10-Q 1 moviestar_10q-123103.txt 12/31/03 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, 2003 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 ------- ------ The number of common shares outstanding on January 30, 2004 was 15,599,975. MOVIE STAR, INC. FORM 10-Q QUARTERLY REPORT INDEX

PART I. Financial Information Page Item 1. Financial Statements Condensed Balance Sheets at December 31, 2003 (Unaudited), June 30, 2003 (Audited) and December 31, 2002 (Unaudited) 3 Statements of Income (Unaudited) for the Three and Six Months Ended December 31, 2003 and 2002 4 Statements of Cash Flows (Unaudited) for the Six Months Ended December 31, 2003 and 2002 5 - 6 Notes to 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 Item 4. Controls and Procedures 17 PART II. Other Information 18 Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19 Certifications

2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements MOVIE STAR, INC. CONDENSED BALANCE SHEETS (In Thousands, Except Share Information)

December 31, June 30, December 31, 2003 2003* 2002 ------------- ---------- ----------- (Unaudited) (Unaudited) Assets Current Assets Cash $ 1,245 $ 219 $ 168 Receivables, net 8,141 8,992 10,420 Inventory 8,362 10,392 9,688 Deferred income taxes 1,792 2,511 1,037 Prepaid expenses and other current assets 305 365 176 -------- ------- ------- Total current assets 19,845 22,479 21,489 Property, plant and equipment, net 1,047 1,153 1,292 Deferred income taxes 50 50 2,662 Other assets 407 407 373 -------- ------- ------- Total assets $21,349 $24,089 $25,816 ======== ======= ======== Liabilities and Shareholders' Equity Current Liabilities Notes payable $ - $2,277 $ 6,155 Current maturity of long-term liabilities 6 27 38 Accounts payable and accrued expenses 2,330 4,196 4,296 -------- ------- ------- Total current liabilities 2,336 6,500 10,489 -------- ------- ------- Long-term liabilities 347 325 282 -------- ------- ------- Commitments and Contingencies - - - Shareholders' equity Common stock, $.01 par value - authorized 30,000,000 shares; issued 17,617,000 shares in December 2003, 17,412,000 in June 2003 and 17,102,000 in December 2002 176 174 171 Additional paid-in capital 4,484 4,353 4,147 Retained earnings 17,624 16,355 14,345 -------- ------- ------- 22,284 20,882 18,663 Less: Treasury stock, at cost - 2,017,000 shares 3,618 3,618 3,618 -------- ------- ------- Total shareholders' equity 18,666 17,264 15,045 -------- ------- ------- Total liabilities and shareholders' equity $21,349 $24,089 $25,816 ======== ======= ======== * Derived from audited financial statements. See notes to condensed unaudited financial statements.

3 MOVIE STAR, INC. STATEMENTS OF INCOME (Unaudited) (In Thousands, Except Per Share Amounts)

Three Months Ended Six Months Ended December 31 December 31, ------------------- ------------------ 2003 2002 2003 2002 ------ ----- ------ ------ Net sales $14,166 $16,689 $30,992 $32,469 Cost of sales 9,889 11,426 21,433 22,520 ------- ------- ------- -------- Gross profit 4,277 5,263 9,559 9,949 Selling, general and administrative expenses 3,554 3,893 7,374 7,362 ------- ------- ------- -------- Income from operations 723 1,370 2,185 2,587 Interest income - (1) - (2) Interest expense 28 119 70 221 ------- ------- ------- -------- Income before income taxes 695 1,252 2,115 2,368 Income taxes 278 501 846 947 ------- ------- ------- -------- Net income $ 417 $ 751 $1,269 $1,421 ======= ======= ======= ======= BASIC NET INCOME PER SHARE $.03 $.05 $.08 $.09 ======= ======= ======= ======= DILUTED NET INCOME PER SHARE $.03 $.05 $.08 $.09 ======= ======= ======= ======= Basic weighted average number of shares outstanding 15,596 15,085 15,548 15,085 ======= ======= ======= ======= Diluted weighted average number of shares outstanding 16,274 15,089 16,241 15,087 ======= ======= ======= =======

See notes to condensed unaudited financial statements. 4 MOVIE STAR, INC. CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (In Thousands)

Six Months Ended December 31, ------------------------- 2003 2002 ------- ------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,269 $ 1,421 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 202 204 Provision for sales allowances and doubtful accounts 373 435 Deferred income taxes 719 805 Deferred lease liability 29 54 (Increase) decrease in operating assets: Receivables 478 (3,854) Inventory 2,030 (891) Prepaid expenses and other current assets 60 26 Other assets (16) (46) Decrease in operating liabilities: Accounts payable and accrued expenses (1,873) (68) -------- ------- Net cash provided by (used in) operating activities 3,271 (1,914) -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of equipment (80) (136) -------- ------- Net cash used in investing activities (80) (136) -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of long-term debt and capital lease obligations (21) (23) (Repayments of) proceeds from revolving line of credit, net (2,277) 2,026 Proceeds from exercise of employee stock options 133 - -------- ------- Net cash (used in) provided by financing activities (2,165) 2,003 -------- ------- NET INCREASE (DECREASE) IN CASH 1,026 (47) CASH, beginning of period 219 215 -------- ------- CASH, end of period $1,245 $ 168 ======== ======= (Cont'd)

5 MOVIE STAR, INC. CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (In Thousands) Six Months Ended December 31, 2003 2002 ------ ------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during period for: Interest $70 $214 ===== ===== Income taxes $277 $14 ===== ===== (Concluded) See notes to condensed unaudited financial statements. 6 MOVIE STAR, INC. NOTES TO CONDENSED UNAUDITED FINANCIAL STATEMENTS 1. Interim Financial Statements In the opinion of the Company, the accompanying condensed unaudited financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position as of December 31, 2003 and the results of operations for the interim periods presented and cash flows for the three and six months ended December 31, 2003 and 2002, respectively. The 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, 2003 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, 2003 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 2003 Annual Report on Form 10-K. 2. Stock Options Pursuant to Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," the Company accounts for stock-based employee compensation arrangements using the intrinsic value method. Accordingly, no compensation expense has been recorded in the financial statements with respect to option grants. The Company has adopted the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123." Had the Company elected to recognize compensation expense for stock-based compensation using the fair value method net income, basic net income per share and diluted net income per share would have been as follows:

Three Months Ended Six Months Ended December 31, December 31, ------------------------ ----------------- 2003 2002 2003 2002 -------- -------- -------- -------- Net Income, as reported $417 $751 $1,269 $1,421 Deduct stock-based employee cost, net of taxes (4) (19) (7) (39) ------ ------ ------ ------- Pro forma net income $413 $732 $1,262 $1,382 ====== ====== ====== ======= Basic net income per share, as reported $.03 $.05 $.08 $.09 Deduct stock-based employee cost per share - - - - ------ ------ ------ ------- Pro forma basic net income per share $.03 $.05 $.08 $.09 ====== ======= ====== ======= Diluted net income per share, as reported $.03 $.05 $.08 $.09 Deduct stock-based employee cost per share - - - - ------ ------ ------ ------- Pro forma diluted net income per share $.03 $.05 $.08 $.09 ======= ======= ====== =======

7 3. Recently Issued Accounting Standards In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123." The standard provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. SFAS No. 148 is effective for fiscal years ending after December 15, 2002. The Company does not plan to change to the fair value based method of accounting for stock-based employee compensation and has included the disclosure requirements of SFAS No. 148 in the accompanying financial statements. In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements apply to the first fiscal year or interim period ending after March 31, 2004. The adoption of FIN 46 will not have a material effect on the results of operations or financial position. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities." This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. This statement is effective for contracts entered into or modified after June 30, 2003, except as for provisions that relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, which should continue to be applied in accordance with their respective dates. The adoption of this pronouncement does not have a material effect on the results of operations or financial position. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement requires that certain financial instruments that, under previous guidance, issuers could account for as equity, be classified as liabilities in statements of financial position. Most of the guidance in SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this pronouncement does not have a material effect on the results of operations or financial position. 4. Inventory The inventory consists of the following (in thousands): December 31, June 30, December 31, 2003 2003 2002 ------------ ------- ----------- Raw materials $ 606 $1,470 $1,880 Work-in process 616 655 921 Finished goods 7,140 8,267 $6,887 ------- -------- ------ $ 8,362 $10,392 $9,688 ======= ======== ====== 8 5. Note Payable In June 2001, the Company renegotiated its revolving credit facility to provide borrowings of up to $30,000,000 until its maturity date, July 1, 2004. Due to an amendment, effective November 7, 2002, the interest on outstanding borrowings is payable at the prime rate, but not less than 4.25% per annum. As of December 31, 2003, the Company had no borrowings outstanding under the credit facility and had approximately $3,402,000 of outstanding letters of credit. Under the terms of the revolving credit facility, the Company is required to meet certain financial covenants, of which the Company is in compliance at December 31, 2003. Availability, as of December 31, 2003, was approximately $10,500,000. Under the terms of this financing, the Company agreed to pledge substantially all of its assets except for the Company's real property. 6. Commitments and Contingencies Employment Agreement - In January 2003, the Company and Mr. Knigin, the Company's CEO and President, finalized their negotiations regarding an extension of Mr. Knigin's employment agreement, which was to expire on June 30, 2004. Under the terms of the extended agreement, Mr. Knigin is to receive total base compensation of $2,625,000 over the five-year term of the agreement, effective as of July 1, 2002 and continuing through June 30, 2007. As of December 31, 2003, the remaining financial liability of this agreement is $1,900,000. Mr. Knigin may also be entitled to certain severance payments at the conclusion of the term of his agreement, provided the Company attains specified financial performance goals or if the David family sells substantially all of their shares of the Company's common stock. On January 28, 2003, Mr. Knigin voluntarily surrendered and forfeited his options to purchase 1,000,000 shares of the Company's common stock, par value $.01 and relinquished any further rights he may have had under the existing option agreements, which have now been terminated. Consulting Agreement - As of January 1, 2003, the Company and Mark M. David, Chairman of the Board, have renegotiated Mr. David's consulting agreement with the Company that was to expire on June 30, 2004. The new agreement is with Mr. David's consulting firm. Under the terms of the new agreement, Mr. David's consulting firm will provide the consulting services of Mr. David to the Company and will receive annual consulting fees of $225,000 through June 30, 2007 plus the reimbursement of expenses in an amount not to exceed $50,000 per year. 7. Related Party Upon the retirement of its Chief Executive Officer, Mark M. David, in July 1999, the Company entered into an agreement, expiring in October 2011, to provide for future medical benefits. As of December 31, 2003 and 2002, the current portion, included in "Accounts payable and other current liabilities," amounted to $13,000 and $11,000, respectively and the long-term portion, included in "Long-term liabilities," amounted to $94,000 and $79,000, respectively. 9 8. Net Income Per Share Net Income Per Share - The Company's calculation of basic and diluted net income per share are as follows (in thousands, except per share amounts):

Three Months Ended Six Months Ended December 31, December 31, ------------------------ ------------------ 2003 2002 2003 2002 -------- --------- ---------- ------ BASIC: Net income $ 417 $751 $1,269 $1,421 ======== ====== ====== ====== Basic weighted average number of shares outstanding 15,596 15,085 15,548 15,085 ======== ====== ====== ====== Basic net income per share $ .03 $.05 $.08 $.09 ======== ====== ====== ====== DILUTED: Net income $ 417 $751 $1,269 $1,421 ======== ====== ====== ====== Weighted average number of shares outstanding 15,596 15,085 15,548 15,085 Shares Issuable Upon Conversion of Stock Options 639 - 654 - Shares Issuable Upon Conversion of Warrants 39 4 39 2 -------- ------- ------- ------ Total average number of equivalent shares outstanding 16,274 15,089 16,241 15,087 ======== ====== ====== ====== Diluted net income per share $ .03 $.05 $.08 $.09 ======== ====== ====== ======

Options to purchase 2,520,000 shares of common stock at prices ranging from $.50 to $1.125 per share were outstanding as of December 31, 2002, but were not included in the computation of diluted net income per share since they would be considered antidilutive. 9. Subsequent Event On February 10, 2004, Mark M. David, the Company's Chairman, and members of his family, entered into an agreement to sell all of their shares of common stock of the Company, an aggregate of 3,532,644 shares, or approximately 22.7% of the total shares outstanding, to TTG Apparel, LLC, for a purchase price of $1.70 per share. At the request of the purchaser, the purchase of the shares was approved by the Company's Board of Directors. Upon the closing of the transaction, Mark M. David and Gary W. Krat will resign from the Company's Board of Directors. The transaction is expected to close shortly after the filing of this Quarterly Report. This transaction will activate a provision under the Company's employment agreement with Melvyn Knigin, its Chief Executive Officer, which requires the Company to make a lump sum payment to Mr. Knigin of approximately $1,070,000 within 90 days. The Company will incur an expense in the third quarter for this amount. 10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion contains certain forward-looking statements with respect to anticipated results, which are subject to a number of risks and uncertainties. Among the factors that could cause actual results to differ materially are: business conditions and growth in our 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; the timing of orders placed by our customers; and the risk factors listed from time to time in our SEC reports. 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 broken down into five selling seasons a 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. In fiscal 2003, approximately 45% of our sales were made to mass merchandisers, 19% to national chains, and 18% to department stores. The balance of our sales were unevenly distributed among discount, specialty, regional chain stores and direct mail catalog marketers. 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. We believe 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, we have found the application of our accounting policies to be appropriate, and actual results generally have not materially differed from those determined using the necessary estimates. 11 Our accounting policies are more fully described in Note 1 to the financial statements located in our Annual Report on Form 10-K for the fiscal year ended June 30, 2003 filed with the Securities and Exchange Commission. We have 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. We write 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 us, additional inventory write-downs may be required. Allowance for doubtful accounts/Sales discounts - We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our 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. We also estimate expenses for customer discounts and incentive offerings. If market conditions were to decline, we may take actions to increase customer incentive offerings possibly resulting in an incremental expense at the time the incentive is offered. Long-lived assets - In the evaluation of the fair value and future benefits of long-lived assets, we perform an analysis of the anticipated undiscounted future net cash flows of the related long-lived assets. If the carrying value of the related asset exceeds the undiscounted cash flows, the carrying value is reduced to its fair value. Various factors including future sales growth and profit margins are included in this analysis. To the extent these future projections or our strategies change, the conclusion regarding impairment may differ from the current estimates. 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 would be able to realize our deferred tax assets in the future, in excess of its recorded amount, an adjustment to the deferred tax asset 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. Results of Operations Net sales for the three months ended December 31, 2003 decreased $2,523,000 to $14,166,000 from $16,689,000 in the comparable period in 2002. Net sales for the six months ended December 31, 2003 decreased $1,477,000 to $30,992,000 from $32,469,000 in the comparable period in 2002. The decrease in sales was due primarily to an overall extremely poor holiday season in intimate apparel at retail, which resulted in lower orders from most of our customers. As a result of the poor holiday season in intimate apparel at retail, the retailers are refocusing their spring and summer purchasing plans and to date the orders we have received for the January through June period are significantly lower than we had at the same time last year. Accordingly, we anticipate that we will experience a significant reduction in sales and net income for the remainder of our fiscal year, which ends on June 30, 2004 as compared to the January through June period in the prior year. The gross profit percentage decreased to 30.2% for the three months ended December 31, 2003 from 31.5% in the similar period in 2002. The gross profit percentage increased to 30.8% for the six months ended December 31, 2003 from 30.6% in the similar period in 2002. The lower margins for the three-month period resulted primarily from a poor retail environment, which resulted in higher markdowns in the current year's quarter. The higher margins for the six months resulted primarily from the addition of the Dominican Republic as a new source for contract labor (which resulted in reduced labor costs), greater efficiencies in the overall production cycle and improved customer compliance (which reduced customer deductions), partially offset by the higher markdowns in the second quarter. 12 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 sale, 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 $3,554,000, or 25.1% of net sales for the three months ended December 31, 2003, as compared to $3,893,000, or 23.3% of net sales for the similar period in 2002. This decrease of $339,000 resulted primarily from a more favorable than expected recovery of bad debts in the current year of approximately $249,000, a decrease in shipping expense of $69,000, commissions of $47, 000 and a net general overall decrease in other general and administrative expenses, partially offset by an increase in salary expense and salary related costs of $72,000. The recovery of bad debts resulted primarily from one customer that resolved our bankruptcy claim more favorably than we had anticipated. The lower shipping and commissions expense were due to the lower sales in the period. The higher salary expense was the result of higher compensation levels and an increased number of personnel. Selling, general and administrative expenses were $7,374,000, or 23.8% of net sales for the six months ended December 31, 2003, as compared to $7,362,000, or 22.7% of net sales for the similar period in 2002. This increase of $12,000 resulted primarily from an increase in salary expense and salary related costs of $234,000 as a result of higher compensation levels and an increased number of personnel and a net increase in general overhead expenses. This increase was partially offset by a reduction in shipping and commission expense of $62,000 and $90,000, respectively, which resulted from lower sales and the more favorable recovery of bad debts discussed above. Income from operations decreased to $723,000 and $2,185,000 for the three and six months ended December 31, 2003, as compared to $1,370,000 and $2,587,000 for the similar periods in 2002. The decrease for the three months was due to lower sales and gross margins, partially offset by lower selling, general and administrative expenses. The decrease for the six months was due to lower sales and higher selling, general and administrative expenses, partially offset by an increase in gross margins. Interest expense for the three and six months ended December 31, 2003 was $28,000 and $70,000 respectively, as compared to $119,000 and $221,000 for the similar periods in 2002. This reduction was due to lower borrowing levels as a result of increased cash flow from our operations and lower interest rates. We provided for income taxes of $278,000 and $846,000 for the three and six months ended December 31, 2003, as compared to income taxes of $501,000 and $947,000 for the similar periods in 2002. We utilized an estimated income tax rate of 40% in all of the periods. We had net income of $417,000 and $1,269,000 for the three and six months ended December 31, 2003 respectively, as compared to $751,000 and $1,421,000 for the similar periods in 2002. The decrease for the three months was due to lower sales and gross margins, partially offset by lower selling, general and administrative expenses, lower interest expense and a lower tax provision in the current year. The decrease for the six months was due to lower sales and higher selling, general and administrative expenses, partially offset by an increase in gross margins, lower interest expense and a lower tax provision in the current year. 13 As discussed above, as a result of the poor holiday season in intimate apparel at retail and the reduced amount of orders on hand, we believe that sales and net income for the remainder of the fiscal year will be significantly reduced. Net income will be further impacted by the approximate $1,070,000 payment that we expect to pay to our Chief Executive Officer under his employment agreement as discussed in Note 9 to the financial statements. 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, 2003 (in thousands):

Payments Due by Period --------------------------------------- Within After 5 Total 1 Year 2-3 Years 4-5 Years Years ----- ------ --------- --------- -------- Contractual Obligations Capital leases $ 6 $ 6 $ - $ - $ - Operating leases 8,349 1,209 2,365 2,329 2,446 Consulting agreement 788 225 450 113 - Employment contract 1,900 513 1,100 287 - ------ ------- -------- ------- ------- Total contractual obligations $11,043 $1,953 $3,915 $2,729 $2,446 ======= ====== ====== ====== ======

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 $ 3,402 $3,402 $ - $ - $ - ------- ------ ---- ---- ---- Total commercial commitments $ 3,402 $3,402 $ - $ - $ - ======= ====== ==== ==== ====

Liquidity and Capital Resources For the six months ended December 31, 2003, our working capital increased by $1,530,000 to $17,509,000, primarily from profitable operations. During the six months ended December 31, 2003, cash increased by $1,026,000. We generated cash of $3,271,000 from operating activities and $133,000 from the exercise of employee stock options. We used cash of $2,277,000 for the payment of our short-term borrowings, $80,000 for the purchase of fixed assets and $21,000 for the payment of capital lease obligations. 14 Receivables at December 31, 2003 decreased by $851,000 to $8,141,000 from $8,992,000 at June 30, 2003. This decrease is due to lower sales for the quarter ending December 31, 2003 as compared to the quarter ending June 30, 2003. Inventory at December 31, 2003 decreased by $2,030,000 to $8,362,000 from $10,392,000 at June 30, 2003. This decrease is in both raw material and finished products. The reduction is primarily due to the expected decrease in business for the January through June 2004 period. The decrease, in raw materials, is also due to a lower volume of cut, make and trim production that requires the purchase of raw materials. We have a secured revolving line of credit of up to $30,000,000. The revolving line of credit expires July 1, 2004 and is sufficient for our projected needs for operating capital and letters of credit to fund the purchase of imported goods through July 1, 2004. Direct borrowings under this line bear interest at the prime rate of JP Morgan Chase Bank but not less than 4.25% per annum. Availability under the line of credit is subject to our compliance with certain agreed upon financial formulas, of which we are in compliance as of December 31, 2003. Under the terms of this financing, we agreed to pledge substantially all of our assets except for our real property. At February 5, 2004, we had no borrowings outstanding and had a cash balance of approximately $3,500,000. As discussed in Note 9 to the financial statements, upon the closing of the sale of common stock by Mark M. David and members of his family, we will be obligated to pay our Chief Executive Office under his employment agreement, a lump-sum payment of approximately $1,070,000 within 90 days of closing. 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, 2004. We expect to extend our current revolving credit agreement for a period of no less than one year or negotiate a new line of credit with another lending institution for a term of not less than one year with terms no less favorable than the expiring terms. We anticipate that capital expenditures for fiscal 2004 will be less than $300,000. Effect of New Accounting Standards In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123." The standard provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. SFAS No. 148 is effective for fiscal years ending after December 15, 2002. We do not plan to change to the fair value based method of accounting for stock-based employee compensation and have included the disclosure requirements of SFAS No. 148 in the accompanying financial statements. In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements apply to the first fiscal year or interim period ending after March 31, 2004. The adoption of FIN 46 will not have a material effect on the results of operations or financial position. 15 In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities." This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. This statement is effective for contracts entered into or modified after June 30, 2003, except as for provisions that relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, which should continue to be applied in accordance with their respective dates. The adoption of this pronouncement does not have a material effect on the results of operations or financial position. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement requires that certain financial instruments that, under previous guidance, issuers could account for as equity, be classified as liabilities in statements of financial position. Most of the guidance in SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this pronouncement does not have a material effect on the results of operations or financial position. 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 fiscal year ended June 30, 2003, borrowings peaked during the year at $10,055,000 and the average amount of borrowings was $6,352,000. 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. 16 Item 4. Controls and Procedures An evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2003 was made under the supervision and with the participation of the our management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit 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 were no significant changes in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over our financial reporting. SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS UNDER THE SECURITIES LITIGATION REFORM ACT OF 1995 Except for historical information contained herein, this Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which involve certain risks and uncertainties. The Company's actual results or outcomes may differ materially from those anticipated. Important factors that the Company believes might cause differences are discussed in the cautionary statement under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-Q. In assessing forward-looking statements contained herein, readers are urged to carefully read those statements. 17 PART II Other Information Item 4 - Submission of Matters to a Vote of Security Holders - On November 20, 2003, the Company held its Annual Meeting of Shareholders in New York City. The following individuals were elected as directors of the Company: Votes Against or Name Votes For Withheld Mark M. David 13,947,481 257,156 Melvyn Knigin 13,935,185 269,452 Saul Pomerantz 13,947,483 257,154 Gary W. Krat 13,948,185 256,452 Joel M. Simon 13,948,185 256,452 Michael Salberg 13,946,555 258,082 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, 2004. 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 13,969,206 164,757 70,674 Item 6 - (a) Exhibits 31.1 Rule 13a-14/15d-14 Certification by Chief Executive Officer. 31.2 Rule 13a-14/15d-14 Certification by Principal Financial and Accounting Officer. 32 Section 1350 Certification. (b) Form 8-K Report Date Items Financial Statements ------- ------------ -------------------- November 3, 2003 7, 12 None 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; Chief Executive Officer By: /s/ Thomas Rende ---------------------- THOMAS RENDE Chief Financial Officer (Principal Financial and Accounting Officer) February 11, 2004 19