Its U.S. Income Tied to Target, Mossimo Seeks Deals Overseas

By ANDY FIXMER

Staff Reporter

Talk about being careful about what you wish for.

Three years ago, Mossimo Inc. was pulled from the brink when it gave up trying to be a cutting edge apparel and fashion wholesaler and tied its fortunes to discount retailer Target Corp.

In a deal that essentially had Mossimo become Target’s exclusive U.S. fashion design arm, the Santa Monica-based company agreed to royalty payments that declined as sales increased.

Starting at 4 percent, Mossimo’s royalty rate slid to 1 percent when net sales hit the $500 million mark. And indeed, sales of Mossimo apparel at Target stores hit the $500 million mark by June.

That caused royalty revenue to sputter in the third quarter, which, combined with a spike in expenses from a Canadian expansion, resulted in markedly lower earnings from a year ago.

“It’s a good sign for the company because sales have been so strong,” said Rommel T. Dionisio, a research analyst with Roth Capital Partners LLC, which makes a market in the company’s stock. “But it was unexpected on the analyst side.”

Mossimo reported third-quarter net income of $630,000, compared with $1.6 million for the like quarter a year ago. Third quarter revenues were $4.2 million, compared to $4.3 million in 2002.

Shares of the company, which traded close to its 52-week high of $7 as recently as September, fell below $5 after its Nov. 7 earnings report.

Analysts have been pushing Mossimo to sign licensing deals similar to the one with Target with international retailers, especially in Europe. Currently, Mossimo receives about 90 percent of its revenues from royalties on retail sales through Minneapolis-based Target.

Calls to Mossimo officials were not returned. But in a Nov. 6 conference call, Edwin Lewis, Mossimo’s vice chairman and president, said the company is pursuing new deals.

“We continue to work at it,” Lewis said. “We are not in any place that we can speak to that specifically now, but we are working diligently and as soon as we have something, it’ll be announced.”

Among the operations Mossimo officials were said to have spoken with are Wal-Mart Stores Inc., the world’s largest retailer, for distribution in that company’s 625 Mexican stores, and Paris-based Carrefour SA, the world’s second largest retailer, for distribution in its 452 stores in Europe.

“Those are both deals that have been bantered about and they seem like obvious places to go,” said Jeffrey P. Klinefelter, a research analyst with U.S. Bancorp Piper Jaffray Inc., which has performed some investment banking work for Mossimo. “It’s important for them to continue to expand. They have this brand, which is their fixed asset, and the only way they can achieve significant earnings growth is to enter a new market.”

The company’s foray into Canada, through an exclusive agreement signed in May 2002 with Hudson’s Bay Co.’s Zellers stores, has proven rocky in the early going.

Canadian sales during the third quarter the first period Mossimo apparel was sold on Zellers shelves were below analysts’ expectations.

“Like any business, when you start there is a learning curve,” said Lewis in the Nov. 6 conference call. “At Zellers, we continue to fine tune our merchandising mix and we are generally pleased with our progress there. We remain focused on further building the Mossimo brand throughout Canada.”

But the expansion contributed to company’s higher operating expenses, which in the third quarter took 75 percent of revenues, compared to 65 percent last year.

“The increase in operating expenses was primarily due to increases in design personnel, their design-related activities and facility expenses to accommodate the additional people,” said Manuel Marrero, Mossimo’s chief financial officer during the conference call.

Two weeks later, Dow Jones Newswire reported that Mossimo had laid off the bulk of its Zellers clothing design staff. The next day, the wire service reported, a Hudson Bay spokeswoman said the company would hire 11 designers to work on the Mossimo product line.

Hudson’s Bay spokeswoman Hillary Stauth told Dow Jones that both companies agreed to change the division of responsibilities, though Mossimo will still oversee the design process.

Hudson Bay officials did not return calls seeking comment.