SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act --- of 1934 For the quarter ended December 31, 2005 Transition Report Pursuant to Section 13 or 15(d) of the Securities ---- Exchange Act of 1934 For the transition period from to ------------------- ------------------------- Commission File Number 1-5893 ---------------------------------------------------------- MOVIE STAR, INC. -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) New York 13-5651322 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1115 Broadway, New York, N.Y. 10010 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (212) 684-3400 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address, and former fiscal year, if changed since last report.) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- ------- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes No X ------- ------- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes No X ------- ------- The number of common shares outstanding on January 31, 2006 was 15,718,754. MOVIE STAR, INC. FORM 10-Q QUARTERLY REPORT TABLE OF CONTENTS PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Condensed Balance Sheets at December 31, 2005 (Unaudited), June 30, 2005 (Audited) and December 31, 2004 (Unaudited) 3 Consolidated Statements of Operations (Unaudited) for the Three and Six Months Ended December 31, 2005 and 2004 4 Consolidated Condensed Statements of Cash Flows (Unaudited) for the Six Months Ended December 31, 2005 and 2004 5 - 6 Notes to Consolidated Condensed Unaudited Financial Statements 7 - 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 - 16 Item 3. Quantitative and Qualitative Disclosures About Market Risk 16 - 17 Item 4. Controls and Procedures 17 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 18 Item 6. Exhibits 18 Signatures 19 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MOVIE STAR, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (In Thousands, Except Share Data) December 31, June 30, December 31, 2005 2005* 2004 ----------------- ---------- ----------- (Unaudited) (Unaudited) Assets Current Assets Cash $ 272 $ 178 $ 761 Receivables, net 10,377 5,973 15,435 Inventory 7,233 11,730 9,837 Deferred income taxes 2,125 2,260 2,744 Prepaid expenses and other current assets 696 372 688 ------ ------ ------ Total current assets 20,703 20,513 29,465 Property, plant and equipment, net 686 755 1,048 Deferred income taxes 2,473 2,473 148 Goodwill 537 537 537 Assets held for sale 174 174 - Other assets 439 455 457 ------ ------ ------ Total assets $25,012 $24,907 $31,655 ======= ======= ======= Liabilities and Shareholders' Equity Current Liabilities Note payable $ 7,018 $ 4 ,794 $11,460 Accounts payable and accrued expenses 2,633 5,046 2,343 ------ ------ ------ Total current liabilities 9,651 9,840 13,803 ------ ------ ------ Long-term liabilities 387 390 377 ------ ------ ------ Commitments and Contingencies - - - Shareholders' equity Common stock, $.01 par value - authorized 30,000,000 shares; issued 17,703,000 shares at December 31, 2005, 17,657,000 shares at June 30, 2005 and 17,637,000 shares at December 31, 2004 177 177 176 Additional paid-in capital 4,789 4,747 4,729 Retained earnings 13,600 13,361 16,178 Accumulated other comprehensive income 26 10 10 Treasury stock, at cost--2,017,000 shares (3,618) (3,618) (3,618) ------ ------ ------ Total shareholders' equity 14,974 14,677 17,475 ------ ------ ------ Total liabilities and shareholders' equity $25,012 $24,907 $31,655 ======= ======= ======= * Derived from audited financial statements. See notes to consolidated condensed unaudited financial statements. 3 MOVIE STAR, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In Thousands, Except Per Share Amounts) Three Months Ended Six Months Ended December 31, December 31, -------------------------- ---------------------------- 2005 2004 2005 2004 ------------ ------------ ------------- ------------ Net sales $17,867 $22,990 $31,504 $35,820 Cost of sales 12,586 17,960 22,510 26,960 ------- ------- ------- ------- Gross profit 5,281 5,030 8,994 8,860 Selling, general and administrative expenses 4,097 5,030 8,312 9,211 ------- ------- ------- ------- Income (loss) from operations 1,184 - 682 (351) Interest expense 167 124 284 157 ------- ------- ------- ------- Income (loss) before provision for (benefit from) income taxes 1,017 (124) 398 (508) Provision for (benefit from) income taxes 407 (49) 159 (203) ------- ------- ------- ------- Net income (loss) $ 610 $ (75) $ 239 $ (305) ===== ===== ======== ====== BASIC NET INCOME (LOSS) PER SHARE $ .04 $ - $.02 $(.02) ===== ==== ===== ===== DILUTED NET INCOME (LOSS) PER SHARE $.04 $ - $.02 $(.02) ==== === ==== ===== Basic weighted average number of shares outstanding 15,684 15,620 15,672 15,619 ====== ====== ====== ====== Diluted weighted average number of shares outstanding 15,698 15,620 15,760 15,619 ====== ====== ====== ====== See notes to consolidated condensed unaudited financial statements. 4 MOVIE STAR, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (In Thousands) Six Months Ended December 31, ------------------------------------- 2005 2004 ---------------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 239 $ (305) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 189 199 Provision for sales allowances and doubtful accounts 734 370 Stock compensation expense 5 - Deferred income taxes 135 (173) Deferred lease liability 3 16 Issuance of common stock for directors' fees 37 - (Increase) decrease in operating assets, net of effect of acquisition of business: Receivables (5,135) (8,228) Inventory 4,497 (1,026) Prepaid expenses and other current assets (324) (98) Other assets (24) (51) Decrease in operating liabilities: Accounts payable and accrued expenses (2,414) (321) ------ ------ Net cash used in operating activities (2,058) (9,617) ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of equipment (80) (182) Acquisition of Sidney Bernstein & Son business - (3,456) ------ ------ Net cash used in investing activities (80) (3,638) ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from revolving line of credit, net 2,224 11,460 Proceeds from exercise of employee stock options - 23 ------ ------ Net cash provided by financing activities 2,224 11,483 ------ ------ Effect of exchange rate changes on cash 8 6 ------ ------ NET INCREASE (DECREASE) IN CASH 94 (1,766) CASH, beginning of period 178 2,527 ------ ------ CASH, end of period $ 272 $ 761 ===== ===== (Cont'd) 5 MOVIE STAR, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (In Thousands) Six Months Ended December 31, ----------------------------- 2005 2004 -------------- ----------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during period for: Interest $230 $159 ==== ==== Income taxes $24 $35 === === (Concluded) See notes to consolidated condensed unaudited financial statements. 6 MOVIE STAR, INC. NOTES TO CONSOLIDATED CONDENSED UNAUDITED FINANCIAL STATEMENTS 1. INTERIM FINANCIAL STATEMENTS In the opinion of the Company, the accompanying consolidated condensed unaudited financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company's financial position as of December 31, 2005 and the results of operations and cash flows for the six months ended December 31, 2005 and 2004, respectively. The consolidated condensed financial statements and notes are presented as required by Form 10-Q and do not contain certain information included in the Company's year-end financial statements. The June 30, 2005 consolidated condensed balance sheet was derived from the Company's audited financial statements. The results of operations for the three and six months ended December 31, 2005 are not necessarily indicative of the results to be expected for the full year. This Form 10-Q should be read in conjunction with the Company's financial statements and notes included in the 2005 Annual Report on Form 10-K. 2. STOCK OPTIONS Previously, pursuant to Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," the Company accounted for stock-based employee compensation arrangements using the intrinsic value method. Accordingly, no compensation expense was recorded in the financial statements with respect to option grants, since the options were granted at/or above market value. Effective July 1, 2005, the Company adopted SFAS No. 123 (revised 2004), "Share Based Payment" ("SFAS No. 123R"), which eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The Company has adopted the modified prospective method whereby compensation cost is recognized in the financial statements beginning with the effective date based on the requirements of SFAS No. 123R for all share-based payments granted after that date and for all unvested awards granted prior to that date. Had the Company elected to recognize compensation expense for stock-based compensation using the fair value method, net income (loss), basic and diluted net income (loss) per share would have been as follows: Three Months Ended Six Months Ended December 31, December 31, --------------------- ------------------ 2005 2004 2005 2004 --------- -------- -------- ------- Net income (loss), as reported $610 $(75) $239 $(305) Add stock-based employee compensation expense, included in reported net income (loss), net of taxes 3 - 5 - Deduct stock-based employee compensation expense determined under fair value based method, net of taxes (3) (23) (5) (27) ---- ---- ---- ----- Pro forma net income (loss) $610 $(98) $239 $(332) ==== ==== ==== ===== 7 Three Months Ended Six Months Ended December 31, December 31, ---------------------- -------------------- 2005 2004 2005 2004 ---------- --------- -------- --------- Basic net income (loss) per share, as reported $.04 $ - $.02 $(.02) ==== ===== ==== ===== Pro forma basic net (loss) income per share $.04 $(.01) $.02 $(.02) ==== ===== ==== ===== Diluted net (loss) income per share, as reported $.04 $ - $.02 $(.02) ==== ===== ===== Pro forma diluted (loss) net income per share $.04 $(.01) $.02 $(.02) ==== ===== ==== ===== Per share amounts may not add due to rounding. During the quarter ended December 31, 2004, the Company granted options to purchase 125,000 shares of common stock under the 1988 Stock Option Plan at an exercise price of $1.45 per share. The Company also granted options to purchase 48,000 shares of common stock under the 2000 Performance Equity Plan at an exercise price of $1.36 per share. The fair value of the options-pricing model was calculated with the following weighted-average assumptions used for the grant: risk-free interest rate 4%; expected life 7 years; expected volatility 36%. The fair value generated by the Black-Scholes model may not be indicative of the future benefit, if any, that may be received by the option holder. There were no options granted in the three and six months ended December 31, 2005. 3. INVENTORY Inventory consists of the following (in thousands): December 31, June 30, December 31, 2005 2005 2004 ------------ ----------- ------------ Raw materials $ 528 $1,574 $1,058 Work-in process 363 382 206 Finished goods 6,342 9,774 8,573 ------ ------- ------ $7,233 $11,730 $9,837 ====== ======= ====== 4. NOTE PAYABLE The Company has a secured line of credit with an international bank which matures on June 30, 2006 and is subject to annual renewals thereafter. Under the terms of this line of credit, the Company may borrow up to $20,000,000, in the aggregate, including revolving loans and letters of credit. As of December 31, 2005, the Company had outstanding borrowings of $7,018,000 under the facility and had approximately $3,746,000 of outstanding letters of credit. Availability under this line of credit is subject to the Company's compliance with certain financial formulas as outlined in the agreement. As of December 31, 2005, the Company was in compliance. Pursuant to the terms of the agreement, the Company pledged substantially all of its assets. Interest on outstanding borrowings is payable at a variable rate per annum, equal to the prime rate less 0.75 percent (6.50 percent as of December 31, 2005). 8 6. NET INCOME (LOSS) PER SHARE Basic net income (loss) per share has been computed by dividing the applicable net income (loss) by the weighted average number of shares outstanding. Diluted net income (loss) per share has been computed by dividing the applicable net income (loss) by the weighted average number of shares outstanding and common equivalents. The Company's calculation of basic and diluted net income per share is as follows (in thousands, except per share amounts): Three Months Ended Six Months Ended December 31, December 31, ------------------- ------------------- 2005 2004 2005 2004 --------- ------- -------- -------- BASIC: ------ Net income (loss) $610 $(75) $239 $(305) ===== ==== ==== ===== Basic weighted average number of shares outstanding 15,684 15,620 15,672 15,619 ====== ====== ====== ====== Basic net income (loss) per share $.04 $ - $.02 $(.02) ===== === ==== ===== DILUTED: -------- Net income (loss) $610 $(75) $239 $(305) ==== ==== ==== ===== Weighted average number of shares outstanding 15,684 15,620 15,672 15,619 Shares issuable upon conversion of stock options - - 70 - Shares issuable upon conversion of warrants 14 - 18 - ------ ------ ------ ------ Total average number of equivalent shares outstanding 15,698 15,620 15,760 15,619 ====== ====== ====== ====== Diluted net income (loss) per share $.04 $ - $.02 $(.02) ==== ===== ==== ===== Options and warrants to purchase 475,000 and 406,000 shares of common stock at prices ranging from $.4375 to $1.0625 per share were not included in the computation of diluted net income (loss) per share for the three and six-month periods ended December 31, 2004, respectively, since they would be considered antidilutive. 7. ACQUISITION On August 3, 2004, the Company completed its acquisition of certain assets of Sidney Bernstein & Son Lingerie, Inc. ("SB&S"), a New York based company engaged in the design, marketing and sale of women's lingerie and related apparel accessories, pursuant to an Asset Purchase Agreement, dated as of July 28, 2004. The transaction allows the Company to expand its offerings, as well as diversify its sales distribution. The assets were purchased for an aggregate price of $3,379,000. The Company also assumed $3,012,000 of SB&S' open purchase orders and received $7,408,000 of open customer orders. Pursuant to the Asset Purchase Agreement, the Company had also agreed to pay up to an additional $1,000,000 in the aggregate based upon certain gross profit levels generated by the Company's newly-established Sidney Bernstein & Son Division during the next three fiscal years (see below). The acquisition was accounted for by the purchase method of accounting and the acquisition consideration was allocated among the tangible and intangible assets in accordance with their estimated fair value on the date of acquisition. In accordance with SFAS No. 142, goodwill will be subject to impairment testing at least annually. The results of operations of SB&S since August 3, 2004, are included in the Company's 9 consolidated statement of operations. The total amount of goodwill is expected to be deductible for income tax purposes. The acquisition consideration and allocation of that consideration are as follows: ACQUISITION CONSIDERATION: Cash consideration paid $ 3,379,000 Transaction related fees 77,000 ----------- Total acquisition consideration $ 3,456,000 =========== ALLOCATION OF ACQUISITION CONSIDERATION: Inventory $2,873,000 Goodwill related to acquisition 537,000 Covenant not to compete 40,000 Property and equipment 4,000 Other current assets 2,000 ----------- Total $ 3,456,000 =========== On August 3, 2004, the Company entered into an employment agreement with Daniel Bernstein, a former employee of SB&S, which was to expire on June 30, 2007. Pursuant to the agreement, Mr. Bernstein was to receive a base compensation of $350,000 annually plus commission based on formulas, as defined, in the agreement. In addition, the Company was to issue Mr. Bernstein options to purchase 75,000 shares of common stock under the Company's 2000 Performance Equity Plan in both fiscal 2005 and 2006. Effective June 10, 2005, Mr. Bernstein terminated his employment agreement with the Company. In addition, due to Mr. Bernstein's termination, he is no longer entitled to be issued options and the Company is no longer required to pay up to an additional $1,000,000 under the Asset Purchase Agreement. 8. CLOSING OF DISTRIBUTION FACILITY During the fiscal year ended June 30, 2005, the Company recorded facility closing costs of $108,000, which includes severance and related salary and benefit costs of $58,000, relating to a plan to close the distribution facility in Petersburg, Pennsylvania. The action was taken by the Company to enhance the Company's competitiveness, to reduce expenses and to improve efficiencies. During fiscal 2005, the Company reclassified certain property and equipment at its Petersburg, Pennsylvania facility to assets held for sale, as the Company expects to sell this facility in fiscal 2006. In connection with the Company's plan of disposal, management estimates that they will not incur a loss in liquidating these assets. As of December 31, 2005, the remaining accrued closing costs are $90,000, which includes severance and related salary and benefit costs of $48,000. The Company's distribution center in Poplarville, Mississippi was forced to close from August 29, 2005 to September 6, 2005 as a result of hurricane Katrina. Because some of the Company's employees were unable to return to work, the facility operated at less than full capacity until the middle of October 2005. In an effort to reduce the impact of this problem, the Company diverted some of its incoming inventory to a public warehouse operation in Los Angeles, California and to its Petersburg, Pennsylvania distribution facility. As a result, the Petersburg distribution facility was reopened on a temporary basis to assist with shipping the Company's finished goods to its customers until December 31, 2005. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward Looking Statements When used in this Form 10-Q and in future filings by the Company with the Commission, the words or phrases "will likely result," "management expects" or "the Company expects," "will continue," "is anticipated," "estimated" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Readers are cautioned not to place undue reliance on any such forward-looking statements, each of which speak only as of the date made. The Company has no obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. These risks are included in "Item 1: Business," "Item 1A: Risk Factors" and "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2005. In assessing forward-looking statements contained herein, readers are urged to carefully read those statements Among the factors that could cause actual results to differ materially are: business conditions and growth in the Company's industry; general economic conditions; the addition or loss of significant customers; the loss of key personnel; product development; competition; foreign government regulations; fluctuations in foreign currency exchange rates; rising costs of raw materials and the unavailability of sources of supply; and the timing of orders placed by the Company's customers. OVERVIEW -------- The intimate apparel business is a highly competitive industry. The industry is characterized by a large number of small companies selling unbranded merchandise, and by several large companies that have developed widespread consumer recognition of the brand names associated with merchandise sold by these companies. In addition, retailers to whom we sell our products have sought to expand the development and marketing of their own brands and to obtain intimate apparel products directly from the same sources from which we obtain our products. The intimate apparel business for the department stores, specialty stores and regional chains is divided into five selling seasons per year. We create a new line of products that represent our own brand name "Cinema Etoile" for each selling season. Our brand name does not have widespread consumer recognition, although it is well known by our customers. We sell our brand name products primarily during these selling seasons. We also develop specific products for some of our larger accounts, mass merchandisers and national chains, and make between five and eight presentations throughout the year to these accounts. We do not have long-term contracts with any of our customers and therefore our business is subject to unpredictable increases and decreases in sales depending upon the size and number of orders that we receive each time we present our products to our customers. On August 3, 2004, we completed the acquisition of certain assets of Sidney Bernstein & Son Lingerie, Inc. ("SB&S"), a company engaged in the design, marketing and sale of women's lingerie and related apparel accessories. This transaction has allowed us to expand our product offerings, as well as diversify and broaden our sales distribution. 11 During fiscal 2005 and 2004, we experienced a significant reduction in sales that was primarily the result of receiving fewer orders from some of our larger customers. However, we do not believe that this is a permanent trend and these larger customers continue to welcome us to present our products to them. Absent the addition of the SB&S division, the dollar volume of orders shipped in fiscal 2005 would have been lower than in fiscal 2004. Hurricane Katrina impacted our business operations during the quarter ended September 30, 2005 and to a lesser extent the quarter ended December 31, 2005. Our distribution center in Poplarville, Mississippi was forced to close from August 29th to September 6th as a result of the hurricane. Operations at the Poplarville distribution center resumed once power was restored to the facility on September 6th. Because some of our employees were unable to return to work, the facility operated at less than full capacity until the middle of October. In our effort to reduce the impact of this problem, we diverted some of our incoming inventory to a public warehouse operation in Los Angeles, California and to our Petersburg, Pennsylvania distribution center, which we closed during the fourth quarter of fiscal 2005. We reopened this facility until December 31, 2005 to assist with shipping our goods to customers. However, notwithstanding our best efforts, some orders were delayed and were shipped in the second quarter of fiscal 2006 instead of the first quarter. We are also working with our insurance companies to minimize the financial impact of this occurrence. As of the date of this report, even though we have not fully determined the financial impact caused by the hurricane, we do not anticipate the unrecoverable portion of the damage to have a material impact on our results of operation. CRITICAL ACCOUNTING POLICIES AND ESTIMATES ------------------------------------------ The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the appropriate application of certain accounting policies, many of which require estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements. Management believes the application of accounting policies, and the estimates inherently required by the policies, are reasonable. These accounting policies and estimates are constantly re-evaluated, and adjustments are made when facts and circumstances dictate a change. Historically, management has found the application of accounting policies to be appropriate, and actual results generally do not differ materially from those determined using necessary estimates. Our accounting policies are more fully described in Note 1 to the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended June 30, 2005. Management has identified certain critical accounting policies that are described below. Inventory - Inventory is carried at the lower of cost or market on a first-in, first-out basis. Management writes down inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Allowance for Doubtful Accounts/Sales Discounts - Management maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Management also estimates allowances for 12 customer discounts, orders and incentive offerings. If market conditions were to decline, management may take actions to increase customer incentive offerings possibly resulting in an incremental allowance at the time the incentive is offered. Deferred Tax Valuation Allowance - In assessing the need for a deferred tax valuation allowance, we consider future taxable income and ongoing prudent and feasible tax planning strategies. Since we were able to determine that we should be able to realize our deferred tax assets in the future, a deferred tax asset valuation allowance was not deemed necessary. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. The following table shows each specified item as a dollar amount and as a percentage of net sales in each fiscal period, and should be read in conjunction with the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q (in thousands, except for percentages): Three Months Ended Six Months Ended December 31, December 31, ----------------------------------------- -------------------------------------- 2005 2004 2005 2004 ------------------- ----------------- ----------------- ------------------ Net sales $17,867 100.0% $22,990 100.0% $31,504 100.0% $35,820 100.0 % Cost of sales 12,586 70.4 17,960 78.1 22,510 71.5 26,960 75.3 ------- ----- ------- ----- ------- ----- ------- ----- Gross Profit 5,281 29.6 5,030 21.9 8,994 28.5 8,860 24.7 Selling, general and administrative expenses 4,097 22.9 5,030 21.9 8,312 26.4 9,211 25.7 ------- ----- ------- ----- ------- ----- ------- ----- Operating income (loss) 1,184 6.6 - - 682 2.2 (351) (1.0) Interest expense 167 0.9 124 0.5 284 0.9 157 157 ------- ----- ------- ----- ------- ----- ------- ----- Income (loss) before income taxes 1,017 5.7 (124) (0.5) 398 1.3 (508) (1.4) Income taxes 407 2.3 (49) (0.2) 159 0.5 (203) (0.6) ------- ----- ------- ----- ------- ----- ------- ----- Net income (loss) $ 610 3.4% $ (75) (0.3)% $ 239 0.8% $ (305) (0.9)% ======= ===== ======= ===== ======= ===== ======= ===== Percent amounts may not add due to rounding. RESULTS OF OPERATIONS --------------------- Net sales for the three months ended December 31, 2005 decreased $5,123,000 to $17,867,000 from $22,990,000 in the comparable period in 2004. Net sales for the six months ended December 31, 2005 decreased $4,316,000 to $31,504,000 from $35,820,000 in the comparable period in 2004. The SB&S division accounted for $4,051,000 and $8,071,000 of the sales for the three and six months ended December 31, 2005, respectively, as compared to $4,100,000 and $7,219,000 for the same periods in the prior year. Absent sales from the SB&S division, we had sales of $13,816,000 and $23,433,000 for the three and six months ended December 31, 2005, respectively, as compared to sales of $18,890,000 and $28,601,000 in the same periods in the prior year. The reduction in sales for the second quarter and for the six months ended December 31, 2005 was primarily due to the shipment of a $7,150,000 low margin order in the prior year's second quarter which we declined to bid on in the current year. This reduction was partially offset by six months of shipping for the SB&S division in the current year as compared to five months in the prior year and an increase in orders with other customers. While business remains challenging for the remainder of fiscal 2006 the initial indications are very positive for our business outlook for the first half of fiscal 2007. 13 The gross profit percentage increased to 29.6% and 28.5% for the three and six months ended December 31, 2005, respectively from 21.9% and 24.7% in the same periods in the prior year. The higher overall margin resulted primarily from not having the large low margin order that we shipped in the second quarter of fiscal 2005, partially offset by additional costs due to hurricane Katrina. The large low margin order that we shipped in the second quarter of fiscal 2005 was approximately $7,150,000. This order was for one major retailer and the expected gross margin was considerably lower than Movie Star's regular business. The costs to prepare this order for shipment were significantly higher than we originally estimated. In addition, a significant portion of the merchandise arrived late at our distribution centers from India and, in some cases, to meet the delivery dates of our customer, goods were shipped via air at a much higher cost. We also incurred additional costs to prepare the goods for shipment to our customer. As a result of differences between the accounting policies of companies in the industry relating to whether certain items of expense are included in cost of sales rather than recorded as selling expenses, the reported gross profits of different companies, including our own, may not be directly compared. For example, we record the costs of preparing merchandise for shipment, including warehousing costs and shipping and handling costs, as a selling expense, rather than a cost of sale. Therefore, our gross profit is higher than it would be if such costs were included in cost of sales. Selling, general and administrative expenses were $4,097,000, or 22.9% of net sales for the three months ended December 31, 2005, as compared to $5,030,000, or 21.9% of net sales for the similar period in 2004. This decrease of $933,000 resulted from a decrease in salary expense and salary related costs of $297,000, shipping expense and shipping related costs of $218,000, samples and design related costs of $125,000, outbound freight expense of $110,000 and consulting fees of $51,000 as well as a net overall reduction in other selling, general and administrative expenses. The decrease in salary expense and salary related costs was the result of a reduction in personnel. The decrease in shipping expense is primarily the result of lower sales and not having the SB&S distribution center in the current year. The decrease in samples and design related costs was the result of utilizing more of our internal staff in the current year as well as not having the start up sample and design related costs for the Maidenform line that we incurred in the prior year. The decrease in outbound freight expense was due to the expediting of the previously discussed large low margin order in the prior year. Selling, general and administrative expenses were $8,312,000, or 26.4% of net sales for the six months ended December 31, 2005, as compared to $9,211,000, or 25.7% of net sales for the similar period in 2004. This decrease of $899,000 resulted from a decrease in salary expense and salary related costs of $353,000, shipping expense and shipping related costs of $231,000, samples and design related costs of $196,000, consulting fees of $93,000 and outbound freight expense of $89,000, partially offset by a net overall increase in other selling general and administrative expenses of which royalty expenses increased $73,000. The decreases in salary expense, shipping expense, samples and outbound freight were for the same reasons described above. The decrease in consulting fees is related to the termination of our prior Chairman's services in connection with our consulting agreement with him. The increase in royalty expense was primarily due to the Maidenform license agreement. We recorded income from operations of $1,184,000 and $682,000 for the three and six months ended December 31, 2005 as compared to a breakeven from operations and a loss from operations of $351,000 for the same three and six month periods in the prior year. This improvement was due to higher gross margins and lower selling, general and administrative expenses partially offset by lower sales. 14 Interest expense for the three and six months ended December 31, 2005 increased to $167,000 and $284,000 as compared to $124,000 and $157,000 in the comparable period in 2004, respectively. These increases were due primarily to higher interest rates and higher borrowing levels. We recorded a provision for income taxes of $407,000 and $159,000 for the three and six months ended December 31, 2005 as compared to an income tax benefit of $49,000 and $203,000 for the same periods in the prior year, respectively. We utilized an estimated income tax rate of 40% in all periods. NET INCOME (LOSS) ----------------- We had net income of $610,000 and $239,000 for the three and six months ended December 31, 2005 as compared to a net loss of $75,000 and $305,000 for the same periods in the prior year, respectively. This improvement was due to higher gross margins and lower selling, general and administrative expenses partially offset by a decrease in sales, an increase in interest expense and a provision for income taxes in the current year as compared to an income tax benefit in the prior year. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS -------------------------------------------------- To facilitate an understanding of our contractual obligations and commercial commitments, the following data is provided as of December 31, 2005 (in thousands): Payments Due by Period ---------------------------------------------------- Within After 5 Total 1 Year 2-3 Years 4-5 Years Years ----------- ------------ ------------- ------------ --------- Contractual Obligations ----------------------- Credit Facility $ 7,018 $7,018 $ - $ - $ - Licensing Agreement 340 150 190 - - Operating Leases 6,034 1,198 2,375 2,456 5 Consulting Agreements 421 308 113 - - Employment Contracts 1,281 993 288 - - ------- ------ ------ ------ ---- Total Contractual Obligations $15,094 $9,667 $2,966 $2,456 $ 5 ======= ====== ====== ====== ==== Amount of Commitment Expiration Per Period --------------------------------------------------- Total Amounts Within After 5 Committed 1 Year 2-3 Years 4-5 Years Years ---------- --------- --------------- ----------- ---------- Other Commercial Commitments ---------------------------- Letters of Credit $3,746 $3,746 $ - $ - $ - ------ ------ ---- ---- ---- Total Commercial Commitments $3,746 $3,746 $ - $ - $ - ====== ====== ==== ==== ==== OFF-BALANCE SHEET ARRANGEMENTS ------------------------------ We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources. 15 LIQUIDITY AND CAPITAL RESOURCES ------------------------------- For the six months ended December 31, 2005, our working capital increased by $379,000 to $11,052,000, primarily due to our income from operations. For the six months ended December 31, 2005, cash increased by $94,000 to $272,000 from $178,000 at June 30, 2005. We used $2,058,000 of cash in our operations and $80,000 for the purchase of fixed assets. Net proceeds of $2,224,000 from short-term borrowings primarily funded these activities. Receivables, net of allowances, at December 31, 2005 increased to $10,377,000 from $5,973,000 at June 30, 2005. This increase is due to higher sales in the quarter ended December 31, 2005 as compared to sales for the quarter ended June 30, 2005. Inventory at December 31, 2005 decreased to $7,233,000 from $11,730,000 at June 30, 2005. This decrease in finished goods and raw material is due to normal inventory fluctuations. Effective July 1, 2005, we renewed our revolving line of credit of up to $20,000,000. The line of credit expires June 30, 2006 and is sufficient for our projected needs for operating capital and letters of credit to fund the purchase of imported goods through June 30, 2006. Direct borrowings under this credit line bear interest at the prime rate less three quarters of one percent per annum. Availability under the line of credit is subject to the Company's compliance with certain agreed upon financial formulas. We were in compliance at December 31, 2005. This line of credit is secured by substantially all of our assets. We believe the available borrowing under our secured revolving line of credit, along with anticipated internally generated funds, will be sufficient to cover our working capital requirements through July 1, 2006. We anticipate that capital expenditures for fiscal 2006 will be less than $700,000. EFFECT OF NEW ACCOUNTING STANDARDS ---------------------------------- There were no recently issued accounting standards that we believe will have a material effect on our financial position, results of operations or cash flows. INFLATION --------- We do not believe that our operating results have been materially affected by inflation during the preceding three years. There can be no assurance, however, that our operating results will not be affected by inflation in the future. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are subject to changes in the prime rate based on the Federal Reserve actions and general market interest fluctuations. We believe that moderate interest rate increases will not have a material adverse impact on our results of operations, or financial position, in the foreseeable future. For the six months ended December 31, 2005, borrowings peaked during the period at $12,613,000 and the average amount of borrowings was $9,436,000. 16 IMPORTS ------- Transactions with our foreign manufacturers and suppliers are subject to the risks of doing business abroad. Our import and offshore operations are subject to constraints imposed by agreements between the United States and a number of foreign countries in which we do business. These agreements impose quotas on the amount and type of goods that can be imported into the United States from these countries. Such agreements also allow the United States to impose, at any time, restraints on the importation of categories of merchandise that, under the terms of the agreements, are not subject to specified limits. Our imported products are also subject to United States customs duties and, in the ordinary course of business, we are from time to time subject to claims by the United States Customs Service for duties and other charges. The United States and other countries in which our products are manufactured may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adversely adjust presently prevailing quotas, duty or tariff levels, which could adversely affect our operations and our ability to continue to import products at current or increased levels. We cannot predict the likelihood or frequency of any such events occurring. ITEM 4. CONTROLS AND PROCEDURES An evaluation of the effectiveness of the Company's disclosure controls and procedures as of December 31, 2005 was made under the supervision and with the participation of the Company's management, including the chief executive officer and chief financial officer. Based on that evaluation, they concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. During the most recently completed fiscal quarter, there has been no change in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 17 PART II OTHER INFORMATION ----------------- Item 4 - Submission of Matters to a Vote of Security Holders - On December 13, 2005, the Company held its Annual Meeting of Shareholders in New York City. The following individuals were elected as directors of the Company to serve for one year and until their successors are elected and qualified: Votes Against or Name Votes For Withheld Melvyn Knigin 14,188,647 675,051 Saul Pomerantz 14,274,647 589,051 Thomas Rende 14,267,077 596,621 Joel M. Simon 14,281,746 581,952 Michael A. Salberg 14,279,446 584,252 Peter Cole 14,297,746 565,952 John L. Eisel 14,284,377 579,321 The shareholders also considered an amendment to the Company's Certificate of Incorporation to eliminate the personal liability of directors to the fullest extent permitted by the New York Business Corporation Law. The results of the vote to amend the Company's Certificate of Incorporation to eliminate the personal liability of directors to the fullest extent permitted by the New York Business Corporation Law were as follows: Votes Against or Abstentions & Broker Votes For Withheld Non-votes 13,487,684 1,351,279 24,735 The shareholders also considered the ratification of the selection of Mahoney Cohen & Company, CPA, P.C. as the Company's auditors for the fiscal year ending June 30, 2006. The results of the vote to ratify the selection of Mahoney Cohen & Company, CPA, P.C. as the Company's auditors were as follows: Votes Against or Abstentions & Broker Votes For Withheld Non-votes 14,315,849 531,236 16,613 Item 6 - (a) Exhibits 31.1 Certification by Chief Executive Officer. 31.2 Certification by Principal Financial and Accounting Officer. 32 Section 1350 Certification. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. MOVIE STAR, INC. By: /s/ Melvyn Knigin ------------------------------------------ MELVYN KNIGIN President and Chief Executive Officer By: /s/ Thomas Rende ------------------------------------------ THOMAS RENDE Chief Financial Officer and Principal Accounting Officer February 13, 2006 19