UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-K/A (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 2006 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF 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 No.) 1115 Broadway, New York, New York 10010 (Address of principal (Zip Code) executive offices) Registrant's telephone number, including area code (212) 684-3400 EXPLANATORY NOTE This Amendment No. 1 to the Annual Report on Form 10-K of Movie Star, Inc. ("Company") for the fiscal year ended June 30, 2006 is being filed to reflect the following changes in response to a comment letter received by the Company from the Securities and Exchange Commission: Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations o The critical accounting policies relating to Inventory and Accounts Receivable/Allowance for Doubtful Accounts/Sales Discounts have been modified. o The Contractual Obligations and Commercial Commitments table has been modified. o The paragraph relating to the changes in cash in the Liquidity and Capital Resources section has been modified. Item 8 - Financial Statements o The Consolidated Statement of Cash Flows for fiscal 2006 have been restated to include within Cash Flows from Investing Activities, the cash proceeds of $1,424,000 received from the insurance recovery relating to the Company's building damage caused by Hurricane Katrina. The restatement did not have an effect on the Company's net loss or net loss per share. This restatement is explained in new Note 18 to the Consolidated Financial Statements. o Note 1 to the Consolidated Financial Statements (Summary of Significant Accounting Policies) - Segment Reporting has been modified to reflect the Company's operations in the United States and Canada. 1 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS When used in this Amendment to Form 10-K and in our future filings with the Securities Exchange Commission, the words or phrases "will likely result," "management expects" or "we expect," "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. We have 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" of our Annual Report on Form 10-K as amended for the fiscal year ended June 30, 2006. 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 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; and the timing of orders placed by our 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 the 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 or similar sources from which we obtain our products. The intimate apparel business for department stores, specialty stores and regional chains is broken down into four selling seasons per year. For each selling season, we create a new line of products that represent our own brand name Cinema Etoile(R). 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 August 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. 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 facility 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 2005. In an effort to reduce the impact of this problem, we diverted some of our 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 have resolved all of our insurance claims relating to hurricane Katrina. The claim for our loss of inventory was resolved in the third quarter of fiscal 2006 and did not result in any significant financial 2 adjustment. The claim for the physical damage to our distribution facilities also was resolved in the third and fourth quarter of fiscal 2006 and resulted in a gain of $1,450,000. The final claim of additional expenses incurred was resolved in the fourth quarter and did not have a material impact on our results of operations. We began fiscal 2007 with a significantly increased level of open orders and therefore we expect sales for the first half of fiscal 2007 to be higher than the first half of fiscal 2006. We have added a new knit sleepwear line that was introduced at our recent August market which was well received by our customers. This new product line, called Cinema Studio(TM), has broadened our product offerings and has increased the amount of product that our customers may buy from us. At June 30, 2006, our backlog of orders was approximately $41,686,000 as compared to $28,363,000 at June 30, 2005. 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. 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, market conditions and the age of the inventory. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Historically, management has found its write down of inventory to be appropriate, and actual results generally do not differ materially from those determined using necessary estimates. Inventory reserves were $1,015,000 at June 30, 2006, and $900,000 at June 30, 2005. Accounts Receivable/Allowance for Doubtful Accounts and Sales Discounts - Accounts receivable is net of allowance for doubtful accounts and sales discounts. An allowance for doubtful accounts is determined through the analysis of the aging of accounts receivable at the date of the financial statements. An assessment of the accounts receivable is made based on historical trends and an evaluation of the impact of economic conditions. This amount is not significant, primarily due to the Company's history of minimal bad debts. An allowance for sales discounts is based on discounts relating to open invoices where trade discounts have been extended to customers, costs associated with potential returns of products as well as allowable customer markdowns and operational charge backs, net of expected recoveries. These allowances are included as a reduction to net sales and are part of the provision for allowances included in accounts receivable. The foregoing results from seasonal negotiations as well as historic deduction trends, net of expected recoveries and the evaluation of current market conditions. As of June 30, 2006 and June 30, 2005, accounts receivable was net of allowances of $950,000 and $1,154,000, respectively. Historically, management has found its allowance for doubtful accounts and sales discounts to be appropriate, and actual results generally do not differ materially from those determined using necessary estimates. However, 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. 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. 3 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 Annual Report on Form 10-K: Years Ended June 30, ----------------------------------------------------- 2006 2005 2004 --------------- --------------- --------------- Net sales $51,639 100.0% $58,533 100.0% $53,691 100.0% Cost of sales 37,528 72.7% 44,304 75.7% 37,581 70.0% ------- ----- ------- ----- ------- ----- Gross profit 14,111 27.3% 14,229 24.3% 16,110 30.0% Selling, general and administrative expenses 16,556 32.1% 19,024 32.5% 15,824 29.5% Insurance recovery (1,450) (2.8)% -- -- -- -- ------- ----- ------- ----- ------- ----- (Loss) income from operations (995) (1.9)% (4,795) (8.2)% 286 .5% Interest income (3) -- (1) -- (12) -- Interest expense 476 .9% 282 .5% 76 .1% ------- ----- ------- ----- ------- ----- (Loss) income before income tax (benefit) Provision (1,468) (2.8)% (5,076) (8.7)% 222 .4% Income tax (benefit) provision (468) (0.9)% (1,954) (3.4)% 94 .2% ------- ----- ------- ----- ------- ----- Net (loss) income $(1,000) (1.9)% $(3,122) (5.3)% $ 128 .2% ======= ===== ======= ===== ======= ===== Percent amounts may not add due to rounding. FISCAL 2006 COMPARED TO FISCAL 2005 Results of Operations Net sales for the year ended June 30, 2006 were $51,639,000 compared to $58,533,000 in the comparable period in 2005. The SB&S division accounted for $14,124,000 and $12,964,000 of net sales for the years ended June 30, 2006 and 2005, respectively. Absent the sales from the SB&S division, we had net sales of $37,515,000 for the year ended June 30, 2006 compared to net sales of $45,569,000 in the comparable period in 2005. The reduction in net sales was primarily due the shipment of a $7,800,000 low margin order in the prior year. We declined to bid on the low margin program in the current year. This reduction was partially offset by the full year of shipping for the SB&S division in the current year as compared to eleven months in the prior year. We began fiscal 2007 with a significantly increased level of open orders and therefore we expect sales for the first half of fiscal 2007 to be higher than the first half of fiscal 2006. At June 30, 2006, our backlog of orders was approximately $41,686,000 as compared to $28,363,000 at June 30, 2005. The low margin order of $7,800,000, as mentioned above, was shipped in the second and third quarters of fiscal 2005. 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 anticipated. In addition, a significant portion of the merchandise arrived late at our distribution centers from India and, in some cases, to meet our customer's delivery dates, goods were air shipped at a much higher cost. The gross profit percentage was 27.3% for the year ended June 30, 2006 as compared to 24.3% for the year ended June 30, 2005. The higher overall margin resulted primarily from not having the large low margin order that we shipped in the second and third quarters of fiscal 2005. 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 4 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 $16,556,000, or 32.1% of net sales, for the year ended June 30, 2006 compared to $19,024,000, or 32.5% of net sales, for the similar period in 2005. This decrease of $2,468,000 resulted from a decrease in salary expense and salary related costs of $857,000, consulting fees of $639,000, shipping expense and shipping related costs of $520,000, samples and design related costs of $411,000, and a net overall reduction in other general overhead expenses, partially offset by an increase in professional fees of $173,000 and royalty expense of $121,000. The decrease in salary expense and salary related costs were the result of changes in the composition of personnel. The decrease in samples and design related costs was the result of lower purchases of sample fabrics and trims and increased usage of in-house resources related to design and artwork. The decrease in shipping expense is primarily the result of lower sales, the elimination of the SB&S distribution center in January 2005 and the Pennsylvania distribution facility in December 2005. The decisions to eliminate these two facilities were made by us to enhance our competitiveness, to reduce expenses and to improve efficiencies. 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 professional fees is primarily related to our continuing exploration of strategic alternatives. The increase in royalty expense is primarily due to the Maidenform license agreement. During the third and fourth quarter of fiscal 2006, we resolved our insurance claim on the Poplarville, Mississippi distribution facilities which resulted in a gain of $1,450,000, net of expenses. A portion of the proceeds has been and will be used to replace certain portions of the facility that were damaged during hurricane Katrina. We recorded a loss from operations of $995,000 for the year ended June 30, 2006, compared to a loss from operations of $4,795,000 for the similar period in 2005. This improvement was primarily due to the insurance recovery, higher gross profit margins and the net overall reduction in selling, general and administrative expenses, partially offset by lower sales volume. Interest income for the year ended June 30, 2006 was $3,000 as compared to $1,000 for 2005. Interest expense for the year ended June 30, 2006 was $476,000 as compared to $282,000 for 2005. This increase was due primarily to higher interest rates and higher borrowing levels. We provided for an income tax benefit of $468,000 for the year ended June 30, 2006, as compared to an income tax benefit of $1,954,000 for the similar period in 2005. The decrease in income tax benefit is due to the lower loss in fiscal 2006. We recorded a net loss for the year ended June 30, 2006 of $1,000,000 as compared to a net loss of $3,122,000 for the same period in 2005. This improvement was primarily due to the insurance recovery, higher gross profit margins and the net overall reduction in selling, general and administrative expenses, partially offset by lower sales volume, an increase in interest expense, and a lower income tax benefit in the current period as compared to the same period last year. FISCAL 2005 COMPARED TO FISCAL 2004 Results of Operations Net sales for the year ended June 30, 2005 were $58,533,000 as compared to $53,691,000 in the comparable period in 2004. The increase in sales was due to the sales contribution of $12,964,000 of the SB&S division and the shipment of a $7,800,000 low margin order partially offset by a reduction in orders from some of our larger customers. The revenues of the Movie Star division declined by approximately $8,122,000 and were adversely impacted by higher than expected markdown allowances due to a highly promotional retail environment as well as lower than anticipated product performance at retail. The low margin order of $7,800,000, as mentioned above, was shipped in the second and third quarters of fiscal 2005. 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 anticipated. 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 and we also incurred additional costs to prepare the goods for shipment to our customer. We declined to bid on this order for fiscal 2006. 5 The gross profit percentage was 24.3% for the year ended June 30, 2005 as compared to 30.0% for the year ended June 30, 2004. The lower overall margin resulted primarily from the addition of the SB&S division, which operated at 23.2% (which was lower than the anticipated margin due to the sale of closeouts), the low margin order that was shipped in the second and third quarters of fiscal 2005 and the higher sale of closeouts. Also contributing to the reduction in gross margins were the additional costs to exit the Dominican Republic as a source of production and move the production of the product being produced there to El Salvador. Selling, general and administrative expenses were $19,024,000, or 32.5% of net sales, for the year ended June 30, 2005 as compared to $15,824,000, or 29.5% of net sales, for the similar period in 2004. This increase of $3,200,000 is a result of an increase in salary expense and salary related costs of $411,000, shipping expense and shipping related costs of $725,000, consulting fees of $520,000, samples and design related costs of $351,000, outbound freight expense of $214,000, commissions of $174,000, a greater recovery of bad debts in the prior year of $308,000 and a net increase in other general overhead expenses. The increase in salaries was primarily the result of the additional personnel for the SB&S division and costs associated with personnel changes, partially offset by a one-time expense of $1,084,000 related to a lump sum payment to President and Chief Executive Officer, Mel Knigin, in the prior year. Absent this one-time expense in the prior year, salaries would have increased approximately $1,495,000. The payment to Mr. Knigin occurred as a result of a stock ownership sale by the former Chairman of the Company, which activated a provision in Mr. Knigin's employment agreement. Under the terms of the agreement with Mr. Knigin, this payment is to be applied against any severance obligations of the Company owed to Mr. Knigin under his employment contract, which, in accordance with its terms, expires on June 30, 2007. The increase in shipping expense is the result of the addition of the SB&S division, unanticipated costs for the large low margin order and the increased use of a West Coast public warehouse. Also, utilizing the SB&S distribution center created excess shipping capacity and as of January 2005, we closed this facility and began shipping the SB&S orders from our distribution centers in Mississippi and Pennsylvania. We also decided in June 2005 to close the Pennsylvania distribution center. In September 2005, we temporarily reopened the Pennsylvania facility to handle some of the backlog of orders caused by the hurricane in Mississippi. The increase in samples and design related costs was the result of the addition of the SB&S division and the new Maidenform line. The increase in outbound freight expense was due to the expediting of the large order discussed earlier. The increase in consulting fees was primarily due to termination of our prior Chairman's services in connection with our consulting agreement with him in the amount of $450,000 and the addition of our consulting agreement with LLI, Inc. to provide the sales representation for us in Canada and supervise the operations of our office in Montreal. The increase in commissionable sales was the result of commissions paid on the SB&S division's sales and an increase in commissionable sales in the remaining business. The recovery of bad debts in the prior year resulted primarily from one customer in bankruptcy that resolved our claim more favorably than we had anticipated. We recorded a loss from operations of $4,795,000 for the year ended June 30, 2005, as compared to operating income of $286,000 for the similar period in 2004. This decrease was due to, lower gross margins and higher selling, general and administrative expenses partially offset by higher sales. Interest income for the year ended June 30, 2005 was $1,000 as compared to $12,000 for 2004. Interest expense for the year ended June 30, 2005 was $282,000 as compared to $76,000 for 2004. This increase was due primarily to higher borrowing levels, which were the result of the acquisition of the SB&S division and higher sales, which required higher inventories and accounts receivable. We provided for an income tax benefit of $1,954,000 for the year ended June 30, 2005, as compared to a provision for income taxes of $94,000 for the similar period in 2004. The tax benefit was the result of the loss in fiscal 2005. We recorded a net loss for the year ended June 30, 2005 of $3,122,000 as compared to net income of $128,000 for the same period in 2004. This reduction was due to lower gross margins, higher selling, general and administrative expenses and higher interest costs, partially offset by higher sales and an income tax benefit in the current year as compared to an income tax provision for 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 June 30, 2006 (in thousands): 6 Payments Due by Period ---------------------------------------- Within After 5 Total 1 Year 2-3 Years 4-5 Years Years ------- ------ --------- --------- ------- Contractual Obligations Note Payable (1) $ 4,955 $4,955 $ -- $ -- $-- Note Payable Interest (2) 372 372 -- -- -- Licensing Agreement 265 170 95 -- -- Operating Leases 5,982 1,290 2,611 2,081 -- Consulting Agreements 133 133 -- -- -- Employment Contracts 771 771 -- -- -- Other Long-term Liability 74 15 22 30 7 ------- ------ ------ ------ --- Total Contractual Obligations $12,552 $7,706 $2,728 $2,111 $ 7 ======= ====== ====== ====== === 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 $7,507 $7,507 $-- $-- $-- ------ ------ --- --- --- Total Commercial Commitments $7,507 $7,507 $-- $-- $-- ====== ====== === === === (1) Note Payable is a less than one-year obligation because the financial institution may demand payment at any time. Interest on outstanding borrowings is payable at a variable rate per annum, equal to the prime rate less 0.75% (our current borrowing rate at June 30, 2006 was 7.50%). (2) Note Payable Interest assumes that the principal amount outstanding on the Company's line of credit is paid in full on June 30, 2007, that the principal amount to be repaid on that date will be $4,955,000 and that the interest rate will be 7.50% (the Company's current borrowing rate at June 30, 2006). The Company has no obligations that have a provision for increased or accelerated payments. 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. LIQUIDITY AND CAPITAL RESOURCES For the year ended June 30, 2006, working capital decreased by $1,741,000 to $8,932,000, primarily due to unprofitable operations. Net cash used in operating activities for the year ended June 30, 2006 was $1,267,000 resulting primarily from the Company's loss of $2,450,000 excluding the gain on insurance recovery of $1,450,000, the increase in accounts receivable of $576,000 and the decrease in accrued expenses and other liabilities of $679,000, offset by the decrease in inventory of $2,749,000. The decrease in inventory was primarily in finished goods. This reduction in inventory was due to customer orders being scheduled to ship later in the first quarter of fiscal 2007 as compared to the first quarter of fiscal 2006, resulting in finished goods arriving later, as well as better inventory management. Net cash provided by investing activities of $1,109,000 consisted of insurance proceeds of $1,424,000 associated with damage to our Poplarville, MS building from Hurricane Katrina offset by purchases of property, plant and equipment of $315,000. Net cash provided by financing activities of $161,000 resulted from net proceeds from short-term borrowings. Effective June 30, 2006, we obtained a new revolving line of credit of up to $30,000,000. The revolving line of credit expires June 30, 2008 and is sufficient for our projected needs for operating capital and letters of credit to fund the purchase of imported goods through June 30, 2008. Direct borrowings under this line bear interest at the prime rate less three quarters of one percent per annum. Availability under the line of credit is subject to our compliance with 7 certain agreed upon financial formulas. We were in compliance with our current lender at June 30, 2006. 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 operating cash flows, will be sufficient to cover our working capital requirements through June 30, 2008. We anticipate that capital expenditures for fiscal 2007 will be less than $700,000. EFFECT OF NEW ACCOUNTING STANDARDS In July 2006, the FASB issued SFAS Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - An Interpretation of SFAS No. 109" ("FIN 48"). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with FIN 48 is a two-step process. We first will be required to determine whether it is more likely than not that a tax position, if any, will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. A tax position that meets the "more likely than not" recognition threshold will then be measured to determine the amount of benefit to recognize in the financial statements based upon the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the effect that FIN 48 may have on our financial statements. 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. 8 ITEM 8. FINANCIAL STATEMENTS. PAGE ------- INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm 10 Consolidated Balance Sheets at June 30, 2006 and 2005 11 Consolidated Statements of Operations for the fiscal years ended June 30, 2006, 2005 and 2004 12 Consolidated Statements of Shareholders' Equity for the fiscal years ended June 30, 2006, 2005 and 2004 13 Consolidated Statements of Cash Flows for the fiscal years ended June 30, 2006, 2005 and 2004 14 - 15 Notes to Consolidated Financial Statements 16 - 29 FINANCIAL STATEMENT SCHEDULE: For the fiscal years ended June 30, 2006, 2005 and 2004: II - Valuation and Qualifying Accounts 30 9 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Movie Star, Inc.: We have audited the accompanying consolidated balance sheets of Movie Star, Inc. and subsidiary as of June 30, 2006 and 2005, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended June 30, 2006. Our audits also included the financial statement schedule listed in the index at Item 15(a)(2) for each of the three years in the period ended June 30, 2006. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Movie Star, Inc. and subsidiary as of June 30, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 2006 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 18, the accompanying fiscal 2006 consolidated statement of cash flows has been restated. /s/ Mahoney Cohen & Company, CPA, P.C. New York, New York August 24, 2006, except for Note 18 for which the date is January 16, 2007 10 MOVIE STAR, INC. CONSOLIDATED BALANCE SHEETS JUNE 30, 2006 AND 2005 (IN THOUSANDS, EXCEPT SHARE INFORMATION) 2006 2005 ------- ------- ASSETS CURRENT ASSETS: Cash $ 203 $ 178 Receivables, net 6,074 5,973 Inventory 8,981 11,730 Deferred income taxes 1,914 2,260 Prepaid expenses and other current assets 801 372 ------- ------- Total current assets 17,973 20,513 PROPERTY, PLANT AND EQUIPMENT - Net 838 755 DEFERRED INCOME TAXES 3,296 2,473 GOODWILL 537 537 ASSETS HELD FOR SALE 174 174 OTHER ASSETS 403 455 ------- ------- TOTAL ASSETS $23,221 $24,907 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Note payable $ 4,955 $ 4,794 Accounts payable 3,273 3,579 Accrued expenses and other current liabilities 813 1,467 ------- ------- Total current liabilities 9,041 9,840 ------- ------- DEFERRED LEASE LIABILITY 339 315 ------- ------- OTHER LONG-TERM LIABILITY 59 75 ------- ------- COMMITMENTS AND CONTINGENCIES -- -- SHAREHOLDERS' EQUITY: Common stock, $.01 par value - authorized, 30,000,000 shares; issued 17,755,000 shares in 2006 and 17,657,000 shares in 2005 178 177 Additional paid-in capital 4,834 4,747 Retained earnings 12,361 13,361 Accumulated other comprehensive income 27 10 Less treasury stock, at cost - 2,017,000 shares (3,618) (3,618) ------- ------- Total shareholders' equity 13,782 14,677 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $23,221 $24,907 ======= ======= See notes to consolidated financial statements. 11 MOVIE STAR, INC. CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED JUNE 30, 2006, 2005 AND 2004 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2006 2005 2004 ------- ------- ------- Net sales $51,639 $58,533 $53,691 Cost of sales 37,528 44,304 37,581 ------- ------- ------- Gross profit 14,111 14,229 16,110 Selling, general and administrative expenses 16,556 19,024 15,824 Insurance recovery (1,450) -- -- ------- ------- ------- (Loss) income from operations (995) (4,795) 286 Interest income (3) (1) (12) Interest expense 476 282 76 ------- ------- ------- (Loss) income before income tax (benefit) provision (1,468) (5,076) 222 Income tax (benefit) provision (468) (1,954) 94 ------- ------- ------- Net (loss) income $(1,000) $(3,122) $ 128 ======= ======= ======= BASIC NET (LOSS) INCOME PER SHARE $ (.06) $ (.20) $ .01 ======= ======= ======= DILUTED NET (LOSS) INCOME PER SHARE $ (.06) $ (.20) $ .01 ======= ======= ======= Basic weighted average number of shares outstanding 15,700 15,625 15,574 ======= ======= ======= Diluted weighted average number of shares outstanding 15,700 15,625 16,199 ======= ======= ======= See notes to consolidated financial statements. 12 MOVIE STAR, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED JUNE 30, 2006, 2005 AND 2004 (IN THOUSANDS) ACCUMULATED COMMON STOCK ADDITIONAL OTHER TREASURY STOCK -------------- PAID-IN RETAINED COMPREHENSIVE --------------- SHARES AMOUNT CAPITAL EARNINGS INCOME SHARES AMOUNT TOTAL ------ ------ ---------- -------- ------------- ------ ------- ------- BALANCE, JUNE 30, 2003 17,412 $174 $4,353 $16,355 $-- 2,017 $(3,618) $17,264 Net income -- -- -- 128 -- -- -- 128 Exercise of stock options 205 2 131 -- -- -- -- 133 Tax benefit from exercise of stock options -- -- 222 -- -- -- -- 222 ------ ---- ------ ------- --- ----- ------- ------- BALANCE, JUNE 30, 2004 17,617 176 4,706 16,483 2,017 (3,618) 17,747 Net loss -- -- -- (3,122) -- -- (3,122) Cumulative translation adjustment -- -- -- -- 10 -- -- 10 ------- Comprehensive loss (3,112) Exercise of stock options 20 -- 22 -- -- -- -- 22 Issuance of common stock for directors' fees 20 1 19 -- -- -- -- 20 ------ ---- ------ ------- --- ----- ------- ------- BALANCE, JUNE 30, 2005 17,657 177 4,747 13,361 10 2,017 (3,618) 14,677 Net loss -- -- -- (1,000) -- -- (1,000) Cumulative translation adjustment -- -- -- -- 17 -- -- 17 ------- Comprehensive loss (983) Stock compensation expense -- -- 19 -- -- -- -- 19 Issuance of common stock for directors' fees 98 1 68 -- -- -- -- 69 ------ ---- ------ ------- --- ----- ------- ------- BALANCE, JUNE 30, 2006 17,755 $178 $4,834 $12,361 $27 2,017 $(3,618) $13,782 ====== ==== ====== ======= === ===== ======= ======= See notes to consolidated financial statements. 13 MOVIE STAR, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2006, 2005, AND 2004 (IN THOUSANDS) 2006 2005 2004 ---------- ------- ------- (RESTATED) CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(1,000) $(3,122) $ 128 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Gain on insurance recovery (1,450) -- -- Depreciation and amortization 316 406 410 Provision for sales allowances and doubtful accounts 480 (539) 316 Stock compensation expense 19 -- -- Deferred income taxes (477) (2,014) 64 Deferred lease liability 24 32 59 Issuance of common stock for directors' fees 69 20 -- (Increase) decrease in operating assets, net of acquisition of business: Receivables (576) 2,154 1,099 Inventory 2,749 (2,919) 4,454 Prepaid expenses and other current assets (404) 218 (223) Other assets (31) (91) (71) (Decrease) increase in operating liabilities: Accounts payable (307) 1,637 (951) Accrued expenses and other liabilities (679) 740 (597) ------- ------- ------- Net cash (used in) provided by operating activities (1,267) (3,478) 4,688 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment (315) (225) (209) Proceeds from insurance recovery 1,424 -- -- Acquisition of Sidney Bernstein & Son business -- (3,456) -- ------- ------- ------- Net cash provided by (used in) investing activities 1,109 (3,681) (209) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of capital lease obligations -- -- (27) Net proceeds from (repayments of) revolving line of credit (4,794) 4,794 (2,277) Proceeds from new revolving line of credit 4,955 -- -- Proceeds from exercise of employee stock options -- 22 133 ------- ------- ------- Net cash provided by (used in) financing activities 161 4,816 (2,171) ------- ------- ------- Effect of exchange rate changes on cash 22 (6) -- ------- ------- ------- NET INCREASE (DECREASE) IN CASH 25 (2,349) 2,308 CASH, BEGINNING OF YEAR 178 2,527 219 ------- ------- ------- CASH, END OF YEAR $ 203 $ 178 $ 2,527 ======= ======= ======= (Continued) 14 MOVIE STAR, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2006, 2005, AND 2004 (IN THOUSANDS) 2006 2005 2004 ---------- ------- ------- (RESTATED) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during year for: Interest $475 $282 $ 76 ==== ==== ==== Income taxes $ 37 $ 60 $343 ==== ==== ==== SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES: Tax benefit from exercise of employee stock options $ -- $ -- $222 ==== ==== ==== (Concluded) See notes to consolidated financial statements. 15 MOVIE STAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 2006, 2005 AND 2004 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business - Movie Star, Inc. (the "Company") is a New York corporation organized in 1935, which designs, manufactures (through independent contractors), imports, markets and distributes an extensive line of ladies' sleepwear, robes, leisurewear, loungewear, panties and daywear. The Company's wholly-owned subsidiary, Cinejour Lingerie Inc., is a Canadian corporation formed in May 2004 to market and sell the Company's products throughout Canada. The Company has an agreement with an independent representative to provide sales representation for the Company in Canada and to supervise the operations of its office in Canada. Principles of Consolidation - The consolidated financial statements include the accounts of Movie Star, Inc. and its wholly-owned subsidiary, Cinejour Lingerie, Inc. (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America also requires management to make estimates and assumptions that affect the disclosures of contingent assets and liabilities at the date of the financial statements. Significant estimates include provision for inventory obsolescence, deferred tax assets, allowances for doubtful accounts and sales discounts. Actual results could differ from those estimates. Allowances for Doubtful Accounts/Sales Discounts - The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company also estimates allowances for customer discounts and incentive offerings. If market conditions were to decline, the Company may take actions to increase customer incentive offerings possibly resulting in an incremental allowance at the time the incentive is offered. Inventory - Inventory is valued at lower of cost (first-in, first-out) or market. The Company 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. Property, Plant and Equipment - Property, plant and equipment are stated at cost. Depreciation and amortization are provided by the straight-line method over the following estimated useful lives: Buildings and improvements 15 - 30 years Machinery & Equipment 5 years Office furniture and equipment 3 - 5 years Leasehold improvements Lesser of life of the asset or life of lease 16 Impairment of Long-lived Assets - The Company follows Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 requires that long-lived assets, including property and equipment, be reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. The Company assesses its assets for impairment based on the estimated future undiscounted cash flows expected to result from the use of the asset and records impairment losses when this amount is less than the carrying amount. Impairment losses are recorded for the excess of the assets' carrying amount over their fair value, which is generally determined based on the estimated future discounted cash flows over the remaining useful life of the asset using a discount rate determined by management at the date of the impairment review. Management believes at this time that the carrying value and useful life of long-lived assets continue to be appropriate. Goodwill and Intangible Assets - Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in a business combination accounted for under purchase method of accounting (see Note 2). The Company follows SFAS No. 142, "Goodwill and Other Intangible Assets," whereby goodwill is not amortized and the Company conducts impairment testing in the fourth quarter of each fiscal year, or sooner if events and changes in circumstances suggest that the carrying amount may not be recoverable from its estimated future cash flows. No amortization or impairment charges relating to goodwill have been recorded for the fiscal years ended June 30, 2006 and 2005. Intangible assets at June 30, 2006 and 2005 consist of a covenant not to compete of $21,000 and $31,000, respectively, which is included in "Other assets" and is being amortized by the straight-line method over the contract life. Amortization is expected to be $10,000 in each of the next two years. Deferred Rent - The Company accounts for scheduled rent increases contained in its leases on a straight-line basis over the non-cancelable lease term. 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. 17 Had the Company elected to recognize compensation expense for stock-based compensation using the fair value method, net (loss) income, basic and diluted net (loss) income per share would have been as follows: YEARS ENDED JUNE 30, ------------------------- 2006 2005 2004 ------- ------- ----- Net (loss) income, as reported $(1,000) $(3,122) $ 128 Add stock-based employee compensation expense, included in reported net (loss) income, net of taxes 11 -- -- Deduct stock-based employee compensation expense determined under fair value based method, net of taxes (11) (30) (15) ------- ------- ----- Pro forma net (loss) income $(1,000) $(3,152) $ 113 ======= ======= ===== Basic and diluted net (loss) income per share, as reported $ (.06) $ (.20) $ .01 ======= ======= ===== Pro forma basic and diluted net (loss) income per share $ (.06) $ (.20) $ .01 ======= ======= ===== The fair value of option grants were calculated with the following weighted-average assumptions: 2006 2005 ------- ----------- Risk-free interest rate 4.56% 3.5% - 4.0% Expected life 7 years 7 years Expected volatility 54% 36% - 63% Expected dividends None None No options were granted in 2004. The fair values generated by the Black-Scholes model may not be indicative of the future benefit, if any, that may be received by the option holder. Revenue Recognition - Revenue is recognized upon shipment. Although sales are made without the right of return, in certain instances, the Company may accept returns or agree to allowances. Sales returns, discounts and allowances are recorded as a component of net sales in the period in which the related sales are recognized. The customer takes title and assumes the risks and rewards of ownership of the products when the merchandise leaves the Company's warehouse. The Company expenses the costs of advertising to customers under cooperative advertising as a reduction of revenue, which is a component of net sales. Cooperative advertising amounted to $232,000, $236,000 and $160,000 for the years ended June 30, 2006, 2005 and 2004, respectively. Cost of Sales and Selling Costs - Cost of sales includes the expenses incurred to acquire and produce inventory for sale, including product costs, freight-in, inspection costs, labor associated with quality repairs, internal transfer costs, purchasing and receiving costs, and travel and entertainment related to product sourcing. Selling costs include the costs of selling the merchandise, including preparing the merchandise for sale, picking and packing costs, and shipping and handling costs, such as warehousing, freight-out and other direct costs to deliver inventory to customers. Shipping and handling costs aggregated approximately $2,278,000 in 2006, $2,808,000 in 2005 and $1,869,000 in 2004. In addition, selling costs include the costs for apparel design and development activities, including sample designs and patterns. The Company expenses these costs as incurred. Selling costs are a component of selling, general and administrative expenses. 18 Deferred tax valuation allowance - In assessing the need for a deferred tax valuation allowance, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Since the Company was able to determine that it should be able to realize its deferred tax assets in the future, a deferred tax valuation allowance was not deemed necessary. Likewise, should the Company determine that it would not be able to realize all or part of the Company's 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. Net (Loss) Income Per Share - Basic net (loss) income per share is computed by dividing net (loss) income by the weighted average number of common shares outstanding for the period. Diluted net income per share also includes the dilutive effect of potential common shares outstanding during the period. Foreign Currency Translation - The assets and liabilities of the Company's Canadian subsidiary are translated into U.S. dollars at current exchange rates on the balance sheet date and revenue and expenses are translated at average exchange rates for the respective years. The net exchange differences resulting from these translations are recorded as a translation adjustment which is a component of shareholders' equity. Cinejour Lingerie Inc.'s functional currency is the Canadian Dollar. Foreign Currency Transactions - The Company considers the United States Dollar to be the functional currency of its overseas offices. Foreign currency gains and losses, which are immaterial, are recorded in selling, general and administrative expenses on the consolidated statement of operations. Segment Reporting - The Company operates in one segment with revenues generated in the United States and Canada as follows (in thousands): FISCAL YEARS ENDED JUNE 30, --------------------------- 2006 2005 2004 ------- ------- ------- Net Sales United States $49,753 $58,214 $53,691 Canada 1,886 319 -- ------- ------- ------- $51,639 $58,533 $53,691 ======= ======= ======= EFFECT OF NEW ACCOUNTING STANDARDS In July 2006, the FASB issued SFAS Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - An Interpretation of SFAS No. 109" ("FIN 48"). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with FIN 48 is a two-step process. The Company first will be required to determine whether it is more likely than not that a tax position, if any, will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. A tax position that meets the "more likely than not" recognition threshold will then be measured to determine the amount of benefit to recognize in the financial statements based upon the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. 19 FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the effect that FIN 48 may have on its financial statements. 2. 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 assets were purchased for an aggregate price of $3,379,000, excluding transaction related fees, and included, among other assets, $2,873,000 of inventory and $500,000 of intangible assets. 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 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 the additional $1,000,000 under the Asset Purchase Agreement. 20 3. INVENTORY Inventory consists of the following: JUNE 30, --------------- 2006 2005 ------ ------- (IN THOUSANDS) Raw materials $1,279 $ 1,574 Work-in process 281 382 Finished goods 7,421 9,774 ------ ------- $8.981 $11,730 ====== ======= 4. RECEIVABLES Receivables consist of the following: JUNE 30, --------------- 2006 2005 ------ ------ (IN THOUSANDS) Trade $7,017 $7,086 Other 7 41 ------ ------- 7,024 7,127 Less allowance for doubtful accounts and sales discounts (950) (1,154) ------ ------- $6,074 $5,973 ====== ====== 5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following: JUNE 30, --------------- 2006 2005 ------ ------ (IN THOUSANDS) Land, buildings and improvements $1,212 $ 989 Machinery and equipment 573 566 Office furniture and equipment 1,182 1,188 Leasehold improvements 279 277 ------ ------ 3,246 3,020 Less accumulated depreciation and amortization (2,408) (2,265) ------ ------ $ 838 $ 755 ====== ====== During fiscal year ended June 30, 2005, the Company reclassified the land and building, with a net carrying value of $174,000, at its Petersburg, Pennsylvania facility to "Assets held for sale." See Note 15. Depreciation expense of $232,000, $321,000 and $340,000 was recorded in fiscal 2006, 2005 and 2004, respectively. 21 6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities consist of the following: JUNE 30, -------------- 2006 2005 ---- ------ (IN THOUSANDS) Insurance $133 $ 129 Salary, commissions and employee benefits 240 559 Consulting fees 113 450 Other 327 329 ---- ------ $813 $1,467 ==== ====== 7. NOTE PAYABLE The Company had a line of credit with an international bank, effective July 1, 2004, which matured on June 30, 2006 (see below). Under this line of credit, the Company could borrow in the aggregate, revolving loans and letters of credit, up to $20,000,000. Availability under this line of credit was subject to the Company's compliance with certain financial formulas as outlined in the agreement. Pursuant to the terms of this line of credit, the Company had pledged substantially all of its assets. Interest on outstanding borrowings was payable at a variable rate per annum equal to the prime rate less 0.75 percent. For the fiscal year ended June 30, 2006, under the credit agreement, the borrowings peaked at $12,613,000 and the average amount of borrowings was $7,272,000, with the weighted average interest rate of 6.29%. For the fiscal year ended June 30, 2005, under the credit agreement, the borrowings peaked at $13,410,000 and the average amount of borrowings was $6,335,000, with the weighted average interest rate of 4.40%. At June 30, 2006, the Company had no borrowings outstanding under this line of credit (see below) and had approximately $7,507,000 of outstanding letters of credit. At June 30, 2005, the Company had borrowings of $4,794,000 outstanding under this line of credit and also had approximately $5,985,000 of outstanding letters of credit. Effective June 30, 2006, the Company secured a new line of credit with another financial institution. This line of credit matures on June 30, 2008 and is subject to annual renewals thereafter. Under this line of credit, the Company may borrow in the aggregate, revolving loans and letters of credit, up to $30,000,000. Availability under this line of credit is subject to the Company's compliance with certain financial formulas as outlined in the agreement. Pursuant to the terms of this line of credit, the Company pledged substantially all of its assets. Interest on outstanding borrowings is payable at a variable rate per annum equal to JPMorgan Chase Bank's prime rate less 0.75 percent (7.5 percent as of June 30, 2006). At June 30, 2006, the Company had outstanding borrowings of $4,955,000 under the facility and had no outstanding letters of credit; however the new financial institution has agreed to indemnify all of the outstanding letters of letter under the old credit facility (see above). 22 The Company believes that the available borrowing under this agreement, along with anticipated operating cash flows, will be sufficient to cover its working capital requirements through June 30, 2008. 8. FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company, using available market information and appropriate valuation methodologies. Cash, Accounts Receivable, Accounts Payable, Accrued Expenses and Other Current Liabilities - The carrying value of these items approximates fair value, based on the short-term maturities of these instruments. Note Payable and Other Long-term Liabilities - The fair value of these liabilities are estimated based on interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities. The carrying value approximates the fair value. The fair value estimates are based on pertinent information available to management as of June 30, 2006 and 2005. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those respective dates, and current estimates of fair value may differ significantly from the amounts presented herein. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. 9. INCOME TAXES Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (b) operating loss and credit carryforwards. The income tax effects of significant items, comprising the Company's net deferred tax assets and liabilities, are as follows: JUNE 30, --------------- 2006 2005 ------ ------ (IN THOUSANDS) Deferred tax liabilities: Differences between book and tax basis of goodwill $ 27 $ 13 ------ ------ Deferred tax assets: Difference between book and tax basis of inventory 635 691 Reserves not currently deductible 607 834 Operating loss carry forwards 3,711 2,931 Other 284 290 ------ ------ 5,237 4,746 ------ ------ Net deferred tax asset $5,210 $4,733 ====== ====== 23 The (benefit from) provision for income taxes is comprised as follows: YEARS ENDED JUNE 30, ---------------------- 2006 2005 2004 ----- ------- ---- (IN THOUSANDS) Current: Federal $ -- $ 10 $(12) ----- ------- ---- State and local 9 50 42 ----- ------- ---- 9 60 30 ----- ------- ---- Deferred Federal (406) (1,712) 54 State and local (71) (302) 10 ----- ------- ---- (477) (2,014) 64 ----- ------- ---- $(468) $(1,954) $ 94 ===== ======= ==== Reconciliation of the U.S. statutory rate with the Company's effective tax rate (benefit) is summarized as follows: YEARS ENDED JUNE 30, -------------------- 2006 2005 2004 ----- ----- ---- (IN THOUSANDS) Federal statutory rate (benefit) (34.0)% (34.0)% 34.0% Increase (decrease) in tax resulting from: State income taxes (net of federal tax benefits) (2.5) (3.3) 17.6 Foreign losses not subject to tax benefit 3.5 -- -- Other 1.1 (1.2) (9.3) ----- ----- ---- Effective rate (31.9)% (38.5)% 42.3% ===== ===== ==== As of June 30, 2006, the Company has net operating loss carryforwards of approximately $9,277,000 for federal income tax purposes that expire between the years 2011 and 2026 and credit carryforwards of approximately $211,000. 10. COMMITMENTS AND CONTINGENCIES Operating Leases --The Company has operating leases expiring in various years through fiscal 2011. Future minimum payments under these leases at June 30, 2006 are as follows (in thousands): FISCAL YEAR AMOUNT ----------- ------ 2007 $1,290 2008 1,298 2009 1,313 2010 1,346 2011 735 ------ $5,982 ====== Rental expense for 2006, 2005 and 2004 was approximately $1,297,000, $1,313,000 and $1,255,000, respectively. 24 Employment Agreement - In January 2003, the Company and Mr. Knigin, the Company's CEO and President, agreed to 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 June 30, 2006, the remaining financial liability of this agreement is $575,000. Mr. Knigin is also entitled to receive an annual bonus under the Company's discretionary 1998 Senior Executive Incentive Plan of not less than 3% of the Company's pre-tax income from $1,200,000 to $3,200,000 and an additional award in an amount of not less than 3.75% of pre-tax income in excess of $3,200,000. 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. The severance obligations of the Company, if any, will be reduced by the lump sum payment paid to Mr. Knigin in connection with the sale by the David family of its shares of the Company's common stock, as discussed below. 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. On February 10, 2004, Mark M. David, the Company's then 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 resigned from the Company's Board of Directors. This transaction closed on February 17, 2004. This transaction activated a provision under the Company's employment agreement with Mr. Knigin, which required the Company to make a lump sum payment to Mr. Knigin. As a result, a special charge of approximately $1,084,000 was recorded in the third quarter of fiscal 2004. Under the terms of the agreement with Mr. Knigin, the payment is to be applied against any severance obligations of the Company owed to Mr. Knigin under his employment contract, which, in accordance with its terms, expires on June 30, 2007. The payment was made on April 8, 2004. Consulting Agreements - As of January 1, 2003, the Company and Mark M. David, the Company's then Chairman of the Board, renegotiated Mr. David's consulting agreement with the Company that was to expire on June 30, 2004. The new agreement was with Mr. David's consulting firm. Under the terms of the new agreement, Mr. David's consulting firm was to provide the consulting services of Mr. David and was to receive annual consulting fees of $225,000 through June 30, 2007. As of June 30, 2005, the services of Mr. David were terminated. As of June 30, 2006, the remaining liability under the agreement is $113,000 which is included in "Accrued expenses and other current liabilities." As of May 3, 2004, the Company and LLI Inc. ("LLI"), a corporation organized under the law of the Province of Quebec, Canada, entered into a consulting agreement whereby LLI is to provide the sales representation for the Company in Canada and supervise the operations of the Company's office in Montreal. The agreement expires on August 31, 2006. LLI is to receive annual consulting fees of $125,000 through August 31, 2006, plus additional consulting fees for sales in excess of targets, as defined in the agreement. As of September 1, 2006, the agreement is on an "at will" basis, whereby the agreement can be terminated upon thirty days written notice. Licensing Agreement - In February 2004, the Company entered into a licensing agreement with Maidenform Inc. Pursuant to the agreement, the Company is obligated to pay licensing fees, based upon a percentage of net sales, subject to an annual minimum guaranteed royalty. Future minimum 25 guaranteed royalty payments under the non-cancelable agreement as of June 30, 2006 are as follows (in thousands): FISCAL YEAR AMOUNT ----------- ------ 2007 $170 2008 95 ---- $265 ==== Guarantees - The Company has not provided any financial guarantees as of June 30, 2006. 11. RELATED PARTY Upon the retirement of its then 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 June 30, 2006 and 2005, the current portion, included in "Accrued expenses and other current liabilities," amounted to $15,000 and $14,000, respectively and the long-term portion, classified as "Other long-term liability," amounted to $59,000 and $75,000, respectively. 12. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS Financial instruments, which potentially expose the Company to concentrations of credit risk, consist primarily of trade accounts receivable. The Company's customers, of which 96% are located throughout the United States, are not concentrated in any specific geographic region, but are concentrated in the retail industry. One customer accounted for 25%, 20%, and 38% of the Company's net sales in fiscal 2006, 2005, and 2004, respectively. Another customer accounted for 0%, 15% and 3% of the Company's net sales in fiscal 2006, 2005 and 2004, respectively, while another customer accounted for 3%, 6% and 10% of the Company's net sales in fiscal 2006, 2005 and 2004, respectively. The Company performs ongoing credit evaluations of its customers' financial condition. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. 13. STOCK PLANS, OPTIONS AND WARRANT Stock Options - On December 8, 1994, the Company's shareholders approved a new Incentive Stock Option Plan (the "1994 ISOP") to replace the 1983 ISOP. Options granted, pursuant to the plan, are not subject to a uniform vesting schedule. The plan permitted the issuance of options to employees to purchase common stock of the Company at a price not less than fair market value on the date of the option grant. The plan reserved 2,000,000 shares of common stock for grant and provides that the term of each award be determined by the Compensation Committee with all awards made within the ten-year period following the effective date. Options to purchase 620,000 shares at an exercise price ranging from $.625 to $.875 per share are outstanding and exercisable as of June 30, 2006. Options to purchase 555,000 shares have been exercised under this plan through June 30, 2006. Effective July 15, 2004, options can no longer be granted under the 1994 ISOP. On February 21, 2000, the Committee adopted a new Performance Equity Plan (including a new Incentive Stock Option Plan) (the "2000 Plan") and on November 28, 2000, the Company's shareholders approved the plan. The 2000 Plan authorizes the Company to grant qualified and non-qualified options to participants for the purchase of up to an additional 750,000 shares of the Company's common stock and to grant other stock-based awards to eligible employees of the Company. Options to purchase 378,000 shares at an exercise price ranging from $.625 to $1.36 per share are outstanding at June 30, 2006. Of the total options granted, 338,000 are presently exercisable. 26 The Company also has the 1988 Non-Qualified Stock Option Plan covering the issuance of up to 1,666,666 shares of the Company's common stock to key employees of the Company. Options to purchase 200,000 shares at an exercise price ranging from $.625 to $1.45 per share are outstanding at June 30, 2006. Of the total options granted, 100,000 are presently exercisable. The options typically vest over five years. Information with respect to stock options is as follows (shares in thousands): 2006 2005 2004 ------------------ ------------------ ------------------ WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE FIXED OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE --------------------------------- ------ --------- ------ --------- ------ --------- Outstanding - beginning of year 1,158 $.81 1,005 $ .71 1,210 $.70 Granted 40 .63 248 1.42 -- -- Exercised -- -- (20) 1.13 (205) .65 Canceled -- -- (75) 1.40 -- -- ----- ---- ----- ----- ----- ---- Outstanding - end of year 1,198 $.80 1,158 $ .81 1,005 $.71 ===== ==== ===== ===== ===== ==== Exercisable - end of year 1,058 $.75 1,023 $ .73 945 $.71 ===== ==== ===== ===== ===== ==== Weighted-average fair value of options granted during the year $.38 $ .73 $ -- ==== ===== ==== OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------------------------- ------------------------------- WEIGHTED- AVERAGE NUMBER REMAINING WEIGHTED- WEIGHTED- RANGE OF OUTSTANDING AT CONTRACTUAL AVERAGE EXERCISABLE AT AVERAGE EXERCISE PRICES JUNE 30, 2006 LIFE IN YRS EXERCISE PRICE JUNE 30, 2006 EXERCISE PRICE --------------- -------------- ----------- -------------- -------------- -------------- $.625 - $.6875 825 2.02 $ .63 785 $ .63 $.875 - $1.45 373 5.83 1.18 273 1.08 ----- ---- ----- ----- ----- 1,198 3.21 $ .80 1,058 $ .75 ===== ==== ===== ===== ===== The total intrinsic value of options exercised during the years ended June 30, 2005, and 2004, was $6,000, and $275,000, respectively. There were no options exercised during the year ended June 30, 2006. The total fair value of shares vested during the years ended June 30, 2006, 2005, and 2004, was $20,000, $51,000, and $25,000, respectively. The aggregate intrinsic value of options outstanding and options currently exercisable at June 30, 2006 was $105,000 and $100,000, respectively. A summary of the status of the Company's non-vested shares as of June 30, 2006, and changes during the year ended June 30, 2006, is presented below: WEIGHTED- SHARES AVERAGE GRANT NON-VESTED SHARES: (IN THOUSANDS) DATE FAIR VALUE --------------------------- -------------- --------------- Non-vested at July 1, 2005 135 $.64 Granted 40 .38 Vested (35) .58 --- ---- Non-vested at June 30, 2006 140 $.58 === ==== 27 All stock options are granted at fair market value of the common stock at grant date. As of June 30, 2006, there was $71,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the plans. That cost is expected to be recognized over a weighted-average period of 3.7 years. Warrant - In October 1998, in connection with an agreement with a financial consulting firm, the Company issued a warrant to purchase 50,000 shares of its common stock at $.4375 per share to the consultants. The warrant is exercisable at any time within ninety days following written notice from the Company of the Company's intention to file a Registration Statement other than on Form S-4 and S-8, under the Securities Act of 1933, as amended. In 1983, the Company adopted an Employee Stock Ownership and Capital Accumulation Plan (the "Plan"). The Plan covers the Company's employees who meet the minimum credited service requirements of the Plan. The Plan is funded solely from employer contributions and income from investments. The Company has made no contributions to the Plan since July 1996 and at that time all employees became 100% vested in their shares. Upon an employee's termination, or in certain other limited circumstances, the employee's shares are distributed to the employee according to his or her direction and the applicable Plan rules. As of June 30, 2006 and 2005, the Plan owned 332,569 and 439,336 shares of common stock of the Company, respectively. The amount of shares eligible for distribution at June 30, 2006 and 2005 were 161,175 and 187,607, respectively. 14. NET (LOSS) INCOME PER SHARE The Company's calculation of basic and diluted net (loss) income per share are as follows (in thousands, except per share amounts): YEARS ENDED JUNE 30, -------------------------- 2006 2005 2004 ------- ------- ------ (IN THOUSANDS, EXCEPT PER SHARE) BASIC: Net (loss) income $(1,000) $(3,122) $ 128 ======= ======= ======= Weighted average number of shares outstanding 15,700 15,625 15,574 ======= ======= ======= Basic net (loss) income per share $ (.06) $ (.20) $ .01 ======= ======= ======= DILUTED: Net (loss) income $(1,000) $(3,122) $ 128 ======= ======= ======= Weighted average number of shares outstanding 15,700 15,625 15,574 Shares issuable upon conversion of stock options -- -- 588 Shares issuable upon conversion of warrants -- -- 37 ------- ------- ------- Total average number of equivalent shares outstanding 15,700 15,625 16,199 ======= ======= ======= Diluted net (loss) income per share $ (.06) $ (.20) $ .01 ======= ======= ======= For the year ended June 30, 2006, shares issuable upon conversion of stock options and warrants of 93,000 and 19,000, respectively and for the year ended June 30, 2005, shares issuable upon conversion of stock options and warrants of 388,000 and 31,000, respectively, were excluded from diluted net loss per share because their effect would be anti-dilutive. 28 15. 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 and is currently under contract to be sold for $670,000. In connection with the Company's plan of disposal, management estimates that they will not incur a loss in liquidating these assets. As of June 30, 2006, the remaining accrued closing costs of $34,000 were written off. As a result of hurricane Katrina, the Petersburg distribution facility was reopened on a temporary basis in fiscal 2006 until December 31, 2005. 16. INSURANCE RECOVERY During fiscal 2006, the Company recorded an insurance recovery of $1,450,000, net of expenses, for damages incurred to its Poplarville, Mississippi distribution facility by hurricane Katrina. 17. UNAUDITED SELECTED QUARTERLY FINANCIAL DATA QUARTER ------------------------------------- FIRST SECOND THIRD FOURTH ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE) FISCAL YEAR ENDED JUNE 30, 2006 Net sales $13,637 $17,867 $11,940 $ 8,195 Gross profit 3,713 5,281 3,251 1,866 Net (loss) income (371) 610 276 (1,515) Basic net (loss) income per share (a) (.02) .04 .02 (.10) Diluted net (loss) income per share (a) (.02) .04 .02 (.10) FISCAL YEAR ENDED JUNE 30, 2005 Net sales $12,830 $22,990 $14,659 $ 8,054 Gross profit 3,830 5,030 3,473 1,896 Net loss (230) (75) (761) (2,056) Basic net loss per share (a) (.01) -- (.05) (.13) Diluted net loss per share (a) (.01) -- (.05) (.13) (a) Quarterly net (loss) income per share amounts may not add to the total for the full year amount, due to rounding. 18. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS The Company has determined that it is necessary to restate its consolidated statements of cash flows for fiscal 2006 in order to reclassify the cash proceeds received of $1,424,000 from the insurance recovery relating to the Company's building damage caused by Hurricane Katrina. The restatement did not have an effect on the Company's net loss or net loss per share. * * * * * 29 SCHEDULE II MOVIE STAR, INC. VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS) ADDITIONS BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD ----------- ---------- ---------- ---------- ---------- FISCAL YEAR ENDED JUNE 30, 2006: Allowance for doubtful accounts $ 12 $ -- $ 5(b) $ 17 Allowance for sales discounts and allowances 1,142 3,717 (3,926) 933 ------ ------ ------- ------ $1,154 $3,717 $(3,921) $ 950 ====== ====== ======= ====== FISCAL YEAR ENDED JUNE 30, 2005: Allowance for doubtful accounts $ -- $ -- $ 12(b) $ 12 Allowance for sales discounts and allowances 1,705 4,774 (5,337) 1,142 ------ ------ ------- ------ $1,705 $4,774 $(5,325) $1,154 ====== ====== ======= ====== FISCAL YEAR ENDED JUNE 30, 2004: Allowance for doubtful accounts $ 339 $ -- $ (91)(a) (248)(b) $ -- Allowance for sales discounts and allowances 1,051 5,759 (5,105) 1,705 ------ ------ ------- ------ $1,390 $5,759 $(5,444) $1,705 ====== ====== ======= ====== (a) Uncollectible accounts written off. (b) Increase (reduction) in allowance. 30 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) The following documents are filed as part of this Report: 1. FINANCIAL STATEMENTS: Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets at June 30, 2006 and 2005 Consolidated Statements of Operations for the fiscal years ended June 30, 2006, 2005 and 2004 Consolidated Statements of Shareholders' Equity for the fiscal years ended June 30, 2006, 2005 and 2004 Consolidated Statements of Cash Flows for the fiscal years ended June 30, 2006, 2005 and 2004 Notes to Consolidated Financial Statements 2. FINANCIAL STATEMENT SCHEDULE: For the fiscal years ended June 30, 2006, 2005 and 2004: II - Valuation and Qualifying Accounts Schedules other than those listed above are omitted for the reason that they are not required or are not applicable, or the required information is shown in the financial statements or notes thereto. Columns omitted from schedules filed have been omitted because the information is not applicable. 3. EXHIBITS: EXHIBIT NUMBER EXHIBIT METHOD OF FILING ------- ------- ---------------- 3.1 Certificate of Incorporation Incorporated by reference as Exhibit 3.1 to Form 10-K for fiscal year ended June 30, 1988 and filed on October 13, 1988. 3.2 Amended Certificate of Incorporation Incorporated by reference as Exhibit 3.1.1 to Form 10-K for fiscal year ended June 30, 1992 and filed on September 25, 1992. 3.3 Amended Certificate of Incorporation Incorporated by reference as Exhibit 3.1.2 to Amendment to Form 10-K for fiscal year ended June 30, 1992 and filed on January 19, 1993. 3.4 Amended and Restated By-Laws Incorporated by reference as Exhibit 3.4 to Form 8-K dated May 31, 2006 and filed on June 5, 2006. 31 EXHIBIT NUMBER EXHIBIT METHOD OF FILING ------- ------- ---------------- 10.1 1994 Incentive Stock Option Plan Incorporated by reference as Exhibit 10.3.1 to Form 10-K for fiscal year ended June 30, 1994 and filed on October 12, 1994. 10.2 Amended and Restated 1988 Incorporated by reference as Exhibit 10.2 to Non-Qualified Stock Option Plan Form 10-K for fiscal year ended June 30, 2006 and filed on September 27, 2006. 10.3 2000 Performance Equity Plan Incorporated by reference as Exhibit 4.1 to Form S-8 and filed on April 1, 2005. 10.4 Agreement dated as of July 1, 1999 Incorporated by reference as Exhibit 10.11 between Mark M. David and the Company to Form 10-K for fiscal year ended June 30, providing for retirement benefits to 1999 and filed on September 28, 1999. Mr. David. 10.5 Agreement dated as of January 1, 2003 Incorporated by reference as Exhibit 10.17 between BENJAM Consulting LLC and the to Form 10-Q for the quarter ended December Company replacing the Agreement dated 31, 2002 and filed on February 13, 2003. as of July 1, 1999 between Mark M. David and the Company for Mr. David's consulting services. 10.6 Employment Agreement dated as of July Incorporated by reference as Exhibit 10.18 1, 2002 between Melvyn Knigin and the to Form 10-Q for the quarter ended December Company replacing the Agreement dated 31, 2002 and filed on February 13, 2003. as of February 22, 2000. 10.7 Letter dated January 28, 2003 from Incorporated by reference as Exhibit 10.19 Melvyn Knigin to the Company for the to Form 10-Q for the quarter ended December surrender and forfeiture of Mr. 31, 2002 and filed on February 13, 2003. Knigin's stock options. 10.8 Non-Employee Director Compensation Incorporated by reference as Exhibit 10.13 Plan effective January 1, 2005 to Form 8-K dated December 6, 2004 and filed between the Directors and the Company. on December 14, 2004. 10.9 Form of Non-Employee Director Incorporated by reference as Exhibit 10.14 Non-Qualified Stock Option Agreement to Form 8-K dated December 6, 2004 and filed on December 14, 2004. 10.10 Employment Agreement effective July Incorporated by reference as Exhibit 10.15 1, 2004 between Saul Pomerantz and to Form 8-K dated December 10, 2004 and the Company. filed on December 15, 2004. 10.11 Non-Qualified Stock Option Agreement Incorporated by reference as Exhibit 10.16 dated as of December 10, 2004 between to Form 8-K dated December 10, 2004 and Saul Pomerantz and the Company. filed on December 15, 2004. 10.12 Employment Agreement effective July Incorporated by reference as Exhibit 10.17 1, 2004 between Thomas Rende and the to Form 8-K dated December 10, 2004 and Company. filed on December 15, 2004. 32 EXHIBIT NUMBER EXHIBIT METHOD OF FILING ------- ------- ---------------- 10.13 Non-Qualified Stock Option Agreement Incorporated by reference as Exhibit 10.18 dated as of December 10, 2004 between to Form 8-K dated December 10, 2004 and Thomas Rende and the Company. filed on December 15, 2004. 10.14 Amendment dated as of September 19, Incorporated by reference as Exhibit 10.16 2005 to Agreement dated as of January to Form 10-K for fiscal year ended June 30, 1, 2003 between BENJAM Consulting LLC 2005 and filed on September 27, 2005. and the Company. 10.15 Accounts Receivable Financing Agreement Incorporated by reference as Exhibit 10.19 dated as of June 30, 2006 between CIT to Form 8-K dated June 30, 2006 and filed Commercial Services and the Company. on July 5, 2006. 10.16 Inventory Security Agreement dated as Incorporated by reference as Exhibit 10.20 of June 30, 2006 between CIT to Form 8-K dated June 30, 2006 and filed on Commercial Services and the Company. July 5, 2006. 10.17 Letter of Credit Agreement dated as Incorporated by reference as Exhibit 10.21 of June 30, 2006 between CIT to Form 8-K dated June 30, 2006 and filed on Commercial Services and the Company July 5, 2006. 10.18 Letter Agreement dated June 30, 2006 Incorporated by reference as Exhibit 10.22 by and between the Company and each to Form 8-K dated June 30, 2006 and filed on of Joel Simon and Michael Salberg July 5, 2006. 14 Code of Ethics Incorporated by Reference as Appendix A to Definitive Proxy Statement filed October 22, 2004. 21 Subsidiary of the Company Incorporated by Reference as Exhibit 21 to Form 10-K dated June 30, 2006 and filed September 27, 2006 23 Consent of Independent Registered Filed herewith. Public Accounting Firm 31.1 Certification by Chief Executive Filed herewith. Officer 31.2 Certification by Principal Financial Filed herewith. and Accounting Officer 32 Section 1350 Certification Filed herewith. 33 SIGNATURE 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. Dated: January 29, 2007 MOVIE STAR, INC. By: /s/ Thomas Rende --------------------------------- Thomas Rende Chief Financial Officer (Principal Financial and Accounting Officer)