.

 

*Cost of product sales*

 

Cost ofsales in the second quarter of 2005 resulted entirely from Modern Amusementproduct sales.  Cost of salesapproximated 75% of sales.  Cost of salesincludes all costs and expenses incurred prior to the receipt of finished goodsat the Company’s distribution facilities. These costs include, but are notlimited to, product cost, inbound freight charges, purchasing and receivingcosts, inspection costs, insurance, duty, and brokers’ fees.

 

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

 

Selling, general and administrative expenses increasedto $5.35 million for the second quarter of 2005 from $4.33 million for thesecond quarter of 2004.  This increasewas primarily due to (i) $345,000 increase in selling, general andadministrative expenses incurred by the operations of Modern Amusement, (ii) increasesin executive officer bonuses of $370,000, (iii) commissions of $349,000and (iv) $350,000 in costs incurred for legal and financial advisorexpenses for the Company and its special committee associated with the reviewand consideration of the transaction proposed by Mossimo Giannulli for the acquisitionof all of the companies remaining outstanding shares and pending litigationrelating to the proposal.  The increasewas offset by operational improvements in the Mossimo segment.  Operating expenses for the Mossimo segment,as a percent of revenues from royalties and design service fees, decreased to55% in the second quarter of 2005 compared to 65% for the second quarter of2004.  The decrease was primarily due toproportionately larger increase in revenues.

 

Selling expenses, comprised of commissions due to athird party who assisted the Company in connection with entering into theinitial agreement with Target, increased to $1.1 million in the second quarterof 2005 compared to $765,000 in the second quarter of 2004.  The increase was due to the increased revenuegenerated from Target for the second quarter of 2005.

 

General and administrative expenses include payrollfor the Company’s officers and its design staff, travel, facilities, insurance,legal and professional fees, and other design related expenses for purchasedservices and artwork used in the design process. Salaries and related costs forthe Mossimo segment decreased to $900,000 for the second quarter of 2005,compared to $1.28 million for the second quarter of 2004 due to additionalsalary and bonus accruals in the second quarter of 2004. Also included ingeneral and administrative expenses are accruals for bonuses of $1.04 millionfor the second quarter of 2005, compared to $667,000 for the second quarter of2004, which are due under bonus plans covering the Company’s co-chief executiveofficers.

 

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Selling, general and administrative expenses incurredby Modern Amusement were $934,000 in the second quarter of 2005 compared to$589,000 in the second quarter of 2004. These increases resulted from salary and related costs of $335,000compared to $235,000 in the second quarter of 2004, consulting fees of $75,000compared to $70,000 in the second quarter of 2004, advertising cost of $86,000compared to $400 in the second quarter of 2004, outsourcing costs of $47,000compared to $0 for the second quarter of 2004, and tradeshow and samples costsof $102,000 compared to $63,000 in the second quarter of 2004.  These increases are associated with theanticipated growth of the Modern Amusement brand.

 

*Interest income*

 

The Companyearned $79,000 in interest income the second quarter of 2005, compared to$20,000 in the second quarter of 2004. No interest expense was incurred in thethree month period ended June 30, 2005.

 

*Income taxes*

 

The Company recorded aprovision for income taxes of $848,000 in the second quarter of 2005 comparedto a provision for income taxes of $680,000 in the second quarter of 2004. Bothprovisions approximate the Company’s effective tax rate for Federal andCalifornia state income taxes.

 

The Company has approximately $11.6 millionand $7.2 million of federal and state income tax net operating loss carryforwards, respectively, available to offset future taxable income which expirein various years through 2022. The Company expects that future taxable income will be offset inthe near-term, for the most part, by its net operating tax loss carryforwards.

 

*Net earnings*

 

The Company’s net earnings for the second quarter of2005 were $2.2 million, or $0.14 per diluted share, compared to net earnings of$1.0 million, or $0.06 per diluted share for the second quarter of 2004 due tothe factors discussed above.

 

# *SixMonths Ended June 30, 2005 and 2004*

# * *

*Revenues*

 

Total revenue from license royalties anddesign service fees for the six months ended June 30, 2005 were $15.5million compared to $12.0 million the six months ended June 30, 2004.  For the six months ended June 30, 2005,91% of the Company’s revenue from license royalties and design fees weregenerated under the Target Agreement, compared to 89% for the same period in2004. 

 

Design service fees and royalties recognized under theTarget Agreement were $14.0 million for the six months ended June 30, 2005compared to $10.6 million in the second quarter of 2004. The 32% increasereflects growth in sales of women’s apparel, accessories and shoes. Royaltiesand design service fees from customers other than Target remained constant at$1.4 million for the six months ended June 30, 2005 and 2004.

 

Modern Amusement achieved gross retail sales of$2.2 million for the six months ended June 30, 2005 compared to $450,000for the period of January 16, 2004 to June 30, 2004.  These sales generated a gross profit ofapproximately $508,000 for the six months ended June 30, 2005 compared to$226,000 for the period from January 16, 2004 to June 30, 2004.

 

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*Cost of product sales*

 

Cost ofsales forthe six months ended June 30, 2005 resulted entirely from Modern Amusement product sales.  Cost of sales approximated 77% of sales.  Cost of sales includes all costs and expensesincurred prior to the receipt of finished goods at the Company’s distributionfacilities. These costs include, but are not limited to, product cost, inboundfreight charges, purchasing and receiving costs, inspection costs, insurance,duty, and brokers’ fees.

 

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

 

Selling, general and administrative expenses increasedto $9.93 million for the six months ended June 30, 2005 from $8.54 millionfor the 2004 period.  This increase wasprimarily due to: (i) $632,000 increase in selling, general andadministrative expenses incurred by the operations of Modern Amusement, (ii) increasesin executive officer bonuses of $382,000, (iii) commissions of $314,000and (iv) $350,000 in costs incurred for legal and financial advisorexpenses for the Company and its special committee associated with the reviewand consideration of the transaction proposed by Mossimo Giannulli for theacquisition of all of the Company’s remaining outstanding shares and pendinglitigation related to the proposal.  Theincrease was offset by operational improvements in the Mossimo segment.  Operating expenses for the Mossimo segment,as a percent of revenues from royalties and design service fees, decreased to52% for the six months ended June 30, 2005 compared to 65% for the sixmonths ended June 30, 2004.  Thedecrease was primarily due to a disproportionate increase of revenues.

 

Selling expenses, comprised of commissions due to athird party who assisted the Company in connection with entering into theinitial agreement with Target, increased to $2.1 million for the six monthsended June 30, 2005 compared to $1.8 million for the six months ended June 30,2004.  The increase was due to theincreased revenue generated from Target for the six months ended June 30,2005.

 

General and administrative expenses include payrollfor the Company’s officers and its design staff, travel, facilities, insurance,legal and professional fees, and other design related expenses for purchasedservices and artwork used in the design process. Salaries and related costs forthe Mossimo segment decreased to $1.64 million for the six months ended June 30,2005, compared to $1.90 million for the six months ended June 30, 2004 dueto additional salary and bonus accruals for the six months ended June 30,2004.  Also included in general andadministrative expenses are accruals for bonuses of $1.66 million for the sixmonths ended June 30, 2005, compared to $1.27 million for the six monthsended June 30, 2004, which are due under bonus plans covering the Company’sco-chief executive officers.

 

Operating expenses for the period ended June 30,2005 includes $110,000 of costs in connection with a legal dispute with thethird party who assisted the Company in connection with entering into theinitial agreement with Target.  This litigation was completedin the first quarter of 2004.

 

Selling, general and administrative expenses incurredby Modern Amusement were $1.89 million for the six months ended June 30,2005 compared to $1.07 million for the period of January 16, 2004 to June 30,2004.  These increases resulted fromsalary and related costs of $535,000 compared to $380,000 for the six monthsended June 30, 2005 and for the period of January 16, 2004 to June 30,2004, respectively, and tradeshow and samples costs of $262,000 compared to$208,000 for the period of January 16, 2004 to June 30, 2004.  These increases were associated with theanticipated growth of the Modern Amusement brand.

 

*Interest income*

 

The Companyearned $110,000 in interest income for the six months ended June 30, 2005,compared to $47,000 for the six months ended June 30, 2004. No interestexpense was incurred in the six month period ended June 30, 2005.

 

*Income taxes*

 

The Company recorded aprovision for income taxes of $2.1 million for the six months ended June 30,2005 compared to a provision for income taxes of $1.5 million for the sixmonths ended June 30, 2004.

 

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Both provisions approximate the Company’s effectivetax rate for Federal and California state income taxes.

 

The Company has approximately $11.6 millionand $7.2 million of federal and state income tax net operating loss carryforwards, respectively, available to offset future taxable income which expirein various years through 2022. The Company expects that future taxable income will be offset inthe near-term, for the most part, by its net operating tax loss carryforwards.

 

*Net earnings*

 

The Company’s net earnings for the six months ended June 30,2005 were $4.0 million, or $0.26 per diluted share, compared to net earnings of$2.2 million, or $0.14 per diluted for the six months ended June 30,2004  due to the factors discussed above.

 

***Liquidity and Capital Resources***

* *

Our sourcesof liquidity and capital resources as of June 30, 2005 consisted of $14.7million of cash and cash equivalents, and $0.7 million of short-term restrictedcash, as well as potential future cash flows from operations primarilyresulting from the Target agreement.  Asof June 30, 2005 we had working capital of approximately $21.4million.  The increase in working capitalis due to increased earnings and associated collections of accrued revenuesfrom Target in six months ended June 30, 2005, which has higher royaltyrates then the period prior to December 31, 2004.

 

The Companyestablished a revolving line of credit with a bank in the amount of $300,000 inFebruary 2004.  The line of creditwas established to open letters of credit with foreign suppliers for finishedgoods for Modern Amusement.  The line ofcredit was increased to $400,000 in June of 2004, and subsequentlyincreased to $500,000 in January of 2005 and increased again to $900,000in May of 2005 .  The line of creditis secured by three certificates of deposit totaling approximately$717,000.  There is no expiration datefor this line, and there are no covenants. There is a fee charged per letter of credit opened and closed.  Open letters of credit at June 30, 2005were approximately $865,000.

 

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

 

As of June 30,2005, cash and cash equivalents were $14.7 million.  During the six months ended June 30,2005, net cash provided by operating activities were $5.4 million.  Cash provided in operating activitiesincludes primarily $4.0 million of net earnings and the increases in deferredincome taxes of $1.9 million, accounts payable of $761,000, accrued commissionsof  $520,000, and accrued bonuses of $1.6million, primarily offset by a change in accounts receivable of $3.5million.  The change was primarily due tothe increase in accrued revenue from Target, which increased accruedcommissions payable to a third party and accrued bonuses.

 

Net cashprovided by investing activities was generated from the sale of securities of$4.8 million, classified as available-for-sale. Capital expenditures for the 2005 quarter were $103,000 and are notexpected to be material for the balance of the 2005 year.

 

We have acommission obligation under an agreement with a third party for 15% of feesreceived from Target for the duration of the Target agreement through January 2008,and for subsequent extensions if they are exercised by Target.  Fees incurred under this obligation were $1.1million in the second quarter of 2005, compared to $765,000 in the secondquarter of 2004 and $2.1 million for the six months ended June 30,2005 compared to $1.8 million for the six months ended June 30, 2004.

 

In January 2004we completed the acquisition of the Modern Amusement and we amended ourfacility lease increasing our space from approximately 6,000 square feet toapproximately 9,000 square

 

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feet, and extending the lease term thru July 2009.The expanded facility is intended to also accommodate Modern Amusement. Thefuture annual obligation under the amended lease varies each year, initially atapproximately $290,000 in 2004, increasing to $334,000 in 2008. The purchaseprice of the Modern Amusement assets of $375,000 was funded with existingcash.  The expected cash requirements in2005 for Modern Amusement are approximately $1.9 million, and is comprisedprimarily of selling, general, and administrative expenses.  Most of this working capital will besatisfied through operating cash flows, and we do not expect to incur anysignificant capital expenditures.

 

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

 

**Critical Accounting Policies**

 

REVENUE RECOGNITION

 

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

 

ModernAmusement extends credit to customers in the normal course of business, subjectto established credit limits. Accounts receivable, net, in the consolidatedbalance sheets, consists of amounts due from customers net of allowance fordoubtful accounts. The allowance for doubtful accounts is determined byreviewing accounts receivable aging and evaluating individual customerreceivables, considering customers’ financial condition, credit history andcurrent economic conditions.   Thewrite-off for bad debt for the current quarter was approximately $16,000, and$47,000 for the six months ended June 30, 2005.

 

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

 

INVENTORY

 

We maintaininventories for the Modern Amusement segment of our business   Inventories are valued at the lower of cost(first-in, first-out) or market. The Company continually evaluates itsinventories by assessing slow moving current product as well as prior seasons’inventory.  Market value of non-currentinventory is estimated based on the impact of market trends, an evaluation ofeconomic conditions and the value of current orders relating to the futuresales of this type of inventory.

 

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

 

IMPAIRMENTOF LONG-LIVED ASSETS

 

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

 

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

 

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

 

DEFERRED TAX ASSET VALUATION

 

The Company accounts for income taxes inaccordance with Statement of Financial Accounting Standard (“SFAS”) No. 109,“Accounting for Income Taxes”. Deferred taxes result from the recognition ofthe income tax benefit to be derived from the Company’s net operating losscarry forward for income taxes purposes. As of June 30, 2005 the Company has approximately $11.6 million and$7.2 million of federal and state income tax net operating loss carry forwards,respectively, available to offset future taxable income which expire in variousyears through 2022.  In accordance with the provisions of SFAS No. 109 the Companyrecords a valuation allowance to reduce deferred tax assets to the amountexpected to “more likely than not” be realized in future tax returns.  The Company monitors its profitability andconsiders the credit and collections risk of future fees under its agreements,particularly in connection with the Target Agreement.  Should we determine that we would not be ableto realize all or part of our net deferred tax assets in the future,adjustments to the valuation allowance for deferred tax assets may be required.

 

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

 

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

 

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IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS

 

SFAS No. 123R—InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 123R, “Share-Based Payment: an amendment of FASB Statements No. 123and 95,” which requires companies to recognize in their income statement thegrant-date fair value of stock options and other equity-based compensationissued to employees.  SFAS No. 123Ris effective for the Company on January 1, 2006.  Accordingly, we will adopt SFAS No. 123Rin our first quarter of 2006. See Note 1 “Earnings Per Share and Stock OptionPlans,” for the pro forma effects of how SFAS No. 123R would have affectedthe results of earnings in the six month period ended June 30, 2005 and2004.  We are currently assessing the impactthis prospective change in accounting will have but believe that it will nothave a material impact on our reported financial position or results ofoperations.

 

INFLATION

 

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

 

EXCHANGERATES

 

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

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUTMARKET RISK**

** **

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

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

Based ontheir evaluation as of June 30, 2005, our Co-Chief Executive Officers andChief Financial Officer have concluded that our internal controls anddisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Act of 1934, as amended) were effective toensure that the information required to be disclosed by us in this annualreport on Form 10-K was recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and instructions for Form 10-K.

 

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

 

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

 

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can provide absolute assurance that allcontrol issues and instances of fraud, if any, within the Company have beendetected.

 

**PART II**—**OTHERINFORMATION**

 

**ITEM1. LEGAL PROCEEDINGS**

** **

On April 12, 2005, Mossimo Giannulli offered to acquire allof the outstanding publicly held common stock of the Company at a price of$4.00 per share.  Since then, sixpurported class action lawsuits have been filed in the Court of Chancery of theState of Delaware. Each of the complaints asserts that the Directors havebreached their fiduciary duties to the Company’s shareholders, and seeks aninjunction preventing the acquisition. On May 27, 2005, the above referenced cases were consolidated underthe following caption: In re Mossimo, Inc. Shareholder Litigation,Consolidated Civil Action No.1246-N.

 

The Company and its Board of Directors intend to vigorously defendthe lawsuits. On April 19, 2005, the Board of Directors appointed aSpecial Committee to consider and evaluate Mr. Giannulli’s proposal.  The Special Committee retained Houlihan Lokeyand Gibson Dunn & Crutcher to serve as the Committee’s independentfinancial advisor and legal counsel, respectively, with respect to theCommittee’s evaluation of Mr. Giannulli’s proposal.  The Committee is currently in the process ofreviewing the terms of Mr. Giannulli’s proposal as well as any indicationsof interest expressed by other third-parties.

 

The Company is involved in certain other legal and administrativeproceedings and threatened legal and administrative proceedings from time totime in the normal course of business. While the outcome of such proceedingsand threatened proceedings cannot be predicted with certainty, in the opinionof management, the ultimate resolution of these matters individually or in theaggregate is not expected to have a material adverse effect on the Company’sbusiness as a whole.

 

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**ITEM 6. EXHIBITS**

 

The following exhibits are included herein:

 
| 31.1 |   | Certification of Principal Executive Officer as required by Rule 13a  - 14(a) of the Securities Act of 1934                                               |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certification of Principal Executive Officer as required by Rule 13a  - 14(a) of the Securities Act of 1934                                               |
| 31.3 |   | Certification of Principal Financial Officer as required by Rule 13a  - 14(a) of the Securities Act of 1934                                               |
| 32.1 |   | Certification of Principal Executive Officer as required by 18  U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
| 32.2 |   | Certification of Principal Executive Officer as required by 18  U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
| 32.3 |   | Certification of Principal Financial Officer as required by 18  U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

 

SIGNATURES

 

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

 

 
|                                          | MOSSIMO, INC. |
|-----------------------------------------------|---------------|
|                                          |
| /s/ MOSSIMO GIANNULLI                         |          |
| Mossimo Giannulli                             |
| Chairman and Co-Chief Executive Officer       |
| August 11, 2005                          |
|                                          |
| /s/ EDWIN LEWIS                               |          |
| Edwin Lewis                                   |
| Vice-Chairman and Co-Chief Executive  Officer |
| August 11, 2005                          |
|                                          |
|                                          |
| /s/ VICKEN FESTEKJIAN                         |          |
| Vicken Festekjian                             |
| Chief Financial Officer                       |
| August 11, 2005                          |
|                                               |               |  |

 

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