ITEM 1 - BUSINESS
GENERAL
DESCRIPTION OF BUSINESS - On March 28, 2000, Mossimo, Inc. ("Mossimo" or the "Company") entered into a multi-year licensing agreement (the "Target Agreement") with Target Corporation ("Target"). Under terms of the Target Agreement, Target has the exclusive United States license for production and distribution through Target stores of substantially all Mossimo products sold in the United States, other than those covered under previously existing Mossimo licensing arrangements. The Target licensed product line includes men's, women's, boy's and girl's apparel and footwear, home textiles, cosmetics and other fashion accessories such as jewelry, watches, handbags, belts, neckwear and gloves. Mossimo's Spring 2001 line was launched in Target's stores in the Fall of 2000 and its Summer 2001 line is expected to be launched in April 2001.
Under the Target Agreement, the Company and Mossimo Giannulli, its President, Chief Executive Officer and principal designer, contribute design services and the Company has approval rights for product design and marketing and advertising materials. Target collaborates on design and is responsible for product development, sourcing, quality control and inventory management with respect to the Target licensed product line. Target is obligated to pay the Company a royalty based upon a percentage of its net sales of Mossimo brand products, with a minimum guaranteed royalty, beginning February 1, 2001, of approximately $27.8 million over the initial three-year term of the agreement, which expires on January 31, 2004. Target paid royalties due on net sales achieved in the period prior to February 1, 2001 based on percentages defined in the Target Agreement. The Company is obligated to pay 15% of all royalties received from Target to a third party who assisted the Company in connection with entering into the Target Agreement. The Target Agreement is subject to early termination under certain circumstances. If Target is current in its payments of the minimum guaranteed royalty amount, Target has the right to renew the Target Agreement, on the same terms and conditions, for additional terms of two years each.
In addition to the Target Agreement, the Company also licenses its trademarks to third party licensees for use in collections of eyewear and women's swimwear and bodywear sold in Target stores in the United States. Currently, Mossimo has five additional license agreements pursuant to which third party licensees have the exclusive right to manufacture and distribute certain products bearing the Company's trademarks according to designs furnished or approved by the Company in specified territories outside of the United States. Mossimo products are characterized by quality workmanship and are targeted towards the fashion conscious consumer generally age 30 or under.
Prior to entering into the Target Agreement, the Company's primary line of business was designing, sourcing and marketing a lifestyle collection of designer men's and women's sportswear and activewear, including knit and woven shirts, outerwear, denim and related products, dresses, pants, sweatshirts, tee-shirts and shorts. The products were distributed to a diversified account base, including department stores, specialty retailers, and sports and activewear stores located throughout the United States, as well as one signature retail store and one outlet store in Southern California. In connection with the Target Agreement, the Company restructured its operations. Currently, the Company operates as a licensor and contributes design services to Target, but it does not manufacture, source or directly market its products.
Mossimo is a Delaware corporation formed in November 1995 to succeed to the assets and liabilities of Mossimo, Inc., a California corporation, which was organized in 1988 to continue the business founded by Mossimo Giannulli in 1987 as a sole proprietorship. References herein to the "Company" and "Mossimo" refer to Mossimo, Inc. and, unless the context otherwise indicates, its subsidiary and predecessors.
PRODUCT DESIGN
The cornerstone of the Company's business is its ability to design products which embody the Mossimo image of a contemporary and youthful lifestyle. The Company's designs are inspired by subtle changes in culture and society including such areas as music, television, cinema, architecture and other forms of artistic expression, and appeal to the contemporary consumer. Mossimo Giannulli, the Company's founder and principal designer, provides leadership and direction for all aspects of the design process. The Company's design staff reflects the Company's fashion conscious consumer as they consistently monitor changes in fashion, style, culture and society. Mr. Giannulli's active participation in, and oversight of, the design process for all Mossimo products is intended to ensure consistency of the quality of such products and their adherence to the Company's distinctive image.
PRODUCTS
The Company has licensed the rights to manufacture and distribute collections of men's, women's, boy's and girl's apparel and footwear, home textiles, cosmetics eyewear, women's swimwear and bodywear and other fashion accessories such as jewelry, watches, handbags, belts, neckwear and gloves
bearing its trademarks and utilizing designs approved by the Company. Currently, Mossimo has five additional license agreements pursuant to which third party licensees have the exclusive right to manufacture and distribute certain products bearing the Company's trademarks according to designs furnished or approved by the Company in specified territories outside of the United States.
Prior to entering into the Target Agreement, the Company's primary line of business was designing, sourcing and marketing collections of men's and women's apparel, including knit and woven tops, outerwear, denim and related products, dresses, pants, sweatshirts, tee-shirts and shorts. The Company discontinued its Moss line, which consisted of activewear products, in 1998. The Company also discontinued its Optics line in 1998 and entered into a license agreement for the production and distribution of eyewear in 1999. As a result of the Target Agreement, the Company discontinued sourcing, production and sales activities, and its ongoing operations have been limited to design and other activities specified in its license agreements. The following table sets forth the components of the Company's net sales by product for the periods indicated:
(1) Other is comprised primarily of: sales by the Company's retail stores; sales by the Company's screen printing subsidiary (discontinued in 1998); and sales of fabric, trim, merchandising supplies and fixtures to certain of the Company's licensees.
MEN'S AND WOMEN'S APPAREL. The Company's men's and women's lines encompass a variety of products, including: knit and woven tops, including polo shirts and collared, button-down shirts; outerwear, including sweaters and jackets; denim and related products, including jeans, shirts and jackets; dresses; pants; screenprinted and embroidered sweatshirts and tee-shirts; and shorts. In March 2000, the Company entered into the Target Agreement under which it licensed to Target the right to produce and distribute its men's and women's apparel lines in the United States. The initial Target licensed product lines were launched in Target's stores in the Fall of 2000 and, in addition to men's and women's apparel, include boy's and girl's apparel and footwear, home textiles, cosmetics and other fashion accessories such as jewelry, watches, handbags, belts, neckwear and gloves.
OPTICS LINE. The Company's Optics line, comprised of high quality men's and women's sunglasses, was discontinued in 1998. In June 1999, the Company signed an exclusive license agreement with the Marcolin Group for the production and distribution of the Mossimo line of eyewear, including sunglasses, sport glasses and optical frames. This agreement was amended in December 2000 to permit Target to sell Mossimo branded eyewear in Target stores. Marcolin continues to sell Mossimo branded eyewear through specialty retail stores such as opticians, optical chains and specialty eyeglass and sunglass stores.
WOMEN'S SWIMWEAR AND BODYWEAR. The Mossimo line of women's swimwear and bodywear is manufactured and distributed through Target stores in the United States through an exclusive license agreement with The Lunada Bay Corporation, which utilizes designs approved by the Company bearing Mossimo trademarks. The high quality swimwear products include both one-piece and two-piece swimsuits which are fashion-oriented and targeted towards youthful-minded, body-conscious women. The women's bodywear line is a collection of fashionable aerobic and fitness activewear which bear Mossimo trademarks and is designed using materials such as lycra, tactel and flexcel nylon that stretch and compensate for body movements during strenuous exercise. The license agreement has been extended to September 30, 2001 pursuant to a letter agreement between the parties.
MEN'S HOSIERY. From the fourth quarter of 1998 through June 2000, the Mossimo line of men's hosiery was manufactured and distributed through an exclusive license agreement with Mountain High Hosiery, Ltd. This license agreement was terminated in June 2000.
MEN'S TAILORED SUITS AND DRESS SHIRTS. From Fall 1998 through Spring 1999, the Mossimo line of men's tailored suits and dress shirts was manufactured and distributed through an exclusive license agreement with GFT Apparel Corporation. This license agreement was terminated in August 2000.
MEN'S NECKWEAR. The Mossimo line of men's neckwear, which was launched in Spring 1997, was manufactured and distributed through an exclusive license agreement with Superba, Inc. This license agreement expired in March 2000.
SOURCING AND MANUFACTURING
Under the Target Agreement, substantially all Mossimo products sold in the United States, other than those covered under Mossimo licensing arrangements existing at the time of the Target Agreement, are manufactured and distributed exclusively by Target. The Target licensed product line includes men's, women's, boy's and girl's apparel and footwear, home textiles, cosmetics and other fashion accessories such as jewelry, watches, handbags, belts, neckwear and gloves.
The Target Agreement provides that Target is responsible for product development, sourcing, quality control and inventory management with respect to the Target licensed product line. The Company believes that these functions can be executed more effectively by a large retailer due to significant economies of scale and vertical integration.
Prior to entering into the Target Agreement, the Company sourced each of its product lines, other than its licensed product lines, separately based on the individual design, styling and quality specifications of such products through independently owned contractors with manufacturing facilities primarily in the United States, Mexico, China, India, Hong Kong, Macau, Korea, Philippines, Thailand, Burma and Indonesia. Under the Target Agreement, Target is responsible for sourcing the Target licensed product line, and the Company has eliminated its sourcing operations.
Prior to entering the Target Agreement, Mossimo contracted for the manufacture and sewing of its products, other than its licensed product lines, with approximately six factories in North America and 18 factories overseas. The Company arranged for production of its products primarily based on projected sales and orders received. Under the Target Agreement, Target is responsible for the manufacture of the Target licensed product line, and the Company has eliminated its production operations.
MARKETING AND ADVERTISING
The Company has developed a distinctive image of a contemporary and youthful lifestyle and strives to maintain consistency through the coordination of advertising, merchandising and promotion. As a result of the Target Agreement, the Company will primarily rely on its licensees to advertise the Mossimo brand and intends to continue to promote a positive brand image through licensee-sponsored advertising. Under the terms of the Target Agreement, the Company has approval rights for marketing and advertising materials.
In connection with the Target Agreement, the Company essentially eliminated its print and outdoor advertising efforts and closed its signature retail store and showrooms prior to the launch by Target of the initial line in Fall 2000. Prior to entering into the Target Agreement, the Company utilized print advertisements in magazines such as DETAILS, ELLE, GQ, IN-STYLE, ROLLING STONE, SPIN and VANITY FAIR as well as bus posters to promote its image and products. This image was also carried forward in the design of the Company's in-store shops and in its Southern California signature retail store.
Effective January 1, 2000, the Company entered into an exclusive, multi-year endorsement agreement with David Duval, one of the world's top-ranked golfers, to further enhance worldwide brand recognition. Under the terms of this agreement, Mossimo had the right to outfit Mr. Duval exclusively during his global golf activities. As a result of entering into the Target Agreement and effective November 1, 2000 the Company terminated its agreement with Mr. Duval.
DISTRIBUTION
Under the Target Agreement, substantially all Mossimo products sold in the United States, other than those covered under Mossimo licensing arrangements existing at the time of the Target Agreement, will be distributed exclusively through Target stores. The Target licensed product line includes men's, women's, boy's and girl's apparel and footwear, home textiles, cosmetics and other fashion accessories such as jewelry, watches, handbags, belts, neckwear and gloves. The Target licensed product line was launched in Target's stores in the Fall of 2000 and its Summer 2001 line is expected to be launched in April 2001.
The Target Agreement provides that Target will be responsible for product development, sourcing, quality control and inventory management with respect to the Target licensed product line. The Company believes that these functions can be executed more effectively by a large retailer due to significant economies of scale and vertical integration.
During the Restructuring Period, distribution of all Mossimo non-licensed products was centralized in the Company's Irvine, California facility. Upon receipt from the manufacturers, the Company's products were inspected, sorted, packed and shipped to retail accounts in the United States. The Company's licensees are responsible for the distribution of licensed products.
During 2000 prior to the Target Agreement, the Company's products were sold in department and specialty retail store locations throughout the United States. The Company's largest customer, Dillard's, accounted for approximately 43% of net sales in 2000. Additionally, cumulative sales to various divisions of Federated Department Stores, Inc., and Saks, Inc. accounted for approximately 14% and 13%, respectively, of net sales in 2000. As a result of the Target Agreement, the Company will no longer sell its products in these stores.
RETAIL STORES
In connection with the Target Agreement, the Company closed its signature retail store and outlet store prior to the launch by Target of the initial line in the Fall of 2000.
Prior to entering into the Target Agreement, the Company operated one signature retail store located in South Coast Plaza, Costa Mesa, California (established in 1993) and one outlet store in Ontario Mills Plaza, Ontario, California (established in 1997). The Company formerly operated a second retail store in Old Town, Pasadena, California, which was closed during the second quarter of 1998.
LICENSING
Through the Target Agreement, the Company has licensed to Target the exclusive right to manufacture and distribute, in the United States, substantially all Mossimo products sold in the United States, other than those covered under Mossimo licensing arrangements existing at the time of the Target Agreement. This agreement expires in January 2004, and is subject to renewal by Target for additional terms of two years each if Target is current with its payments of the minimum guaranteed royalty amount. The Target Agreement is subject to early termination under certain circumstances, including a material failure by Mossimo Giannulli to perform specified design services or the termination of employment, death or permanent disability of Mr. Giannulli or a material change in his ownership or control of the Company which is deemed to materially affect the Company's ability to perform its obligations under the Target Agreement.
Prior to entering into the Target Agreement, the Company entered into licensing agreements for certain products and geographical territories when the Company believed such arrangements would provide more effective manufacturing, distribution or marketing of such products than could otherwise be achieved "in house". The Company generally maintains substantial control over the design and advertising of its licensed products and maintains a policy of evaluating its licensing arrangements to ensure consistent presentation of the Mossimo image.
Mossimo has licensed the exclusive right to manufacture and distribute eyewear bearing its trademarks through specialty retail stores such as opticians, optical chains and specialty eyeglass and sunglass stores pursuant to a license agreement with the Marcolin Group. This agreement expires in December 2003, and is subject to renewal upon negotiation.
The Company has licensed the exclusive right to manufacture and distribute women's swimwear and bodywear bearing its trademarks through Target stores in the United States pursuant to a license agreement with The Lunada Bay Corporation. The license agreement has been extended to September 30, 2001 pursuant to a letter agreement between the parties.
From the fourth quarter of 1998 through June 2000, the Mossimo line of men's hosiery was manufactured and distributed through an exclusive license agreement with Mountain High Hosiery, Ltd. This license agreement was terminated in June 2000.
From Fall 1998 through Spring 1999, the Mossimo line of men's tailored suits and dress shirts was manufactured and distributed through an exclusive license agreement with GFT Apparel Corporation. This license agreement was terminated in August 2000.
The Mossimo line of men's neckwear, which was launched in Spring 1997, was manufactured and distributed through an exclusive license agreement with Superba, Inc. This license agreement expired in March 2000.
Currently, Mossimo has five additional license agreements pursuant to which third party licensees have the exclusive right to manufacture and distribute certain products bearing the Company's trademarks according to designs furnished or approved by the Company in specified territories outside of the United States. These territories include Australia, Bolivia, Japan, Mexico, New Zealand, Paraguay, Peru, and Uruguay. Two of the license agreements expired in the first quarter of 2001 and are currently being renegotiated by the Company. The remaining three license agreements (exclusive of renewal terms) expire at various dates ranging from December 2003 through December 2011.
Under all license agreements, Mossimo retains approval rights with respect to the design of products and advertising. Royalty payments under the
Target agreement are due on a quarterly basis and range from 1% to 4% depending on the net sales achieved in a contract year. Under all other license agreements royalty payments are due on a quarterly basis and range from approximately 2% to 7% of the licensee's net sales.
TRADEMARKS
The Company utilizes a variety of trademarks, including the script Mossimo trademark. Currently, the Company has 16 registrations and 6 pending applications for its trademarks in the United States, and approximately 360 trademark registrations and applications in over 70 other countries. The Company regards its trademarks and other proprietary rights as valuable assets and believes they have significant value in the marketing of its products. The Company vigorously protects its trademarks against infringement by using, among other things, cease-and-desist letters, administrative proceedings and lawsuits.
COMPETITION
Mossimo brand products are subject to extensive competition from designer and non-designer lines, as well as from stores other than Target which have increased in recent years the amount of sportswear and activewear manufactured specifically for them and sold under their own labels. The Company's products compete based on factors including brand appeal, design, style and color selection, quality and price. Many of the Company's competitors are significantly larger and more diversified and have achieved greater recognition for their brand names than the Company. Increased competition by existing and future competitors could result in reductions in sales or prices of Mossimo products that could have a material adverse effect on the Company's financial condition and results of operations.
The Company's men's and women's designer sportswear lines have historically encountered substantial competition from Liz Claiborne, DKNY, Perry Ellis, Esprit, Guess, Calvin Klein, Tommy Hilfiger, Nautica and Polo/Ralph Lauren, as well as from certain other designer and non-designer lines. With respect to its activewear products, the Company has historically encountered substantial competition from various activewear lines including Quiksilver, Billabong and Hurley. The Company expects that its products will continue to face significant competition following the launch of the Target licensed product line.
EMPLOYEES
As a result of entering into the Target Agreement, the Company implemented a significant number of layoffs in 2000. At December 31, 2000, the Company had approximately 8 full-time employees, compared to 102 at the same time last year. None of the Company's employees are covered by collective bargaining agreements. The Company considers its relations with its employees to be satisfactory.
RISK FACTORS
In addition to the matters set forth in the foregoing discussion of the Company's business, the operations and financial results of the Company are subject to the risks described below.
CHANGES IN FASHION TRENDS
The apparel industry is subject to rapidly changing consumer demands and preferences, which may adversely affect companies which misjudge such demands and preferences. The Company believes that its success depends on its ability to anticipate, gauge and respond in a timely manner to changing consumer demands and fashion trends. There can be no assurance that the Company will be successful in this regard. If fashion trends shift away from the Company's products, or if the Company otherwise misjudges the market for its product lines, resulting in a decline in sell-through rates at retail, the Company may be faced with conditions which could have a material adverse effect on the Company's financial condition and results of operations. Decisions with respect to product designs often need to be made several months in advance of the time when consumer acceptance of such products is known. In addition, any failure by the Company to identify and respond to changing demands and trends could adversely affect consumer acceptance of the Mossimo brand name, which may have an adverse effect on the Company's business and prospects.
NEW PRODUCT INTRODUCTIONS
The Company's success is dependent upon its ability to design and deliver new products and new product lines. As is typical with new products, demand for and market acceptance of new products introduced by the Company are subject to uncertainty. There can be no assurance that the Company's efforts will be successful. In addition, the failure of new products or new product lines to gain sufficient market acceptance could adversely affect the image of the Mossimo brand name and consumers' demand for other Mossimo products.
DEPENDENCE ON KEY PERSONNEL
The success of the Company is largely dependent on the personal efforts and abilities of Mossimo Giannulli, the Company's President, Chief Executive Officer and principal designer. The Target Agreement is subject to early termination under certain circumstances, including a material failure by Mossimo Giannulli to perform specified design services or the termination of employment, death or permanent disability of Mr. Giannulli or a material change in his ownership or control of the Company which is deemed to materially affect the Company's ability to perform its obligations under the Target Agreement. A three-year employment agreement between Mr. Giannulli and the Company has been approved by the Board of Directors and is currently subject to final documentation.
UNCERTAINTIES IN APPAREL RETAILING; GENERAL ECONOMIC CONDITIONS
The apparel industry historically has been subject to substantial cyclical variations. During recessionary periods, when disposable income is low, purchases of apparel and related goods tend to decline. Accordingly, a recession in the general economy or uncertainties regarding future economic prospects that affect consumer spending habits could have a material adverse effect on the Company's results of operations. The Company cannot predict what effect, if any, continued changes within the retail industry will have on the Company's business.
DEPENDENCE ON CERTAIN LICENSEES
Royalty income from the Target Agreement commenced in November 2000, and will represent a significant portion of the Company's future income. Termination of the Target Agreement could have a material adverse effect on the Company's financial condition and results of operations.
PROTECTION OF TRADEMARKS
The Company believes that its trademarks and other proprietary rights are important to its success and its competitive position. Accordingly, the Company devotes substantial resources (including time and attention by its executive officers) to the establishment and protection of its trademarks on a worldwide basis. There can be no assurance that the actions taken by the Company to establish and protect its trademarks and other proprietary rights will be adequate to prevent imitation of its products by others or to prevent others from seeking to block sales of the Company's products as violative of the trademarks and proprietary rights of others. No assurance can be given that others will not assert rights in, and ownership of, trademarks and other proprietary rights of the Company. In addition, the laws of certain foreign countries do not protect proprietary rights to the same extent as do the laws of the United States.
CONTROL BY PRINCIPAL STOCKHOLDERS
Mossimo Giannulli has majority control of the Company and the ability to control the election of directors and the results of other matters submitted to a vote of stockholders. Such concentration of ownership, together with the anti-takeover effects of certain provisions in the Delaware General Corporation Law and in the Company's Certificate of Incorporation and Bylaws, may have the effect of delaying or preventing a change in control of the Company.
ITEM 2
ITEM 2 - PROPERTIES
The Company's current corporate headquarters are located in Santa Monica, California and consist of a leased building totaling approximately 3,000 square feet of space.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
The Company is the defendant in an action filed in the Superior Court of the State of California for the County of Orange on October 20, 2000 by The Irvine Company, the lessor of the Company's former industrial warehouse space. The plaintiff alleges the Company breached the lease by failing to pay rent and vacating the leased premises prior to the lease's expiration in 2007. A settlement agreement was entered into on January 24, 2001 whereby the Company is obligated to pay to the plaintiff approximately $235,000 (including interest) in equal monthly installments commencing February 2001 through July 2001. On actual receipt of the final monthly installment the plaintiff has agreed to dismiss the action against the Company. Provision has been made in the financial statements as of December 31, 2000 for the amount due under the settlement agreement.
Two of the Company's retail customers have demanded payment by the Company of certain alleged markdown reimbursements. The aggregate amount of these alleged reimbursements is approximately $3.5 million. The Company has disputed these alleged markdown reimbursements and intends to vigorously contest the customers' demands. Management is currently unable to estimate the ultimate outcome of this matter.
On February 1, 2001, the Company filed actions in the Superior Court of the State of California for the County of Los Angeles against Macy's West, Inc., Bloomingdale's, Inc., and Federated Department Stores, three former customers of the Company. As to Macy's West, Inc., the complaint seeks damages of approximately $857,000 for merchandise sold and delivered and $1,000,000 for breach of contract related to cancelled orders. As to Bloomingdale's, Inc., the complaint seeks damages of approximately $62,000 for merchandise sold and delivered and $75,000 related to cancelled orders. As to Federated Department Stores the complaint seeks damages for interference with contract of approximately $3,000,000. As of this date, none of the defendants have responded to the complaints. All amounts believed by the Company to be due have been fully reserved against in its consolidated financial statements.
The Company is involved in certain other legal and administrative proceedings and threatened legal and administrative proceedings arising in the normal course of its business. While the outcome of such proceedings and threatened proceedings cannot be predicted with certainty, in the opinion of management, the ultimate resolution of these matters individually or in the aggregate will not have a material adverse effect on the Company.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 2000.
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock, par value $.001 per share (common stock), began trading February 23, 1996 on the New York Stock Exchange ("NYSE") upon completion of the Company's initial public offering (trading symbol "MGX"). On May 25, 2000, trading of the Company's common stock was suspended by the NYSE and the Company's common stock was subsequently delisted. On May 26, 2000 the Company's common stock commenced trading on the National Association of Securities Dealers Over-the-Counter Bulletin Board under the symbol MGXO.OB.
---- HIGH LOW ---- ---
First Quarter............................................. $ 12.31 $ 7.37 Second Quarter............................................ $ 11.75 $ 8.25 Third Quarter............................................. $ 11.25 $ 7.06 Fourth Quarter............................................ $ 10.19 $ 6.37
---- HIGH LOW ---- ---
First Quarter............................................. $ 9.50 $ 2.69 Second Quarter............................................ $ 3.00 $ 0.25 Third Quarter............................................. $ 2.75 $ 0.76 Fourth Quarter............................................ $ 3.12 $ 1.03
Since its initial public offering, the Company has not paid a dividend on its common stock. Any future determination as to the payment of dividends will be at the discretion of the Company's Board of Directors and will depend upon the Company's results of operations, financial condition, contractual restrictions and other factors deemed relevant by the Board of Directors.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data regarding the Company which is qualified by reference to, and should be read in conjunction with, the consolidated financial statements and notes thereto (see "Index to Consolidated Financial Statements") and "Item 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis should be read in conjunction with the Company's consolidated financial statements and the notes thereto set forth in this Form 10-K commencing on page.
RESTRUCTURING
On March 28, 2000, the Company entered into the Target Agreement under which Target has the exclusive right to use certain of the Company's United States trademarks in connection with the design, manufacture and sale of selected products in the United States. Under this agreement, Target is obligated to pay the Company a royalty based upon a percentage of its net sales of Mossimo brand products, with a minimum guaranteed royalty, beginning February 1, 2001, of approximately $27.8 million over the initial three-year term of the agreement, which expires on January 31, 2004. Target is obligated to pay royalties due on net sales achieved in the period prior to February 1, 2001 based on percentages defined in the Target Agreement. The Company is obligated to pay 15% of all royalties received from Target to a third party who assisted the Company in connection with entering into the Target Agreement. The Target Agreement is subject to early termination under certain circumstances. If Target is current in its payments of the minimum guaranteed royalty amount, Target has the right to renew the Target Agreement, on the same terms and conditions, for additional terms of two years each.
As a result of entering into the Target Agreement, a restructuring of the Company's business was initiated during the first quarter of 2000. Management implemented several changes to the Company's operations during the period from March 28, 2000 to the end of 2000 (the "Restructuring Period"). The most significant changes included a work force reduction of approximately 90% of all employees, closure of the Company's showrooms, signature retail store and outlet store, termination of all sourcing, production and sales operations and termination of relationships with substantially all existing customers and suppliers. During the Restructuring Period, the Company suffered the elimination of all wholesale and retail sales. In addition, the Company experienced increased difficulties in collecting its accounts receivable.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Net sales decreased to $24.2 million during 2000 from $47.4 million in 1999. Net sales of the men's and women's lines, which represented 97% of the Company's net sales for 2000, decreased to $23.4 million in 2000 from $45.1 million in 1999. The decrease in net sales was primarily due to the termination of all sourcing, production and sales operations during the second quarter of 2000 as a result of the Company entering into the Target Agreement, partially offset by additional business with new customers as a result of the Company's broader product lines and focused sales efforts during the first quarter of 2000.
Gross profit decreased to $3.4 million during 2000 from $10.3 million in 1999. Gross profit as a percentage of net sales decreased to 14% during 2000 from 22% in 1999. The decrease was primarily due to the termination of all sourcing, production and sales operations during the second quarter of 2000 as a result of the Company entering into the Target Agreement, partially offset by better inventory management and increased men's and women's regular-priced sales during the first quarter of 2000. This termination of certain operations substantially eliminated regular-priced sales of the Company's men's and women's lines during the final three quarters of 2000.
Royalty income decreased to $3.5 million in 2000 from $3.7 million in 1999. The decrease was primarily due to reduced royalties from some of the Company's foreign licensees and was partially offset by royalties due under the Target Agreement of $835,000 for sales of products using the Company's trademarks achieved by Target in 2000 following the launch of the Target licensed product line in the Fall of 2000.
Operating expenses decreased to $19.0 million in 2000 from $26.1 million in 1999. Expenses related to payroll, selling, design, merchandising, travel, building and office expenses decreased by approximately $5.4 million from 1999 as a result of the changes to the Company's operations implemented during the Restructuring Period. Marketing expenses decreased to $4.0 million in 2000 from $4.7 million in 1999. Direct marketing expenses decreased to $1.4 million in 2000 from $4.7 million in 1999 as a result of the changes to the Company's operations implemented during the Restructuring Period. This decrease was partially offset by endorsement expenses in connection with the initiation and termination of the endorsement agreement with David Duval of $2.6 million in 2000. At December 31, 2000 approximately $1.8 million was payable to Mr. Duval in connection with the termination of the endorsement agreement. General and administrative expenses increased to $6.5 million in 2000 from $3.9 million in 1999 primarily as a result of an increase in the provision for doubtful accounts receivable as a result of the Company entering into the Target Agreement.
During 2000, the Company recorded a restructuring charge of $3.5 million as a result of the changes resulting from the restructuring described above. This charge included (i) a write-down of property and equipment of $2.3 million; (ii) lease obligations on closed properties of $592,000; (iii) severance expense of $531,000; (iv) $93,000 of legal and professional services expenses; (v) a write-off of security deposits of $61,000 and (vi) a gain on disposal of property and equipment previously written down of $154,000.
In the second quarter of 2000, due to cash shortages and the anticipated changes resulting from entering into the Target Agreement, the Company developed a creditor plan to give certain of its unsecured vendor creditors two repayment options: (i) a single cash payment of 50 cents on the dollar for the first $10,000 and 35 cents on the dollar for amounts in excess of $10,000 or (ii) a 10 percent cash payment with the balance to be paid in 36 equal monthly installments beginning June 15, 2001. In connection with the creditor plan the Company recorded vendor discounts of $917,000, offset by related professional fees of $510,000, during 2000.
During 1999, the Company's President, Chief Executive Officer and principal stockholder personally purchased excess insurance coverage for the benefit of the Company. Accordingly, a one-time, non-cash charge of $6.1 million is included in operating expenses for 1999 with an offsetting credit to stockholders' (deficit) equity. In 2000, the Company's President, Chief Executive Officer and principal stockholder was personally assigned a refund by the Company in respect of the excess insurance coverage purchased by him in 1999. Accordingly, one-time, non-cash earnings of $713,000 are included as a reduction of operating expenses in 2000 with an offsetting debit to stockholders' (deficit) equity. Neither the earnings nor the charge impact the Company's cash flows or total stockholders' (deficit) equity position.
Total operating expenses for 2000, excluding the restructuring charge, vendor discounts and non-cash insurance refund, were $16.7 million, and total operating expenses for 1999, excluding the non-cash insurance premium, were $20.0 million.
During 2000, the Company recorded other income of $760,000, which is, primarily, comprised of additional royalties of $750,000 received in connection with the early termination of the Company's men's tailored suits and dress shirts license.
The Company had net interest expense of $923,000 in 2000 compared to net interest expense of $834,000 in 1999. The increase is due to increased interest expense corresponding to increased borrowings on the Company's line of credit and amortization of capitalized deferred financing costs associated with continuing the line of credit during 2000 as compared to 1999.
The Company recorded no tax benefit in 2000 and 1999 as a result of its pretax losses. Losses for 2000 and 1999 were not benefited due to carryback limitations and uncertainty regarding realization of the related deferred tax asset.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Net sales increased to $47.4 million in 1999 from $45.3 million in 1998. Net sales of the men's and women's lines, which represented 95% of the Company's net sales in 1999, increased to $45.1 million in 1999 from $36.5 million in 1998. The increase in net sales of the men's and women's lines in 1999 was primarily due to additional business with new customers as a result of the Company's broader product lines and focused sales efforts in the second, third and fourth quarters, partially offset by narrower product lines and the reduction of unprofitable accounts during the first quarter and severe price reductions in department stores, resulting in additional markdown provisions during the fourth quarter.
The Moss and Optics lines were discontinued during 1998, resulting in a decrease in net sales of $2.3 million and $1.2 million, respectively, during 1999 compared to 1998. In June 1999, the Company entered into a license agreement for the production and distribution of the Optics line. Also during 1998, the Company discontinued operations of its screen printing business, which contributed $2.2 million of net sales in 1998.
Gross profit increased to $10.3 million in 1999 from $9.3 million in 1998. Gross profit as a percentage of net sales increased to 22% in 1999 from 21% in 1998. The increase was primarily due to better inventory management, increased men's and women's regular-priced sales and increased margins on sales of excess inventory during 1999, partially offset by additional production costs for product which did not clear, or was delayed by, United States Customs and additional markdown provisions during the fourth quarter of 1999, as compared to 1998. Additionally, during 1998, the Company recorded write-downs of its excess and Optics inventory.
Royalty income increased to $3.7 million in 1999 from $3.2 million in 1998. The increase was primarily due to increased royalties from some of the Company's domestic licensees, which were offset in part by reduced royalties as a result of the termination of the Company's accessories license agreement as of December 31, 1998.
Operating expenses increased to $26.1 million in 1999 from $25.5 million in 1998. Selling, general and administrative expenses decreased to $20.0 million in 1999 compared to $21.7 million in 1998. This decrease was primarily due to reduced staffing levels and reduced rent, legal and professional services expenses, partially offset by additional marketing expenditures.
During the second quarter of 1999, the Company's Chairman of the Board and principal stockholder personally purchased excess insurance coverage for the benefit of the Company in connection with its agreement to settle a class action lawsuit. Accordingly, a one-time, non-cash charge of $6.1 million is included in operating expenses in 1999 with an offsetting credit to stockholders' equity. This charge did not impact the Company's cash flow or total stockholders' equity position.
During the second quarter of 1998, the Company recorded a lease restructuring charge of $3.8 million. This charge included (i) $2.7 million in corporate lease restructuring expense and costs, including the write-down of certain fixed assets; (ii) $900,000 for the discontinuation of the Company's screen printing business; and (iii) $200,000 for closing the Company's Pasadena retail store.
Total operating expenses for 1999, excluding the non-cash insurance premium, were $20.0 million, or 42% of net sales, compared to total operating expenses for 1998, excluding the lease restructuring charge, of $21.7 million, or 48% of net sales.
The Company had other expense of $3,000 in 1999 compared to $140,000 in 1998. The decrease was primarily due to reduced losses on disposals of fixed assets.
The Company had net interest expense of $834,000 in 1999 compared to $612,000 in 1998. The increase was due to increased interest expense corresponding to increased borrowings on the Company's line of credit during 1999, partially offset by additional fees paid during 1998 associated with continuing the revolving line of credit.
The Company recorded minimum state tax provisions of $13,000 in 1999 compared to alternative minimum tax expense of $107,000 in 1998. Losses for 1999 were not benefited due to carryback limitations and uncertainty regarding realization of the related deferred tax asset. Losses for 1998 were benefited only to the extent the Company could apply for carryback claims in its income tax returns.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities totaled $5.4 million for 2000. Cash used in operating activities was comprised primarily of the Company's net loss of $12.3 million, non-cash earnings of $713,000 in respect of an insurance refund, a $1.3 million decrease in due to factor, net, vendor discounts, net of $407,000, offset by a $5.7 million decrease in inventory, a decrease in prepaid expenses and other current assets of $438,000, an increase in accounts payable of $1.2 million, a write-down of property and equipment of $2.3 million, and depreciation and amortization expense of $545,000. At December 31, 2000, working capital deficit was approximately $5.4 million as compared to $680,000 at December 31, 1999. The decrease in working capital is primarily due to a $5.7 million decrease in inventory and a $900,000 increase in the Company's current poriton of its line of credit, partially offset by a $900,000 decrease in current accounts payable and a $1.3 million decrease in due to factor, net during 2000.
Since the year ended December 31, 1996, the Company has experienced a significant decline in revenues, resulting in operating losses, negative cash flow and a working capital deficit.
During 2000, the Company recorded a restructuring charge of $3.5 million as a result of the changes to the Company's business described above. This charge included (i) a write-down of property and equipment of $2.3 million; (ii) lease obligations on closed properties of $592,000; (iii) severance expense of $531,000; (iv) $93,000 of legal and professional services expenses; (v) a write-off of security deposits of $61,000 and (vi) a gain on disposal of property and equipment previously written down of $154,000.
In the second quarter of 2000, due to cash shortages and the anticipated changes resulting from entering into the Target Agreement, the Company developed a creditor plan to give certain of its unsecured vendor creditors two repayment options: (i) a single cash payment of 50 cents on the dollar for the first $10,000 and 35 cents on the dollar for amounts in excess of $10,000 or (ii) a 10 percent cash payment with the balance to be paid in 36 equal monthly installments beginning June 15, 2001. In connection with the creditor plan the Company recorded vendor discounts of $917,000, offset by related professional fees of $510,000, during 2000.
Effective January 1, 2000, the Company entered into an endorsement agreement with David Duval, one of the world's top-ranked golfers, under which the Company was obligated to pay cash compensation. Effective November 1, 2000 the Company terminated its endorsement agreement with Mr. Duval. The termination obligated the Company to pay to Mr. Duval $1,760,993, payable by an initial
payment of $325,000 followed by equal monthly installments of principal and interest, commencing April 2001 through March 2002. Interest commencing April 2001 at the rate of 12% accrues on the outstanding amount due.
In July 2000, the Company's credit facility was amended to provide for a $9.0 million revolving credit line, which is collateralized by inventory, receivables, machinery and equipment and intangibles. The revolving credit line is also secured by a $5.0 million personal guaranty given by the Company's Chairman of the Board, President and Chief Executive Officer. Advances under the amended agreement bear interest at a bank's prime rate plus 1.5% (11% at December 31, 2000). The revolving credit line shall be reduced at the rate of $1.0 million per quarter beginning on June 1, 2001 and terminates on June 1, 2003. The personal guaranty given by the Company's Chairman of the Board, President and Chief Executive Officer shall be reduced at the rate if $500,000 per quarter beginning on June 1, 2001. At December 31, 2000 approximately $7.0 million was due under the line of credit.
Prior to entering into the Target Agreement and pursuant to the provisions of a factoring agreement, the Company assigned a substantial portion of its trade accounts receivable to a factor, which assumed the credit risk with respect to collection of the nonrecourse accounts receivable.
Effective August 1, 2000, the Company entered into a lease agreement for its principal office space in Santa Monica, California. Rent obligations under the lease agreement are approximately $9,000 per month for an initial term of three years.
INFLATION
The Company does not believe that the relatively moderate rates of inflation experienced in the United States over the last three years have had a significant effect on its net sales or profitability.
EXCHANGE RATES
The Company receives United States dollars for substantially all of its product sales and its licensing revenues. During the last three fiscal years, exchange rate fluctuations have not had a material impact on the Company's operating results. The Company does not engage in hedging activities with respect to such exchange rate risk.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designed as part of a hedge transaction and, if it is, the type of hedge transaction. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". SFAS No. 137 delays the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. In June 2000 the FASB issued SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133". SFAS No. 138 is effective concurrent with the delayed effective date of SFAS No. 133. SFAS No. 138 amends the accounting and reporting standards for certain derivative instruments and certain hedging activities. The Company does not expect that the adoption of SFAS Nos. 133, 137 and 138 will have a material impact on its consolidated financial statements because the Company does not currently hold any derivative instruments.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company adopted SAB No. 101 during the fourth quarter of fiscal 2000. The adoption of this SAB did not have a material impact on the Company's financial position or results of operations.
In March 2000, the Financial Accounting Standards Board issued Interpretation (FIN) No. 44 "Accounting for Certain Transactions Involving Stock Compensation - an Interpretation of APB No. 25." FIN No. 44 clarifies (a) the definition of employee for purposes of applying APB No. 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN No. 44 became effective July 1, 2000, but certain conclusions in FIN No. 44 cover specific events that occur after either December 15, 1998, or January 12, 2000. To the extent that FIN No. 44 covers events occurring during the period after December 15, 1998, or January 12, 2000, but before the effective date of July 1, 2000, the effects of applying FIN 44 are recognized on a prospective basis from July 1, 2000. Such effects are considered by management to be immaterial to the Company's financial position and results of operations.
In May 2000, Emerging Issues Task Force (EITF) No. 00-10, "Accounting for Shipping and Handling Fees and Costs" was issued. EITF No. 00-10 governs the accounting treatment and classification of the Company's shipping revenues and certain of its shipping expenses. In accordance with the Issue, the Company adopted EITF No. 00-10 during the fourth quarter of fiscal 2000. The adoption of this EITF did not materially affect the classification of revenues from shipments to customers and certain expenses related to shipping and handling of the Company's product for all periods presented. In addition, there was no effect on the Company's net income.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risks related to fluctuations in variable interest rates on its revolving line of credit and factoring agreement. For variable rate debt, changes in interest rates generally do not influence
fair market value, but do affect future earnings and cash flows. Holding the variable rate debt balance constant, a 1.0% increase in interest rates occurring on January 1, 2001 would result in an increase in interest expense for the following 12 months of approximately $70,000.
The Company does not use interest rate swaps, futures contracts or options on futures, or other types of derivative financial instruments. The Company does not believe that future market risks arising from holdings of its financial instruments will have a material impact on its financial position or results of operations.
FORWARD LOOKING INFORMATION
This report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward looking statements relate to matters such as the Company's future operating results, the success of its licensing program with Target and other licensees, the ability of the Company to timely deliver its products to customers, and the outcome of the Company's legal proceedings. Such forward-looking statements are based on the beliefs of the Company's management as well as assumptions made by and information currently available to the Company's management. 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 the Company or its management when used in this document, are intended to identify such forward-looking statements. Such statements are based on management's current expectations and are subject to certain risks, uncertainties and assumptions, including those described in "Business - Risk Factors". Should one or more risks or uncertainties materialize, or should underlying assumptions prove incorrect, the Company's actual results, performance or achievements could differ materially from those expressed in, or implied by such forward-looking statements. The Company's future operations, financial performance, business and share price may be affected by a number of factors, including changes in consumer demands and preferences, competition from other lines, risks generally associated with product introductions and shifting trends in the overall retail and apparel retailing markets and the other factors described in "Business-Risk Factors." Accordingly, undue reliance should not be placed on these forward-looking statements.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Index to Consolidated Financial Statements" at Item 14(a) for a listing of the consolidated financial statements and supplementary data submitted as part of this report.
PART III
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will be contained in the Company's Proxy Statement for its 2001 Annual Stockholders Meeting to be filed with the Securities and Exchange Commission within 120 days after December 31, 2000 and is incorporated herein by reference.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this item will be contained in the Company's Proxy Statement for its 2001 Annual Stockholders Meeting to be filed with the Securities and Exchange Commission within 120 days after December 31, 2000 and is incorporated herein by reference.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be contained in the Company's Proxy Statement for its 2001 Annual Stockholders Meeting to be filed with the Securities and Exchange Commission within 120 days after December 31, 2000 and is incorporated herein by reference.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be contained in the Company's Proxy Statement for its 2001 Annual Stockholders Meeting to be filed with the Securities and Exchange Commission within 120 days after December 31, 2000 and is incorporated herein by reference.
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
(1) Financial Statements:
PAGE ----
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS...................................
FINANCIAL STATEMENTS Consolidated Balance Sheets as of December 31, 2000 and 1999............... Consolidated Statements of Operations for the Years Ended December 31, 2000, 1999 and 1998..................................................... Consolidated Statements of Stockholders' (Deficit) Equity for the Years Ended December 31, 2000, 1999 and 1998.................................. Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998..................................................... Notes to Consolidated Financial Statements.................................
(2) Exhibits: The Exhibits listed on the accompanying Index to Exhibits immediately following the financial statement schedules are filed as part of, or incorporated by reference into, this Report.
(1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 (No. 33-80597), as amended, which became effective February 22, 1996.
(2) Incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996.
(3) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996.
(4) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.
(5) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the Quarter ended June 30, 1998.
(6) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the Quarter ended September 30, 1998.
(7) Incorporated by reference from the Registrant's Current Report on Form 8-K, dated December 8, 1998.
(8) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the Quarter ended March 31, 1999.
(9) Incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998.
(10) Incorporated by reference from the Registrant's Current Report on Form 8-K, dated March 28, 2000.
(11) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the Quarter ended June 30, 2000.
(12) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the Quarter ended September 30, 2000.
(b) Reports on Form 8-K:
The Registrant did not file any reports on Form 8-K during the three months ended December 31, 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 16th day of April 2001.
MOSSIMO, INC.
By: /s/ MOSSIMO GIANNULLI ------------------------------------ Mossimo Giannulli CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 16th day of April 2001.
/s/ MOSSIMO GIANNULLI Chairman of the Board, President and - ------------------------------------ Chief Executive Officer Mossimo Giannulli
/s/ GIA CASTROGIOVANNI Senior Vice President, Treasurer and - ------------------------------------ Secretary (Principal Accounting Officer) Gia Castrogiovanni
/s/ ROBERT MARTINI Director - ------------------------------------ Robert Martini
/s/ JOHN STAFFORD Director - ------------------------------------ John Stafford
/s/ WILLIAM HALFORD Director - ------------------------------------ William Halford
/s/ BRETT WHITE Director - ------------------------------------ Brett White
MOSSIMO, INC. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Stockholders of Mossimo, Inc.:
We have audited the accompanying consolidated balance sheets of Mossimo, Inc. (a Delaware corporation) and subsidiary as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' (deficit) equity and cash flows for the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Mossimo, Inc. and subsidiary as of December 31, 2000 and 1999, and the results of their operations and their cash flows for the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Orange County, California March 23, 2001
MOSSIMO, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to consolidated financial statements.
MOSSIMO, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes to consolidated financial statements
MOSSIMO, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
MOSSIMO, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS - On March 28, 2000, Mossimo, Inc. ("Mossimo" or the "Company") entered into a multi-year licensing agreement (the "Target Agreement") with Target Corporation ("Target"). Under the terms of the Target Agreement, Target has the exclusive United States license for production and distribution through Target stores of substantially all Mossimo products sold in the United States, other than those covered under existing Mossimo licensing arrangements. The Target licensed product line includes men's, women's, boy's and girl's apparel and footwear , home textiles, cosmetics and other fashion accessories such as jewelry, watches, handbags, belts, neckwear and gloves. The Target licensed product line for Spring 2001 was launched in Target's stores in the Fall of 2000.
Under the Target Agreement the Company and Mossimo Giannulli, its President, Chief Executive Officer and principal designer, contribute design services and the Company has approval rights for product design and marketing and advertising materials. Target collaborates on design and is responsible for product development, sourcing, quality control and inventory management with respect to the Target licensed product line. Target is obligated to pay the Company a royalty based upon a percentage of its net sales of Mossimo brand products, with a minimum guaranteed royalty, beginning February 1, 2001, of approximately $27.8 million over the initial three-year term of the agreement, which expires on January 31, 2004. Target pays royalties due on net sales achieved in the period prior to February 1, 2001 based on percentages defined in the Target Agreement. The Company is obligated to pay 15% of all royalties received from Target to a third party who assisted the Company in connection with entering into the Target Agreement. The Target Agreement is subject to early termination under certain circumstances. If Target is current in its payments of the minimum guaranteed royalty amount, Target has the right to renew the Target Agreement, on the same terms and conditions, for additional terms of two years each.
In addition to the Target Agreement, the Company also licenses its trademarks to third party licensees for use in collections of eyewear and women's swimwear and bodywear sold in Target stores in the United States. Currently, Mossimo has five additional license agreements pursuant to which third party licensees have the exclusive right to manufacture and distribute certain products bearing the Company's trademarks according to designs furnished or approved by the Company in specified territories outside of the United States.
Prior to entering into the Target Agreement, the Company's primary line of business was designing, sourcing and marketing a lifestyle collection of designer men's and women's sportswear and activewear, including knit and woven shirts, outerwear, denim and related products, dresses, pants, sweatshirts, tee-shirts and shorts. The products were distributed to a diversified account base, including department stores, specialty retailers, and sports and activewear stores located throughout the United States, as well as one signature retail store and one outlet store in Southern California. In connection with the Target Agreement, the Company restructured its operations. Currently, the Company operates as a licensor and contributes design services to Target, but it does not manufacture, source or directly market its products.
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of Mossimo, Inc., a Delaware corporation and its wholly-owned subsidiary, Giannico, Inc. (collectively, the "Company"). Giannico's operations were discontinued in 1998. All significant intercompany balances and transactions have been eliminated in consolidation.
SEGMENT AND GEOGRAPHIC INFORMATION - The Company operates in one principal business segment across domestic and international markets. International sales are primarily made through the Company's licensees in their respective territories.
COMPREHENSIVE INCOME (LOSS) - As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income", which establishes standards for the reporting and display of comprehensive income and its components in the financial statements. There are no items of comprehensive income (loss) that the Company is required to report.
CONCENTRATION OF CREDIT RISK - The Company's receivables consist, primarily, of royalties receivable from Target and its other licensees. Collateral is not required. Prior to entering into the Target Agreement the Company assigned a substantial portion of its receivables to a factor, which assumed the credit risk with respect to collection of nonrecourse receivables.
INVENTORIES - Inventories are stated at the lower of cost, determined by the first-in, first-out method, or market.
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation is computed using the straight-line method over generally a three to ten-year period for furniture and fixtures, machinery and equipment and automobiles.
DEFERRED FINANCING COSTS - During 2000, $287,000 of deferred financing costs related to the amendment of the Company's credit facility were capitalized. The costs are amortized over the term of the credit facility and amortization expense in 2000 was $40,000.
REVENUE RECOGNITION - Prior to the Target Agreement, revenue was recognized when merchandise was shipped to a customer. Reserves for estimated returns and allowances were recorded at the time of shipment based upon management's estimates and the Company's historical experience. Royalty income is recognized as the Company's licensees achieve sales of the Company's products. Royalty payments are due on a quarterly basis and range from 1% to 4% of net sales under the Target Agreement and from 2% to 7% of net sales for all other license agreements.
INCOME TAXES - The Company accounts for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes". Deferred taxes result from temporary differences between the reporting of income and losses for financial and tax reporting purposes and are provided for using the liability method as prescribed by SFAS No. 109.
USE OF ESTIMATES - The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
STOCK-BASED COMPENSATION - The Company accounts for stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. The Company follows the pro forma disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation", which require presentation of the pro forma effect of the fair value based method on net income (loss) and net income (loss) per share in the financial statement footnotes. See Note 13 - Stockholders' (Deficit) Equity.
LOSS PER SHARE - The Company calculates loss per share in accordance with SFAS No. 128, "Earnings Per Share". This statement requires the presentation of both basic and diluted net loss per share. Basic net loss per share is computed by dividing loss available to common stockholders by the weighted average number of common shares outstanding. Diluted net loss per share includes the effect of potential shares outstanding, including dilutive stock options, using the treasury stock method. For the years ended December 31, 2000, 1999 and 1998, there was no dilution from outstanding options.
During 1998, the Company issued stock options to Edwin Lewis, the Company's former Chief Executive Officer and President, under the Stock Option Plan for Edwin Lewis (Note 13). The shares of common stock to be issued upon exercise of these options were to be contributed to the Company by Mossimo Giannulli, Chairman of the Board, under a Contribution Agreement (Note 13). Accordingly, these shares are included in basic weighted average shares outstanding as of December 31, 1999 and 1998. On March 28, 2000, Edwin Lewis resigned from his positions as President, Chief Executive Officer and Director of the Company. In connection with his resignation, Mossimo Giannulli was appointed as President and Chief Executive Officer of the Company, all options granted under the Lewis Plan were canceled and the Lewis Plan and Contribution Agreement were terminated.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS - In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designed as part of a hedge transaction and, if it is, the type of hedge transaction. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". SFAS No. 137 delays the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. In June 2000 the FASB issued SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133". SFAS No. 138 is effective concurrent with the delayed effective date of SFAS No. 133. SFAS No. 138 amends the accounting and reporting standards for certain derivative instruments and
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED)- certain hedging activities. The Company does not expect that the adoption of SFAS Nos. 133, 137 and 138 will have a material impact on its consolidated financial statements because the Company does not currently hold any derivative instruments.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company adopted SAB No. 101 during the fourth quarter of fiscal 2000. The adoption of this SAB did not have a material impact on the Company's financial position or results of operations.
In March 2000, the Financial Accounting Standards Board issued Interpretation (FIN) No. 44 "Accounting for Certain Transactions Involving Stock Compensation - an Interpretation of APB No. 25." FIN No. 44 clarifies (a) the definition of employee for purposes of applying APB No. 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN No. 44 became effective July 1, 2000, but certain conclusions in FIN No. 44 cover specific events that occur after either December 15, 1998, or January 12, 2000. To the extent that FIN No. 44 covers events occurring during the period after December 15, 1998, or January 12, 2000, but before the effective date of July 1, 2000, the effects of applying FIN 44 are recognized on a prospective basis from July 1, 2000. Such effects are considered by management to be immaterial to the Company's financial position and results of operations.
In May 2000, Emerging Issues Task Force (EITF) No. 00-10, "Accounting for Shipping and Handling Fees and Costs" was issued. EITF No. 00-10 governs the accounting treatment and classification of the Company's shipping revenues and certain of its shipping expenses. In accordance with the Issue, the Company adopted EITF No. 00-10 during the fourth quarter of fiscal 2000. The adoption of this EITF did not materially affect the classification of revenues from shipments to customers and certain expenses related to shipping and handling of the Company's product for all periods presented. In addition, there was no effect on the Company's net income.
MERCHANDISE RISK - The Company's success is largely dependent upon its ability to gauge the fashion tastes of its licensees' targeted consumers and provide designs for merchandise that satisfy consumer demand. Any inability to provide successful designs could have a material adverse effect on the Company's business, operating results and financial condition.
RECLASSIFICATIONS - Certain reclassifications have been made in the audited consolidated 1999 and 1998 financial statements to conform to the 2000 presentation.
2. RESTRUCTURING
As a result of entering into the Target Agreement on March 28, 2000, a restructuring of the Company's business was initiated during the first quarter of 2000. Management implemented several changes to the Company's operations during the period from March 28, 2000 to the end of 2000. The restructuring included a work force reduction of approximately 90 employees, closure of the Company's showrooms, signature retail store and outlet store, and termination of relationships with substantially all existing customers and suppliers. The work force reduction was as a result of the termination of all sourcing, production and sales operations and included the President and Chief Executive Officer, and the Senior Vice Presidents of Operations, Design and Production. The restructuring was complete at December 31, 2000.
The restructuring resulted in a charge during the year ended December 31, 2000 of approximately $3.5 million which is included in operating expenses in the accompanying Statement of Operations for the year ended December 31, 2000. The charge includes (i) a write-down of approximately $2.3 million relating to property and equipment disposed of; (ii) lease obligations on closed properties of $592,000; (iii) terminated employees severance expense of $531,000; (iv) $93,000 of legal and professional services expenses; (v) a write-off of security deposits of $61,000 and (vi) a gain on disposal of property and equipment previously written down of $154,000. During the year ended December 31, 2000, the Company paid $531,000 and $357,000 for severance and lease obligations, respectively, and also reduced the remaining lease obligation by $19,000 due to a settlement agreement related to a remaining lease obligation.
3. DUE TO FACTOR
Prior to entering into the Target Agreement and pursuant to the provisions of a factoring agreement, the Company assigned a substantial portion of its trade accounts receivable to a factor, which assumed the credit risk with respect to collection of the nonrecourse accounts receivable. The Company requested advances against a percentage, determined by the factor, of the qualifying accounts receivable factored at any time before their maturity date. The factoring charge ranged from 0.5% to 0.8% of the receivables assigned. Interest at the prime rate plus 0.5% (prime rate plus 1.0% beginning January 1, 2000) per annum was charged on advances received through the Company's credit facility. Outstanding advances on the credit facility were collateralized by the Company's receivables, inventories, machinery and equipment and intangibles.
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. DUE TO FACTOR (CONTINUED)
Due to factor consists of the following at December 31, 2000 and 1999:
2000 1999 -------- -------- (IN THOUSANDS) Unmatured accounts receivable: Nonrecourse ................................ $ -- $ 8,017 With recourse .............................. -- 48 Allowance for sales returns and markdowns ....... (31) (9,363) -------- -------- $ (31) $(1,298) ======== ========
4. INVENTORIES
Inventories consist of the following at December 31, 2000 and 1999:
2000 1999 ------- ------- (IN THOUSANDS) Raw materials ............................ $ -- $1,301 Work-in-process .......................... -- 168 Finished goods ........................... -- 4,213 ------- ------- $ -- $5,682 ======= =======
5. INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred income taxes as of December 31, 2000 and 1999 are as follows:
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES (CONTINUED)
The Company has provided a full valuation allowance on the net deferred tax assets at December 31, 2000 and 1999 due to the uncertainty regarding its realization.
As of December 31, 2000, the Company has approximately $39,300,000 and $25,200,000 of federal and state net operating loss carryforwards, respectively, available to offset future taxable income which expire in various years through 2020.
Under the Tax Reform Act of 1986, the benefits from net operating losses carried forward may be impaired or limited in certain circumstances. Events which may cause limitations in the amount of net operating losses that the Company may utilize in any one year include, but are not limited to, accumulative ownership change of more than 50% over a three-year period. The impact of any limitations that may be imposed for future issuances of equity securities, including issuances with respect to acquisitions, has not been determined.
6. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 2000 and 1999:
2000 1999 -------- -------- (IN THOUSANDS) Furniture and fixtures ......................... $ 403 $ 4,437 Machinery and equipment ........................ 716 3,053 Automobiles .................................... -- 153 Construction in progress ....................... -- 21 -------- -------- 1,119 7,664 Accumulated depreciation and amortization ...... (773) (4,567) -------- -------- $ 346 $ 3,097 ======== ========
7. LINE OF CREDIT
Prior to entering into the Target Agreement, the Company maintained a $15,000,000 revolving line of credit, collateralized by inventory, receivables, machinery and equipment and intangibles, bearing interest at the prime rate plus 0.5% (9.0% at December 31, 1999) and prime rate plus 1.0% beginning January 1, 2000 (9.5%). The Company's borrowings under the facility were limited to 50% of eligible inventory and 85% of eligible receivables. The facility allowed for up to $6.0 million in letters of credit.
In July 2000, the Company's credit facility was amended to provide for a $9.0 million revolving credit line, which is collateralized by inventory, receivables, machinery and equipment and intangibles. The revolving credit line is also secured by a $5.0 million personal guaranty given by the Company's Chairman of the Board, President and Chief Executive Officer. Advances under the amended agreement bear interest at a bank's prime rate plus 1.5% (11% at December 31, 2000). The revolving credit line shall be reduced at the rate of $1.0 million per quarter beginning on June 1, 2001 and terminates on June 1, 2003. The personal guaranty given by the Company's Chairman of the Board, President and Chief Executive Officer shall be reduced at the rate of $500,000 per quarter beginning on June 1, 2001.
8. LONG-TERM PAYABLES
In the second quarter of 2000, due to cash shortages and the anticipated changes resulting from entering into the Target Agreement the Company developed a creditor plan to give certain of its unsecured vendor creditors two repayment options: (i) a single cash payment of 50 cents on the dollar for the first $10,000 and 35 cents on the dollar for amounts in excess of $10,000 or (ii) a 10 percent cash payment with the balance to be paid in 36 equal monthly installments beginning June 15, 2001. The Company has recorded vendor discounts of $917,000, offset by related professional fees of $510,000, during 2000.
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM PAYABLES (CONTINUED)
Effective November 1, 2000 the Company terminated its endorsement agreement with a PGA professional. The termination obligated the Company to pay to the PGA professional $1,760,993, payable by an initial payment of $325,000 followed by equal monthly installments of principal and interest, commencing April 2001 through March 2002. Interest commencing April 2001 at the rate of 12% accrues on the outstanding amount due.
Future scheduled long-term payables and line of credit payments are as follows (in thousands):
Year ending December 31: 2001.................................................. $ 4,398 2002.................................................. 4,897 2003.................................................. 550 2004.................................................. 229 -------- Total scheduled maturities 10,074 Less: current portion (included in accounts payable) 1,398 current portion of line of credit 3,000 -------- Long-term portion $ 5,676 ========
9. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution plan under Section 401(k) of the Internal Revenue Code covering all full-time employees after six months of employment. The plan provides for annual matching contributions by the Company as a percentage of employee contributions and annual wages. Contributions made to the plan for the years ended December 31, 2000, 1999 and 1998 were $12,000, $17,000 and $31,000, respectively.
In February 1997, the Company adopted the Mossimo, Inc. Employee Stock Purchase Plan (the "Employee Plan"), which provides eligible employees of the Company the opportunity to acquire stock in the Company through periodic payroll deductions that are applied at semi-annual intervals to purchase shares of common stock at a discount from the then current market price. The purchase price of the shares is the lower of 85% of the fair market value of the Company's common stock on the first day of the purchase period; or, 85% of the fair market value of the Company's common stock on the purchase date. During 2000, the Company issued 2,602 shares to employees through the Employee Plan. A total of 500,000 shares have been reserved under the Employee Plan, and 481,345 are available for issuance at December 31, 2000.
10. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - The Company is committed under a noncancelable operating lease for its corporate and design office which expires August 31, 2003. Prior to entering into the Target Agreement the Company was committed under several noncancelable operating leases expiring at various dates through June 2007. Rent expense for the years ended December 31, 2000, 1999 and 1998 was $731,000, $1,814,000 and $2,492,000, respectively.
Future minimum annual rental payments required under the noncancelable operating lease are as follows (in thousands):
Year ending December 31: 2001.................................................. $ 105 2002.................................................. 108 2003.................................................. 64 -------- $ 277 ========
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LITIGATION - Various state and federal class action complaints were brought against the Company in 1997, 1998 and 1999. On March 20, 2000, District Court Judge Gary L. Taylor approved a $13.0 million settlement of the State Actions and Federal Action. There were no objections to the settlement. The settlement was funded by the Company's insurance coverage.
The Company is the defendant in an action filed in the Superior Court of the State of California for the County of Orange on October 20, 2000 by the lessor of the Company's industrial warehouse space. The plaintiff alleges the Company breached the lease by failing to pay rent and vacating the leased premises prior to the lease's expiration in 2007. A settlement agreement was entered into on January 24, 2001 whereby the Company is obligated to pay to the plaintiff approximately $235,000 (including interest) in equal monthly installments commencing February 2001 through July 2001. On actual receipt of the final monthly installment the plaintiff has agreed to dismiss the action against the Company. Provision has been made in the financial statements as of December 31, 2000 for the amount due under the settlement agreement.
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Two of the Company's retail customers have demanded payment by the Company of certain alleged markdown reimbursements. The aggregate amount of these alleged reimbursements is approximately $3.5 million. The Company has disputed these alleged markdown reimbursements and intends to vigorously contest the customers' demands. Management is currently unable to estimate the ultimate outcome of this matter.
In February 2001 the Company filed actions in the Superior Court of the State of California for the County of Los Angeles against three former customers of the Company. The claims seek damages for breaches of contract, and repayment of amounts due, in relation to merchandise sold and delivered, and for damages for breaches of contract relating to cancelled orders. The defendants have yet to respond to the filed actions. All amounts believed by the Company to be due have been fully reserved against in the consolidated financial statements.
The Company is involved in certain other legal and administrative proceedings and threatened legal and administrative proceedings arising in the normal course of its business. While the outcome of such proceedings and threatened proceedings cannot be predicted with certainty, in the opinion of management, the ultimate resolution of these matters individually or in the aggregate will not have a material adverse effect on the Company.
11. MAJOR CUSTOMERS
During the years ended December 31, 2000, 1999 and 1998, sales to one department store customer in its various regions represented approximately 43%, 38% and 8% of net sales, respectively. Cumulative sales to various divisions of one department store group represented approximately 14%, 15% and 30% of net sales during the years ended December 31, 2000, 1999 and 1998, respectively. Additionally, cumulative sales to various divisions of two department store groups each represented approximately 13% of net sales during the year ended December 31, 2000.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's consolidated balance sheets include the following financial instruments: cash, accounts receivable, amounts due to its factor, accounts payable and long-term payables. The Company considers the carrying amounts in the financial statements to approximate fair value for cash, accounts receivable, accounts payable and amounts due to its factor, because of the relatively short period of time between origination and their expected realization. The carrying value of long-term payables approximates fair value as it represents the amounts for which certain of the Company's vendors will settle and release the Company from all claims of the vendors.
13. STOCKHOLDERS' (DEFICIT) EQUITY
In February 1996, the Company completed an initial public offering of 2,000,000 shares of the Company's common stock for $18.00 per share, generating proceeds to the Company after underwriting discounts and expenses of approximately $32,100,000. In conjunction with its initial public offering, the Company terminated its S corporation status and distributed to its stockholder $17,600,000, representing previously earned and undistributed taxable S corporation earnings in the form of promissory notes (S distribution notes). The estimated remaining amount payable to stockholder for previously earned and undistributed taxable S Corporation earnings under the S distribution notes was $255,000 and $215,000 at December 31, 2000 and 1999, respectively.
During 1999, the Company's President, Chief Executive Officer and principal stockholder personally purchased excess insurance coverage for the benefit of the Company. Accordingly, a one-time, non-cash charge of $6.1 million is included in operating expenses for 1999 with an offsetting credit to stockholders' (deficit) equity. In 2000, the Company's President, Chief Executive Officer and principal stockholder personally was personally assigned a refund by the Company in respect of the excess insurance coverage purchased by him in 1999. Accordingly, one-time, non-cash earnings of $713,000 are included as a reduction of operating expenses in 2000 with an offsetting debit to stockholders' (deficit) equity. Neither the earnings nor the charge impact the Company's cash flows or total stockholders' (deficit) equity position.
1995 STOCK OPTION PLAN - In December 1995, the Company adopted the Mossimo, Inc. 1995 Stock Option Plan (the "1995 Plan"), which provides for the grant of stock options, stock appreciation rights and other stock awards to certain officers and key employees of the Company and to certain advisors or consultants to the Company. A total of 1,500,000 shares have been reserved for issuance under the 1995 Plan. Options granted thereunder have an exercise price
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCKHOLDERS' (DEFICIT) EQUITY (CONTINUED)
equal to the fair market value of the common stock on the date of grant. In April 2000, the Company amended the 1995 Plan so that an optionee's vesting in such options automatically terminates when the optionee's employment with the Company is terminated for reasons other than retirement, disability or death. In May 2000, the Company further amended the 1995 Plan so that employees whose employment is terminated by the Company, as a result of the implementation of its restructuring (Note 2), shall become immediately vested in the options granted under the 1995 Plan and so that the exercise period of such options is extended to one year from the date of termination.
1995 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN - The Company's Non-Employee Directors Stock Option Plan (the "Directors Plan") provides for the automatic grant to each of the Company's non-employee directors of (i) an option to purchase 30,000 shares of common stock on the date of such director's initial election or appointment to the Board of Directors and (ii) an option to purchase 3,000 shares of common stock on each anniversary thereof on which the director remains on the Board of Directors. A total of 250,000 shares have been reserved under the Directors Plan. Options granted thereunder have an exercise price equal to the fair market value of the common stock on the date of grant.
Changes in shares under option for the 1995 Plan and the Directors Plan (the "Plans") are summarized as follows:
Outstanding stock options for the Plans at December 31, 2000 consist of the following:
The fair value of each option grant was estimated as of the grant date using the Black-Scholes option-pricing model for the years ended December 31, 2000, 1999 and 1998 assuming risk-free interest rates of 6.55%, 5.75% and 5.29%, respectively; volatility of 202%, 99% and 141%, respectively; zero dividend yield; and expected lives of five years for all periods. In accordance with APB Opinion No. 25, no compensation expense has been recognized related to stock options granted with an option price at or above the fair market value of the Company's stock.
As of December 31, 2000 there were 568,733 shares of common stock under the Plans that were available for future grant.
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCKHOLDERS' (DEFICIT) EQUITY (CONTINUED)
STOCK OPTION PLAN FOR EDWIN LEWIS. On November 30, 1998, the Board of Directors adopted the Stock Option Plan for Edwin Lewis (the "Lewis Plan"). The total number of shares of common stock of the Company authorized for issuance upon exercise of options under the Lewis Plan was established at 6,186,111, subject to adjustment.
On November 30, 1998, subject to approval by the stockholders of the Company, the Board of Directors granted the following stock options to Mr. Lewis (the "Lewis Options") under the Lewis Plan: (i) a Nonqualified Stock Option Agreement, under which Mr. Lewis was granted an immediately exercisable option to purchase up to 5,152,778 shares of the common stock at a purchase price of $3.00 per share, (i.e., the fair market value of the common stock on the date of grant); (ii) an Incentive Stock Option Agreement, under which Mr. Lewis was granted an immediately exercisable option to purchase up to 33,333 shares of common stock at a purchase price of $3.00 per share; (iii) a Nonqualified Performance Stock Option Agreement, under which Mr. Lewis was granted an option to purchase up to 966,667 shares of common stock at a purchase price of $3.00 per share, with such options vesting on November 30, 2005, subject to accelerated vesting upon the happening of certain events relating in part to the common stock price; and (iv) a Performance Incentive Stock Option Agreement, under which Mr. Lewis was granted an option to purchase 33,333 of common stock at a purchase of $3.00 per share, with such options vesting on November 30, 2005, subject to accelerated vesting upon the happening of certain events relating in part to the common stock price (together, the "Stock Option Agreements").
In connection with the execution of the Stock Option Agreements, the Company and Mossimo Giannulli entered into (i) a Contribution Agreement dated as of November 30, 1998, pursuant to which Mr. Giannulli agreed to contribute to the Company a number of shares of common stock equal to the aggregate number of shares of common stock to be issued by the Company upon Mr. Lewis' exercise of the Lewis Options and (ii) an Escrow Agreement dated as of November 30, 1998, pursuant to which Mr. Giannulli agreed to place 6,186,111 shares of common stock in an escrow account pending Mr. Lewis' exercise of the Lewis Options (together, the "Funding Agreements"). Mr. Giannulli entered into the Funding Agreements for no consideration payable by the Company.
On March 28, 2000, Edwin Lewis resigned from his positions as President, Chief Executive Officer and Director of the Company. In connection with his resignation, Mossimo Giannulli was appointed as President and Chief Executive Officer of the Company, all options granted under the Lewis Plan were canceled and the Lewis Plan and Contribution Agreement were terminated.
If compensation expense was determined based on the fair value method beginning with grants in the year ended December 31, 1996, the Company's net loss and net loss per share would have resulted in the approximate pro forma amounts indicated below for the years ended December 31, 2000, 1999 and 1998:
2000 1999 1998 ----------- ----------- ----------- (IN THOUSANDS EXCEPT PER SHARE) -------------------------------
Actual net loss .................. $ (12,288) $ (12,941) $ (13,798) Pro forma net loss ............... (13,466) (14,352) (28,827) Actual net loss per share: Basic and diluted ........... $ (0.81) $ (0.86) $ (0.92) Pro forma net loss per share: Basic and diluted ........... $ (0.89) $ (0.95) $ (1.92)
14. VALUATION AND QUALIFYING ACCOUNTS
Changes in the allowance for doubtful accounts, allowance for sales returns and markdowns and lease restructuring reserve for the years ended December 31, 2000, 1999 and 1998, are as follows:
MOSSIMO, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. VALUATION AND QUALIFYING ACCOUNTS (CONTINUED)
15. RELATED PARTY TRANSACTIONS
In October 1998, the Company entered into a lease agreement for a facility in Santa Monica, California with 3002 Pennsylvania Avenue, LLC, of which Mr. Giannulli is a partner. The Company intended to open a design studio in the facility, however, due to management changes within the Company, these plans were terminated. During 1999, the Company entered into a sublease agreement with a third party. The lease and sublease agreements have concurrent termination dates. The annual rent obligation under the lease for the facility is approximately $77,000.
On November 30, 1998, in connection with the transactions associated with the appointment of Edwin H. Lewis as President, Chief Executive Officer and Director of the Company, the Company entered into a Registration Rights Agreement (the "Registration Rights Agreement") with Mossimo Giannulli and Edwin H. Lewis. Pursuant to the Registration Rights Agreement, the Company granted each of Mr. Giannulli and Mr. Lewis limited demand registration rights to facilitate the resale of certain securities owned by them and certain piggyback rights to sell their securities in connection with certain offerings of securities of the Company.
16. INTERIM FINANCIAL INFORMATION (UNAUDITED)
The following tables set forth certain selected interim financial data for the Company by quarter for the years ended December 31, 2000 and 1999.
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