10-K 1 moviestar.txt FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------------------------------- FORM 10-K (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, 2003 or [ ] 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, NY 10010 (Address of Principal (Zip Code) Executive Offices) Registrant's telephone number including area code (212) 684-3400 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock, $.01 par value American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes X No ------ ------- The aggregate market value of voting stock held by nonaffiliates of the Registrant totaled $26,861,252 on August 29, 2003, based upon the closing price of $2.30 at the close of trading on August 29, 2003. As of August 29, 2003, there were 15,536,975 common shares outstanding. DOCUMENTS INCORPORATED BY REFERENCE See Item 15 with respect to exhibits to this Form 10-K which are incorporated herein by reference to documents previously filed or to be filed by the Registrant with the Commission. MOVIE STAR, INC. 2003 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PART I Page No. Item 1 Business.................................................I-1 Item 2 Properties...............................................I-5 Item 3 Legal Proceedings........................................I-5 Item 4 Submission of Matters to a Vote of Shareholders.................................... I-6 PART II Item 5 Market for Company's Common Stock and Related Shareholder Matters.............................II-1 Item 6 Selected Financial Data.................................II-3 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations...................................II-5 Item 7A Quantitative and Qualitative Disclosures About Market Risk .....................................II-12 Item 8 Financial Statements and Supplementary Data.......................................F-1 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....II-14 Item 9A Controls and Procedures ...............................II-14 PART III Item 10 Executive Officers and Directors of the Company.........................................III-1 Item 11 Executive Compensation.................................III-2 Item 12 Security Ownership of Certain Beneficial Owners and Management..................................III-7 Item 13 Certain Relationships and Related Transactions...................................III-8 Item 14 Principal Accounting Fees and Services................ III-8 PART IV Item 15 Exhibits, Financial Statement Schedule and Reports on Form 8-K........................IV-1 PART I ITEM 1. BUSINESS (a) Movie Star, Inc. ("the Company"), a New York corporation organized in 1935, designs, manufactures, markets and sells an extensive line of ladies' sleepwear, robes, leisurewear, loungewear, panties and daywear. During fiscal 2001, the Company discontinued its retail operations. The Company's products consist of ladies' pajamas, nightgowns, baby dolls, nightshirts, dusters, shifts, caftans, sundresses, rompers, short sets, beachwear, peignoir ensembles, robes, leisurewear, panties, and daywear consisting of bodysuits, soft bras, slips, half-slips, teddies, camisoles and cami top sets. These products are manufactured in various fabrics, designs, colors and styles depending upon seasonal requirements, changes in fashion and customer demand. Between 1992 and 1997, as a result of consolidations in the retail industry, the high cost of domestic manufacturing and difficulties the Company had encountered in engaging reliable offshore contractors and obtaining sufficient quantities of acceptable quality finished products from overseas, the Company experienced a loss of sales to certain of its customers. In fiscal 1998, the Company began to regain a portion of the sales it had lost by creating new designs at competitive prices and by improving on-time delivery and the quality of its products. The Company has shifted its production to offshore based contractors and has developed an infrastructure that has given the Company greater control over its operations, quality and on-time delivery. The Company maintains an in-house design staff which affords it the flexibility to work with merchandise buyers on fashion design and price points. (b) Intentionally omitted. (c) (i) The Company's products are sold to discount, specialty, national and regional chain, mass merchandise and department stores and direct mail catalog marketers throughout the United States. The prices to consumers for the Company's products range from approximately $6.00 for certain of its products, such as panties, to approximately $85.00 for certain other products, such as peignoir sets. The Company's products are sold by in-house sales personnel and outside manufacturer's representatives. Approximately 45% of the Company's sales are made to mass merchandisers, 19% to national chains, and 18% to department stores; the balance of the Company's sales are unevenly distributed among discount, specialty, regional chain stores and direct mail catalog marketers. The Company's gross profit on its sales for each of the fiscal years ended June 30, 2003, 2002, and 2001 was approximately 31.7%, 28.0% and 29.4%, respectively. The Company limits the promotion of its products to cooperative advertising in conjunction with its retail customers directed to the ultimate retail consumer of its products. (i) Not applicable. (ii) The Company utilizes a large variety of fabrics made from natural and man-made fibers including, among others, polyester, cotton, broadcloth, stretch terry, brushed terry, flannel, brushed flannel, nylon, spun polyester, velour, satins, tricot, jersey, fleece, jacquards, lace, stretch lace, charmeuse, chambray, micro fibers, spandex and various knit fabrics. These materials are available from a variety of both domestic and foreign sources. The sources are highly competitive in a world market. The Company expects these competitive conditions to continue in the foreseeable future. Generally, the Company has long-standing relationships with its domestic and foreign suppliers and purchases its raw materials in anticipation of orders or as a result of need based on orders received. Purchase of raw materials in high volume provides the Company with the opportunity to buy at relatively low prices. In turn, the Company is able to take advantage of these lower prices in the pricing of its finished goods. I-1 The Company has historically produced its products either at one of its domestic facilities or by purchasing them from a finished package manufacturer or by contracting for their assembly from a cut, make and trim manufacturer ("CMT"). Due to the Company's strategic decision to take advantage of lower labor costs by purchasing more of its finished goods offshore, the Company has eliminated its domestic production and increased its finished package purchases. Domestic production decreased from 2.5% of total production in fiscal 2001 to less than 1% in fiscal 2002 and no domestic production in fiscal 2003. The purchase of finished packages increased from 49.5% of total production in fiscal 2001 to 70% in fiscal 2002 and 68% in fiscal 2003. CMT production was 48% of total production in fiscal 2001, 30.0% in fiscal 2002 and 32% in fiscal 2003. The following table sets forth a list of the countries from which the Company has purchased finished goods and in which the Company has contracted for the assembly of its products, including the approximate percentage of the Company's total production allocable to each country:

2003 2002 ---- ---- CMT FG Purchased Total CMT FG Purchased Total ---- ------------ ----- ---- ------------ ----- Bangladesh - % 14.0% 14.0% - % 7.0% 7.0% Cambodia - 12.5 12.5 - 13.0 13.0 Dominican Republic 14.0 - 14.0 - - - Mexico 9.0 4.0 13.0 14.0 10.0 24.0 Pakistan - 10.0 10.0 - 12.0 12.0 Philippines 9.0 23.0 32.0 15.0 23.0 38.0 Other - 4.5 4.5 1.0 5.0 6.0 ------ ------- ------- ------- ------ ------- Total Production 32.0% 68.0% 100.0% 30.0% 70.0% 100.0% ====== ======= ======= ======= ====== =======

Currently, the Company has one employee in Mexico, three employees in Bangladesh, two employees in the Dominican Republic and eight employees in the Philippines supervising the production of finished products purchased by the Company or assembled for the Company by CMT manufacturers in those countries. These employees assist in maintaining quality and on-time delivery. Management personnel travel to Mexico, Asia and the Caribbean throughout the year to monitor the performance of the Company's offshore manufacturers and contractors. In order to facilitate the coordination of its production in the Philippines, which has increased from 28% of total production in 2001 to 38% of total production in 2002 and 32% of total production in 2003, the Company opened a representative office in the Philippines in 2002. The office is being utilized primarily for administrative and manufacturing support functions, as well as sample making and pattern making. The Company's transactions with its foreign manufacturers and suppliers are subject to the risks of doing business abroad. The Company's import and offshore operations are subject to constraints imposed by agreements between the United States and a number of foreign countries in which the Company does 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. The Company's imported products are also subject to United States customs duties and, in the ordinary course of business, the Company is 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 the Company's 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 the Company's operations and its ability to continue to import products at current or increased levels. The Company cannot predict the likelihood or frequency of any such events occurring. I-2 The Company believes it maintains adequate inventories to cover the needs of its customers. (iii) The Company has several registered trademarks, of which "Movie Star", "Movie Star Loungewear", "Cinema Etoile", "Seductive Wear", "Meant To Be", "Cine Jour", "Private Property", "Heather Nicole" and "Night Magic" are material to the marketing by the Company of its products. There is no litigation with respect to patents, licenses and trademarks. (iv) The Company manufactures a wide variety of intimate apparel in many different styles and sizes and for use in all seasons and climates in the United States. Because of its product mix, it is subject to certain seasonal variations in sales. Historically, more than 50% of the Company's sales have been made in the first six months of its fiscal year. In fiscal 2003, the Company's sales were evenly distributed between the first and second half of the year. (v) All sales are outright sales. Terms are generally net 10 days E.O.M. or net 30 days from the date the goods are shipped which, depending on date of shipment, can be due from as short a period as twenty-one days or as long as fifty days. It has become industry practice to extend payment terms up to an additional thirty days for certain customers. Although sales are made without the right of return, in certain instances the Company may accept returns or agree to allowances. The Company maintains sufficient inventories of raw materials and finished goods to meet its production requirements and the delivery demands of its customers. As a result, the Company relies on its short-term line of credit to supplement internally generated funds to fulfill its working capital needs. (vi) Wal-Mart accounted for 42% of sales for fiscal 2003, 32% of sales for fiscal 2002, and 27% for fiscal 2001. Sears, Roebuck and Company accounted for 10% of sales for fiscal 2003, 13% of sales for fiscal 2002 and 13% for fiscal 2001. Target accounted for 4% sales for fiscal 2003, 7% of sales for fiscal 2002, and 11% for fiscal 2001. Purchasing decisions by the Company's customers with respect to each group of the Company's products and, in some instances, products within a group, generally are made by different buyers and purchasing departments. The Company believes that the loss of orders from any one buyer or purchasing department would not necessarily result in the loss of sales to other buyers or purchasing departments of those customers. (vii) The backlog of orders was approximately $27,420,000 as of June 30, 2003, $32,561,000 as of June 30, 2002 and $31,700,000 as of June 30, 2001. The lower backlog of orders this year is due primarily to certain major customers placing spring orders later this year than last year. Orders are booked upon receipt. The Company believes that the current backlog is firm and will be filled by the end of the current fiscal year. (viii) There is no material portion of the business which may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government. (ix) The intimate apparel business is fragmented and highly competitive. The industry is characterized by a large number of small companies manufacturing and selling unbranded merchandise, and by several large companies which have developed widespread consumer recognition of the brand names associated with merchandise manufactured and sold by these companies. In addition, certain of the larger retailers to whom the Company has historically sold its products have sought to expand the development and marketing of their own brands and to obtain intimate apparel products directly from similar sources as the Company. Owning manufacturing facilities has required the investment of substantial capital and subjected the Company to the costs of maintaining excess capacity. Competitive conditions in the industry have required the Company to place greater reliance on obtaining raw materials and finished products from sources outside the United States. As a result, the Company has eliminated the production in its domestic plants. Between August 1990 and June 2000, the Company has closed eighteen manufacturing plants in an effort to lower costs by reducing excess manufacturing capacity and in response to the need to produce and purchase products at a lower cost from sources outside the United States. I-3 The intimate apparel industry is further characterized by competition on the basis of price, quality, efficient service and prompt delivery. Because of this competitive pressure, the Company no longer relies on domestic manufacturing and relies entirely on offshore manufacturers and contractors. Accordingly, changes in import quotas, currency valuations and political conditions in the countries from which the Company imports products could adversely affect the Company's business. (x) No material research activities relating to the development of new products or services or the improvement of existing products or services were undertaken during the last fiscal year, except for the normal continuing development of new styles and marketing methods. (xi) There are no costs relating to complying with environmental regulations in the fiscal year just completed or over future periods of which the Company is aware. (xii) Of the approximately 240 full-time and 16 part-time employees of the Company, approximately 24 are executive, design and sales personnel, 87 are administrative personnel, and the balance are in distribution, warehousing and offshore support. The Company has never experienced an interruption of its operations because of a work stoppage. Even though the Company is subject to certain seasonal variations in sales, significant seasonal layoffs are rare. Employees have an interest in the Company's Common Stock through the Company's ESOP. The Company deems its relationship with its employees to be good. The Company is not a party to any collective bargaining agreement with any union. Restriction on Dividends Pursuant to the Company's secured revolving line of credit agreement with Rosenthal and Rosenthal, Inc., as amended, the Company is prohibited from making or declaring any dividend payments or setting apart any money for the purchase, redemption, retirement or other acquisition of any shares of the Company's stock. I-4 ITEM 2. PROPERTIES The following table sets forth all of the facilities owned or leased by the Company as of June 30, 2003.

Bldg. Owned or Area (sq. Expiration Productive Extent of Location Use Leased ft.) of Lease Capacity(2) Utilization(2) -------- --- -------- --------- ---------- ------------ -------------- 1115 Broadway, Executive and Leased 31,000 12/10 N/A N/A New York, NY Administrative offices; Divisional Sales Office and Showroom 180 Madison Ave., Sales Office Leased 3,000 03/06 N/A N/A New York, NY and Showroom Petersburg, PA Warehousing Owned 140,000 N/A N/A N/A for finished goods; Dis- tribution Center South Mississippi 1 Mfg. Leased (1) 212,000 11/20 N/A N/A Support/ Dist./Warehouse; Owned 27,000 N/A N/A N/A 1 Warehouse Philippines Administrative Leased 3,800 4/05 N/A N/A and Mfg. Support; Sample and Pattern Making

(1) Leased from municipalities. (2) "Productive Capacity" is based on the total number of employees that can be employed at a facility providing direct labor for the manufacture of the Company's products based on existing machinery and equipment and plant design. "Extent of Utilization" is the percentage obtained by dividing the average number of employees actually employed at a facility during the fiscal year providing direct labor for the manufacture of the Company's products by Productive Capacity. The Company no longer manufactures products at any of its facilities. The following table sets forth the amount of space allocated to different functions in shared facilities set forth in the preceding table.

AMOUNT OF SPACE LOCATION FUNCTION (Sq. ft.) -------- -------- --------- 1115 Broadway and 180 Madison Avenue Corporate Offices; 11,000 New York, New York Divisional Sales Offices and Showrooms; 11,000 Production Staff and Design 12,000 Petersburg, Pennsylvania Warehousing and Distribution; 137,000 Offices 3,000 Mississippi Manufacturing Support; 24,000 Warehousing and Distribution; 197,000 Offices 18,000 Philippines Administrative and Mfg. Support; 3,800 Sample and Pattern Making

ITEM 3. LEGAL PROCEEDINGS There are no legal proceedings pending which are material. I-5 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS None. I-6 PART II ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS The Common Stock is traded on the American Stock Exchange. The following table sets forth for the indicated periods the reported high and low prices per share. High Low ---- --- Year Ended June 30, 2003 First Quarter .................................... $ .50 $.32 Second Quarter ................................... .60 .36 Third Quarter..................................... 1.20 .51 Fourth Quarter.................................... 1.94 .91 Year Ended June 30, 2002 First Quarter..................................... $ .79 $.51 Second Quarter.................................... .72 .51 Third Quarter..................................... .57 .35 Fourth Quarter.................................... .65 .42 As of August 29, 2003, there were approximately 2,533 holders of record of the Common Stock. For restrictions on dividends, see Item 1 at page I-4. MARKET FOR COMPANY'S 12.875% SUBORDINATED DEBENTURE (per $1,000 par value) High Low ---- --- Year Ended June 30, 2002 First Quarter .................................... $ 1,000.00 $990.00 II-1 EQUITY COMPENSATION PLAN INFORMATION The following sets forth certain information as of June 30, 2003 concerning the Company's equity compensation plans:

Number of Shares Remaining Number of Shares to be Weighted-Average Available for Future Issued Upon Exercise of Exercise Price of Issuance Under Equity Outstanding Options, Outstanding Options, Compensation Plan Category Warrants and Rights Warrants and Rights Plans ------------- ----------------------- ------------------- --------------------------- Equity compensation plans approved by shareholders 1988 Non-Qualified Stock Option Plan 75,000 $ .63 1,591,666 1994 Incentive Stock Option Plan 845,000 .66 825,000 2000 Performance Equity Plan 290,000 .83 460,000 ---------- ------- ---------- 1,210,000 .70 2,876,666 Equity compensation plans not approved by shareholders Warrant 50,000 .44 - ---------- ------- ---------- Total 1,260,000 $ .69 2,876,666 ========== ======= ==========

II-2 ITEM 6. SELECTED FINANCIAL DATA (In Thousands, Except Per Share Amounts) --------------------------------------------------------------------------------

Statement of Operations Data: Fiscal Years Ended June 30, 2003 2002 2001 2000 1999 Net sales $ 64,916 $ 54,359 $ 62,462 $ 62,483 $ 62,871 --------- --------- -------- -------- -------- Cost of sales 44,345 39,157 44,072 44,783 45,242 Selling, general and administrative expenses 14,623 13,689 14,869 13,797 13,058 Loss on closing of distribution facility - - 1,188 - - -------- --------- -------- -------- -------- 58,968 52,846 60,129 58,580 58,300 -------- --------- -------- -------- -------- Operating income from continuing operations 5,948 1,513 2,333 3,903 4,571 Gain on purchases of subordinated debentures and senior notes - - (482) (565) - Interest income (4) (3) (6) (145) (118) Interest expense 351 695 1,476 1,856 2,694 --------- --------- -------- -------- -------- Income from continuing operations before income taxes 5,601 821 1,345 2,757 1,995 Income taxes (benefit) 2,170 360 (695) 35 21 --------- --------- -------- -------- -------- Income from continuing operations 3,431 461 2,040 2,722 1,974 Income (loss) from discontinued operations - 86 (326) 398 699 --------- --------- -------- -------- -------- Net income $ 3,431 $ 547 $ 1,714 $ 3,120 $ 2,673 ========= ========= ======== ======== ======== BASIC NET INCOME (LOSS) PER SHARE: From continuing operations $.23 $.03 $ .14 $.18 $.14 From discontinued operations - .01 (.02) .03 .05 --------- --------- -------- -------- -------- Net income $.23 $.04 $ .12 $.21 $.19 ========= ========= ======== ======== ======== DILUTED NET INCOME (LOSS) PER SHARE: From continuing operations $.22 $.03 $ .13 $.17 $.13 From discontinued operations - .01 (.02) .03 .04 --------- --------- -------- -------- -------- Net income $.22 $.04 $ .11 $.20 $.17 ========= ========= ======== ======== ======== Basic weighted average number of shares outstanding 15,133 15,085 14,899 14,889 14,309 ========= ========= ======== ======== ======== Diluted weighted average number of shares outstanding 15,407 15,112 15,301 15,928 15,869 ========= ========= ======== ======== ========

(Continued) II-3 ITEM 6. Selected Financial Data (In Thousands, Except Per Share Amounts) --------------------------------------------------------------------------------

Balance Sheet Data: At June 30, 2003 2002 2001 2000 1999 WORKING CAPITAL $ 15,979 $ 9,529 $ 8,016 $ 17,345 $ 22,727 ========= ========= ======== ======== ======== TOTAL ASSETS $ 24,089 $ 22,406 $ 27,799 $ 31,627 $ 36,759 ========= ========= ======== ======== ======== SHORT-TERM DEBT - Including current maturities of long-term debt and capital lease obligations $ 2,304 $ 4,169 $ 10,327 $ 1,773 $ 45 ========= ========= ======== ======== ======== LONG-TERM DEBT - Including deferred lease and other long-term liabilities $ 325 $ 254 $ 183 $ 12,222 $ 20,814 ========= ========= ======== ======== ======== SHAREHOLDERS' EQUITY $ 17,264 $ 13,624 $ 13,021 $ 11,292 $ 8,166 ========= ========= ======== ======== ========

(Concluded) II-4 ITEM 7. 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 the Company's industry; general economic conditions; the addition or loss of significant customers; the loss of key personnel; product development; competition; foreign government regulations; fluctuations in foreign currency exchange rates; rising costs of raw materials and the unavailability of sources of supply; the timing of orders placed by the Company's customers; and the risk factors listed from time to time in the Company's SEC reports. We urge you to carefully read the following discussion in conjunction with these factors. 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 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 financial statements, located in the Annual Report on Form 10-K filed with the Securities and Exchange Commission. Management has identified certain critical accounting policies that are described below. Inventory - Inventory is carried at the lower of cost or market on a first-in, first-out basis. Management writes down inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. 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 our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company also estimates expenses for customer discounts, programs and incentive offerings. If market conditions were to decline, the Company 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, management performs an analysis of the anticipated undiscounted future net cash flows of the related long-lived assets. If the II-5 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, 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. Fiscal 2003 Compared to Fiscal 2002 ----------------------------------- Results of Continuing Operations ----------------------------------- Net sales for the year ended June 30, 2003 were $64,916,000 as compared to $54,359,000 in the comparable period in 2002. The increase in sales was due primarily to an increase in programs with the Company's primary customer and an overall net increase in programs with the remaining customer base. The gross profit percentage was 31.7% for the year ended June 30, 2003 as compared to 28.0% for the year ended June 30, 2002. The higher margins 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. Selling, general and administrative expenses were $14,623,000, or 22.5% of net sales, for the year ended June 30, 2003 as compared to $13,689,000, or 25.2% of net sales, for the similar period in 2002. This increase of $934,000 resulted primarily from increases in salary expense and salary related costs of $713,000, merchandising, design and sample expenses of $184,000 and an overall net increase in general overhead expenses offset by a decrease in bad debt expense of $162,000. Operating income from continuing operations increased to $5,948,000 for the year ended June 30, 2003, from $1,513,000 for the similar period in 2002. This increase was due to higher sales and margins partially offset by higher selling, general and administrative expenses. Interest income for the year ended June 30, 2003 was $4,000 as compared to $3,000 for 2002. Interest expense for the year ended June 30, 2003 was $351,000 as compared to $695,000 for 2002. This reduction was due to lower borrowing levels and lower interest rates. The Company provided for income taxes of $2,170,000 for the year ended June 30, 2003, as compared to $360,000 for the similar period in 2002. The Company recorded net income from continuing operations for the year ended June 30, 2003 of $3,431,000 as compared to $461,000 for the same period in 2002. This increase was due to higher sales and gross margins and lower interest costs II-6 partially offset by higher selling, general and administrative expenses and a larger provision for income taxes in the current year. Results of Discontinued Operations ---------------------------------- In December 2000, the Company decided to dispose of the majority of the assets of its retail division. Accordingly, the operating results of this division are classified as discontinued operations. There was no activity for the year ended June 30, 2003 as compared to income from discontinued operations of $86,000, net of income taxes for the similar period in 2002. The income in fiscal 2002 relates to the sale of certain assets that were fully depreciated. Net Income ---------- The Company had net income of $3,431,000 for the year ended June 30, 2003 as compared to $547,000 for the similar period in 2002. This increase was due to higher sales and gross margins and lower interest costs partially offset by higher selling, general and administrative expenses and a larger provision for income taxes in the current year, partially offset by income from discontinued operations in the prior year. Fiscal 2002 Compared to Fiscal 2001 ----------------------------------- Results of Continuing Operations ----------------------------------- Net sales for the year ended June 30, 2002 were $54,359,000 as compared to $62,462,000 in the comparable period in 2001. The decrease in sales was due primarily to a soft retail environment and a reduction in programs with certain customers. The gross profit percentage was 28.0% for the year ended June 30, 2002 as compared to 29.4% for the year ended June 30, 2001. The lower margins resulted primarily from increased pricing pressures from certain customers and an increase in the sale of excess inventory at discounted prices. Selling, general and administrative expenses were $13,689,000, or 25.2% of net sales, for the year ended June 30, 2002 as compared to $14,869,000, or 23.8% of net sales, for the similar period in 2001. This decrease of $1,180,000 resulted primarily from decreases in salary expense and salary related costs of $481,000, shipping expense of $380,000, commissions of $175,000, bad debt expense of $118,000, and a net decrease in general overhead expenses offset by an increase in rent related expenses of $476,000. The decrease in shipping expense was primarily due to the shutdown of the Company's Virginia distribution facility. The increase in rent related expenses was primarily due to an increase in rent at the Company's new offices in New York. During the second quarter of fiscal 2001, the Company implemented a plan to close the distribution operation at its Virginia facility and to consolidate these operations with the warehouse and distribution facility located in Mississippi. This decision was made to increase the overall efficiencies of the Mississippi facility and reduce overall shipping costs. The Company recorded a charge of $1,188,000 in connection with this closure. The charge consisted of a non-cash charge for the impairment of assets of $915,000 and other charges totaling $273,000. II-7 Operating income from continuing operations decreased to $1,513,000 for the year ended June 30, 2002, from $2,333,000 for the similar period in 2001. This decrease was due to lower sales, a decrease in gross margins partially offset by lower selling, general and administrative expenses and a charge for the closure of the Virginia distribution facility in the prior year. During fiscal 2001, the Company purchased $167,000 in principal amount of its 12.875% Subordinated Debentures and $5,283,000 in principal amount of its 8% Senior Notes. As a result of these purchases, the Company recorded a gain of $482,000, net of related costs. Interest income for the year ended June 30, 2002 was $3,000 as compared to $6,000 for 2001. Interest expense for the year ended June 30, 2002 was $695,000 as compared to $1,476,000 for 2001. This reduction was due to lower borrowing levels and interest rates. For the year ended June 30, 2002, the Company provided for a deferred tax, related to continuing operations of $360,000. For the year ended June 30, 2001, the Company recorded an alternative minimum tax of $18,000, a deferred tax of $524,000 and recognized a tax benefit of $1,237,000 related to the reversal of a valuation allowance on the deferred tax asset. The Company reversed its deferred tax valuation allowance because it was considered more likely than not that the Company would utilize the entire asset. The Company recorded net income from continuing operations for the year ended June 30, 2002 of $461,000 as compared to $2,040,000 for the same period in 2001. This reduction was primarily due to a decrease in sales and gross margins in the current year partially offset by a decrease in selling, general and administrative expenses and net interest costs. The Company also recorded a tax expense in the current year as compared to an overall tax benefit in the prior year, recorded a loss on the disposal of the Virginia distribution facility in the prior year and a gain in the prior year on the purchases of the Company's 12.875% Subordinated Debentures and 8% Senior Notes. Results of Discontinued Operations ---------------------------------- In December 2000, due to the continued decline in performance of the Company's retail division, the Company decided to dispose of the majority of the assets of this division. Accordingly, the operating results of this division have been reclassified as income from discontinued operations. In the second quarter ended December 31, 2000, the Company recorded a loss on the disposal of the retail stores of $448,000, net of a benefit from income taxes of $299,000. The estimated loss on disposal provided for the write-down of assets to the estimated market value, the loss on fulfilling lease obligations and the costs of disposal. At the end of March 2001, the Company had closed all of its stores and had disposed of all of its inventory. The retail division had income from discontinued operations of $86,000 for the year ended June 30, 2002 as compared to $122,000 for the similar period in 2001. Net Income ---------- The Company had net income of $547,000 for the year ended June 30, 2002 as compared to $1,714,000 for the similar period in 2001. This reduction was primarily due to a decrease in sales and gross margins in the current year partially offset by a decrease in selling, general and administrative expenses II-8 and net interest costs. The Company also recorded a tax expense in the current year as compared to an overall tax benefit in the prior year, recorded a loss on the disposal of the Virginia distribution facility in the prior year and a gain in the prior year on the purchases of the Company's 12.875% Subordinated Debentures and 8% Senior Notes. The results of the discontinued operations had a positive effect on the current year's net income as compared to a loss in the prior year. Contractual Obligations and Commercial Commitments -------------------------------------------------- To facilitate an understanding of our contractual obligations and commercial commitments, the following data is provided as of June 30, 2003 (in thousands):

Payments Due by Period ------------------------------------------------- Within After 5 Total 1 Year 2-3 Years 4-5 Years Years ----------- ---------- --------- --------- -------- Contractual Obligations Credit Facility $ 2,277 $ 2,277 $ - $ - $ - Capital Leases 27 27 - - Operating Leases 8,937 1,178 2,398 2,310 3,051 Consulting Agreement 900 225 450 225 Employment Contract 2,150 500 1,075 575 - --------- --------- --------- -------- -------- Total Contractual Obligations $ 14,291 $ 4,207 $ 3,923 $ 3,110 $ 3,051 ========= ========= ========= ======== ======== 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 $ 6,165 $ 6,165 $ - $ - $ - --------- --------- --------- -------- -------- Total Commercial Commitments $ 6,165 $ 6,165 $ - $ - $ - ========= ========= ========= ======== ========

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, 2003, the Company's working capital increased by $6,450,000 to $15,979,000, primarily from profitable operations. During the fiscal year ended June 30, 2003, cash increased by $4,000. The Company used cash of $1,852,000 for the net reduction of its short-term borrowings, $43,000 for the payment of capital lease obligations and $181,000 for the purchase of fixed assets. These activities were funded by cash generated from operating activities of $1,871,000 and the exercise of employee stock options of $209,000. Receivables at June 30, 2003 increased by $1,991,000 to $8,992,000 from $7,001,000 at June 30, 2002. This increase is due to higher sales in the fourth II-9 quarter of 2003 as compared to the prior year. Inventory at June 30, 2003 increased by $1,595,000 to $10,392,000 from $8,797,000 at June 30, 2002. The increase is primarily due to an increase in finished goods, which are required for replenishment business. The Company has 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 the Company's 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 Chase Manhattan Bank but not less than 4.25% per annum. Availability under the line of credit is subject to the Company's compliance with certain agreed upon financial formulas. Under the terms of this financing, the Company has agreed to pledge substantially all of its assets, except the Company's real property. Management believes the available borrowing under its secured revolving line of credit, along with anticipated internally generated funds, will be sufficient to cover its working capital requirements through July 1, 2004. The Company anticipates that capital expenditures for fiscal 2004 will be less than $400,000. Effect of New Accounting Standards ---------------------------------- In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The provisions of SFAS No. 143 are effective for fiscal years beginning after June 15, 2002. The Company adopted SFAS No. 143 in the first quarter of fiscal 2003. The adoption of SFAS No. 143 did not have a material impact on the Company's results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The primary objectives of SFAS No. 144 were to develop one accounting model based on the framework established in SFAS No. 121, and to address significant implementation issues. The provisions of SFAS No. 144 are effective for fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 in the first quarter of fiscal 2003. The adoption of SFAS No. 144 did not have a material impact on the Company's results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires companies to classify certain gains and losses from debt extinguishments as extraordinary items, eliminates the provisions of SFAS No. 44 regarding the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require that certain lease modifications be treated as sale leaseback transactions. The provisions of SFAS No. 145 related to the classification of debt extinguishment are effective for fiscal years beginning after May 15, 2002. Reclassification of the gains and losses related to debt extinguishment are required for all prior periods presented in comparative financial statements. Accordingly, the Company has adjusted the statements of income to reclassify its extraordinary gains of $482,000 ($289,000 net of income taxes) and $401,000 ($393,000 net of income taxes) to "Gain on purchases of subordinated debentures and senior notes" for fiscal 2001 and 2000, respectively. The adoption of SFAS No. 145 does not have a material impact on the Company's financial position. II-10 In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," replacing Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred instead of at the date an entity commits to an exit plan. This statement also established that fair value is the objective for initial measurement of the liability. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 had has not had a material impact on the Company's financial position. In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires certain guarantees to be recorded at fair value and requires a guarantor to make significant new disclosures, even when the likelihood of making any payments under the guarantee is remote. Generally, FIN 45 applies to certain types of financial guarantees that contingently require the guarantor to make payments to the guaranteed party based on changes in an underlying (i.e. change in interest rate) that is related to an asset, liability, or an equity security of the guaranteed party. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Disclosure requirements under FIN 45 are effective for financial statements for periods ending after December 15, 2002 and are applicable to all guarantees issued by the guarantor subject to FIN 45's scope, including guarantees issued prior to FIN 45. We have evaluated the accounting provisions of this interpretation and there was no material impact on our financial condition, results of operations or cash flows for the year ended June 30, 2003. The Company has no guarantees as defined by FIN 45. 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 148 in the accompanying financial statements. 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 Company does not expect the adoption of this pronouncement to have a material effect on the results of operations or financial position. II-11 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 Company does not expect the adoption of this pronouncement to have a material effect on the results of operations or financial position. Inflation --------- The Company does not believe that its operating results have been materially affected by inflation during the preceding three years. There can be no assurance, however, that the Company's operating results will not be affected by inflation in the future. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is subject to changes in the prime rate based on the Federal Reserve actions and general market interest fluctuations. The Company believes that moderate interest rate increases will not have a material adverse impact on its 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 ------- The Company's transactions with its foreign manufacturers and suppliers are subject to the risks of doing business abroad. The Company's import and offshore operations are subject to constraints imposed by agreements between the United States and a number of foreign countries in which the Company does 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. The Company's imported products are also subject to United States customs duties and, in the ordinary course of business, the Company is 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 the Company's 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 the Company's operations and its ability to continue to import products at current or increased levels. The Company cannot predict the likelihood or frequency of any such events occurring. II-12 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-K 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-K. In assessing forward-looking statements contained herein, readers are urged to carefully read those statements. II-13 ITEM 8. INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Movie Star, Inc.: We have audited the accompanying balance sheet of Movie Star, Inc. as of June 30, 2003, and the related statements of income, shareholders' equity and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the index at Item 15(a)(2) for the year ended June 30, 2003. 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Movie Star, Inc. as of June 30, 2003, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such 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. /s/ Mahoney Cohen & Company, CPA, P.C. Mahoney Cohen & Company, CPA, P.C. New York, New York August 11, 2003 F-1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Movie Star, Inc.: We have audited the accompanying balance sheet of Movie Star, Inc. as of June 30, 2002, and the related statements of income, shareholders' equity and cash flows for each of the two years in the period ended June 30, 2002. Our audits also included the financial statement schedule listed in the index at Item 15(a)(2) for the two years in the period ended June 30, 2002. 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Movie Star, Inc. as of June 30, 2002, and the results of its operations and its cash flows for each of the two years in the period ended June 30, 2002 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such 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. /s/ Deloitte & Touche LLP Deloitte & Touche LLP Parsippany, New Jersey August 20, 2002 (Except for the adjustments referred to in Note 1 relating to the adoption of Financial Accounting Standards Board Statement No. 145 for which the date is September 25, 2003) F-2 MOVIE STAR, INC. BALANCE SHEETS JUNE 30, 2003 AND 2002 (In Thousands, Except Number of Shares) --------------------------------------------------------------------------------

ASSETS 2003 2002 CURRENT ASSETS: Cash $ 219 $ 215 Receivables, net 8,992 7,001 Inventory 10,392 8,797 Deferred income taxes 2,511 1,842 Prepaid expenses and other current assets 365 202 -------- -------- Total current assets 22,479 18,057 PROPERTY, PLANT AND EQUIPMENT - Net 1,153 1,350 DEFERRED INCOME TAXES 50 2,662 OTHER ASSETS 407 337 -------- -------- TOTAL ASSETS $ 24,089 $ 22,406 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable $ 2,277 $ 4,129 Current maturities of capital lease obligations 27 40 Accounts payable 2,888 3,355 Accrued expenses and other current liabilities 1,308 1,004 -------- -------- Total current liabilities 6,500 8,528 -------- -------- CAPITAL LEASE OBLIGATIONS - 30 -------- -------- DEFERRED LEASE LIABILITY 224 140 -------- -------- OTHER LONG-TERM LIABILITY 101 84 -------- -------- COMMITMENTS AND CONTINGENCIES - - SHAREHOLDERS' EQUITY: Common stock, $.01 par value - authorized, 30,000,000 shares; issued 17,412,000 shares in 2003 and 17,102,000 shares in 2002 174 171 Additional paid-in capital 4,353 4,147 Retained earnings 16,355 12,924 -------- -------- 20,882 17,242 Less treasury stock, at cost - 2,017,000 shares 3,618 3,618 -------- -------- Total shareholders' equity 17,264 13,624 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 24,089 $ 22,406 ======== ========

See notes to financial statements. F-3 MOVIE STAR, INC. STATEMENTS OF INCOME YEARS ENDED JUNE 30, 2003, 2002 AND 2001 (In Thousands, Except Per Share Amounts) --------------------------------------------------------------------------------

2003 2002 2001 Net sales $ 64,916 $ 54,359 $ 62,462 Cost of sales 44,345 39,157 44,072 -------- -------- -------- Gross profit 20,571 15,202 18,390 Operating Expenses: Selling, general and administrative expenses 14,623 13,689 14,869 Loss on closing of distribution facility 1,188 -------- -------- -------- - - Operating income from continuing operations 5,948 1,513 2,333 Gain on purchases of subordinated debentures and senior notes - - (482) Interest income (4) (3) (6) Interest expense 351 695 1,476 -------- -------- -------- Income from continuing operations before income taxes 5,601 821 1,345 Income taxes (benefit) 2,170 360 (695) -------- -------- -------- Income from continuing operations 3,431 461 2,040 Discontinued operations: Income from operations of discontinued retail stores, net of income taxes - - 122 Gain (loss) on disposal of discontinued retail stores, including provision for operating losses during phase-out period, net of income taxes - 86 (448) -------- -------- -------- Net income $ 3,431 $ 547 $ 1,714 ======== ======== ======== BASIC NET INCOME (LOSS) PER SHARE: From continuing operations $ .23 $ .03 $ .14 From discontinued operations - .01 (.02) -------- -------- -------- Net income per share $ .23 $ .04 $ .12 ======== ======== ======== DILUTED NET INCOME (LOSS) PER SHARE: From continuing operations $ .22 $ .03 $ .13 From discontinued operations - .01 (.02) -------- -------- -------- Net income per share $ .22 $ .04 $ .11 ======== ======== ======== Basic weighted average number of shares outstanding 15,133 15,085 14,899 ======== ======== ======== Diluted weighted average number of shares outstanding 15,407 15,112 15,301 ======== ======== ========

See notes to financial statements. F-4 MOVIE STAR, INC. STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED JUNE 30, 2003, 2002 AND 2001 (In Thousands) --------------------------------------------------------------------------------

Additional Common Stock Paid-in Retained Treasury Stock Shares Amount Capital Earnings Shares Amount Total BALANCE, JUNE 30, 2000 16,914 $ 169 $4,078 $ 10,663 2,017 $(3,618) $11,292 Net income - - - 1,714 - - 1,714 Conversion of long-term debt for common stock 40 1 14 - - - 15 ------ ----- ------- -------- -------- -------- ------- BALANCE, JUNE 30, 2001 16,954 170 4,092 12,377 2,017 (3,618) 13,021 Net income - - - 547 - - 547 Conversion of long-term debt for common stock 148 1 55 - - - 56 ------ ----- ------- -------- -------- -------- ------- BALANCE, JUNE 30, 2002 17,102 171 4,147 12,924 2,017 (3,618) 13,624 Net income - - - 3,431 - - 3,431 Exercise of stock options 310 3 206 - - - 209 ------ ----- ------- -------- -------- -------- ------- BALANCE, JUNE 30, 2003 17,412 $174 $4,353 $16,355 2,017 $(3,618) $17,264 ====== ===== ======= ========= ======== ======== =======

See notes to financial statements. F-5 MOVIE STAR, INC. STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2003, 2002, AND 2001 (In Thousands) --------------------------------------------------------------------------------

2003 2002 2001 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $3,431 $ 547 $ 1,714 Adjustments to reconcile net income to net cash provided by continuing operating activities Depreciation and amortization 403 356 431 Provision for sales allowances and doubtful accounts 69 (67) 60 Deferred income taxes 1,943 411 (906) Deferred lease liability 84 110 30 Loss (gain) on discontinued operations - (86) 326 Gain on purchases of subordinated debentures and senior notes - - (482) Non-cash impairment charge - - 915 Loss on disposal of property, plant and equipment 19 - 24 (Increase) decrease in operating assets: Receivables (2,060) 925 41 Inventory (1,595) 3,150 1,162 Prepaid expenses and other current assets (163) 116 98 Other assets (114) (75) 242 Increase (decrease) in operating liabilities: Accounts payable (467) 503 (1,565) Accrued expenses and other liabilities 321 (288) (324) ------- ------ ------- Net cash provided by operating activities 1,871 5,602 1,766 ------- ------ ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment (181) (205) (555) Proceeds from sale of property, plant and equipment - 737 121 Proceeds from exercise of employee stock options 209 - - ------- ------ ------- Net cash provided by (used in) investing activities 28 532 (434) ------- ------ ------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment on and purchases of long-term debt and capital lease obligations (43) (6,537) (5,026) Net (repayment) proceeds from revolving line of credit (1,852) 395 2,044 ------- ------ ------- Net cash used in financing activities (1,895) (6,142) (2,982) ------- ------ ------- Net cash (used in) provided by discontinued operations - (38) 1,199 ------- ------ ------- NET (DECREASE) INCREASE IN CASH 4 (46) (451) CASH, BEGINNING OF YEAR 215 261 712 ------- ------ ------- CASH, END OF YEAR $ 219 $ 215 $ 261 ======= ====== =======

(Continued) F-6 MOVIE STAR, INC. STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2003, 2002, AND 2001 (In Thousands) --------------------------------------------------------------------------------

2003 2002 2001 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during period for: Interest $ 358 $ 863 $ 1,530 ======= ====== ======= Income taxes (net of refunds received) $ 43 $ (51) $ 69 ======= ====== ======= SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES: Conversion of long-term debt for common stock $ - $ (56) $ (15) Issuance of common stock - 56 15 ------- ------ ------- $ - $ - $ - ======= ====== =======

(Concluded) See notes to financial statements. F-7 MOVIE STAR, INC. NOTES TO FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 2003, 2002 AND 2001 -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business - Movie Star, Inc. (the "Company") is a New York corporation organized in 1935, which designs, manufactures, markets and sells an extensive line of ladies' sleepwear, robes, leisurewear, loungewear, panties and daywear. 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 inventory provision, sales return, allowance for doubtful accounts, allowance for sales discounts and lives of long-lived assets. 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 expenses for customer discounts, programs and incentive offerings. If market conditions were to decline, the Company may take actions to increase customer incentive offerings possibly resulting in an incremental expense 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 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 F-8 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. 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 - 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 common share and net income per diluted common share would have been as follows:

Years Ended June 30, 2003 2002 2001 Net Income, as reported $3,431 $547 $1,714 Add (deduct) net stock-based employee forfeitures (cost), net of taxes 146 (68) (66) ------- ------- ------ Pro forma net income $3,577 $479 $1,648 ======= ======= ====== Basic net income per share, as reported $.23 $ .04 $ .12 Add (deduct) net stock-based employee forfeitures (cost) per share .01 (.01) (.01) ------- ------- ------ Pro forma basic net income per share $.24 $ .03 $ .11 ======= ======= ====== Diluted net income per share, as reported $.22 $ .04 $ .11 Add (deduct) net stock-based employee forfeitures (cost) per share .01 (.01) - ------- ------- ------ Pro forma diluted net income per share $.23 $ .03 $ .11 ======= ======= ======

The fair value of each option-pricing model was calculated with the following weighted-average assumptions used for grants in 2003, 2002 and 2001, respectively; risk-free interest rate 4.0%, 4.0% and 4.2%; expected life 7 years; expected volatility of 69.99%, 69.22% and 59.12%. 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. Shipping and Handling Costs - Shipping and handling costs include warehousing, freight-out and other direct costs to deliver inventory to customers. Such amounts, which are included in selling, general and F-9 administrative expenses in the statements of income, aggregated approximately $1,917,000 in 2003, $1,984,000 in 2002 and $2,371,000 in 2001. Income Taxes - The Company follows SFAS No. 109, "Accounting for Income Taxes." 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 would be able to realize its deferred tax assets in the future, an adjustment to the deferred tax asset was not deemed necessary. Likewise, should the Company determine that it 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. Net Income Per Share - Basic income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted income per share also includes the dilutive effect of potential common shares outstanding during the period. Effect of New Accounting Standards In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The provisions of SFAS No. 143 are effective for fiscal years beginning after June 15, 2002. The Company adopted SFAS No. 143 in the first quarter of fiscal 2003. The adoption of SFAS No. 143 did not have a material impact on the Company's results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The primary objectives of SFAS No. 144 were to develop one accounting model based on the framework established in SFAS No. 121, and to address significant implementation issues. The provisions of SFAS No. 144 are effective for fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 in the first quarter of fiscal 2003. The adoption of SFAS No. 144 did not have a material impact on the Company's results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires companies to classify certain gains and losses from debt extinguishments as extraordinary items, eliminates the provisions of SFAS No. 44 regarding the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require that certain lease modifications be treated as sale leaseback transactions. The provisions of SFAS No. 145, related to the classification of debt extinguishment, are effective for fiscal years beginning after May 15, 2002. Reclassification of the gains and losses related to debt extinguishment are required for all prior periods presented in comparative financial statements. Accordingly, the Company has adjusted the statement of income to reclassify its extraordinary gain of $482,000 ($289,000 net of income taxes) to "Gain on purchases of subordinated debentures and senior notes" for the year ended June 30, 2001. The adoption of SFAS No. 145 does not have a material impact on the Company's financial position. The adjustment also resulted in the reclassification to income from continuing operations of the related tax amounts included in the disclosures of Note 9. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" replacing Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred instead of at the date an entity commits to an exit plan. This statement also established F-10 that fair value is the objective for initial measurement of the liability. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 had has not had a material impact on the Company's financial position. In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires certain guarantees to be recorded at fair value and requires a guarantor to make significant new disclosures, even when the likelihood of making any payments under the guarantee is remote. Generally, FIN 45 applies to certain types of financial guarantees that contingently require the guarantor to make payments to the guaranteed party based on changes in an underlying (i.e. change in interest rate) that is related to an asset, liability, or an equity security of the guaranteed party. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Disclosure requirements under FIN 45 are effective for financial statements for periods ending after December 15, 2002 and are applicable to all guarantees issued by the guarantor subject to FIN 45's scope, including guarantees issued prior to FIN 45. We have evaluated the accounting provisions of this interpretation and there was no material impact on our financial condition, results of operations or cash flows for the year ended June 30, 2003. The Company has no guarantees as defined by FIN 45. 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 148 in the accompanying financial statements. 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 Company does not expect the adoption of this pronouncement to 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 Company does not expect the adoption of this pronouncement to have a material effect on the results of operations or financial position. F-11 2. INVENTORY Inventory consists of the following: June 30, 2003 2002 (In Thousands) Raw materials $ 1,470 $1,499 Work-in process 655 640 Finished goods 8,267 6,658 ------- ------ $10,392 $8,797 ======= ====== 3. RECEIVABLES Receivables are comprised of the following: June 30, 2003 2002 (In Thousands) Trade $ 10,377 $ 8,321 Other 5 1 -------- ------- 10,382 8,322 Less allowance for doubtful accounts and sales discounts (1,390) (1,321) -------- ------- $8,992 $ 7,001 ======== ======= 4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following: June 30, 2003 2002 (In Thousands) Land, buildings and improvements $ 1,891 $ 1,890 Machinery and equipment 466 553 Office furniture and equipment 955 1,239 Leasehold improvements 264 248 ------- ------- 3,576 3,930 Less accumulated depreciation and amortization (2,423) (2,580) ------- ------- $ 1,153 $ 1,350 ======= ======= F-12 In September 2001, the Company sold its two non-operating facilities located in Virginia and a retail store from discontinued operations for $729,000 and $52,000, respectively. Depreciation expense of $359,000, $336,000 and $391,000 was recorded in fiscal 2003, 2002 and 2001, respectively. 5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities are comprised of the following: June 30, 2003 2002 (In Thousands) Insurance $ 335 $512 Salary, commissions and employee benefits 655 274 Other 318 218 ------ ------ $1,308 $1,004 ====== ====== 6. NOTES PAYABLE The Company amended and restated its credit agreement (the "Amended Credit Agreement"), effective June 30, 2001. The Amended Credit Agreement matures on July 1, 2004 and is subject to annual renewals thereafter. Under the agreement, the Company may borrow, in the aggregate, revolving loans and letters of credit, up to $30,000,000. Availability under the line of credit is subject to the Company's compliance based on financial formulas as outlined in the agreement. Pursuant to the terms of the agreement, the Company has pledged substantially all of its assets, except the Company's real property. Interest on outstanding borrowings is payable at the prime rate, but not less than 4.25 percent per annum. The Amended Credit Agreement contains financial covenants, with respect to tangible net worth, as defined, and working capital. Because compliance is based on management's estimates and actual results can differ from these estimates, compliance through fiscal 2004 cannot be assured. The Company believes the assumptions used are appropriate. Furthermore, the Company is prohibited from paying dividends or incurring additional indebtedness, as defined, outside the normal course of business. For the fiscal year ended June 30, 2003, under the credit agreement, the borrowings peaked at $10,055,000 and the average amount of borrowings was $6,352,000, with the weighted average interest rate of 4.84%. For the fiscal year ended June 30, 2002, under the credit agreement, the borrowings peaked at $15,783,000 and the average amount of borrowings was $7,806,000, with the weighted average interest rate of 5.99%. At June 30, 2003, the Company had borrowings of $2,277,000 outstanding under this line of credit at an interest rate of 4.25 percent and also had approximately $6,165,000 of outstanding letters of credit. At June 30, 2002, the Company had borrowings of $4,129,000 outstanding under this line of credit at an interest rate of 5.75 percent and also had approximately $6,184,000 of outstanding letters of credit. F-13 7. LONG-TERM DEBT Long-term debt consists of the following: June 30, 2003 2002 (In Thousands) Capital Lease Obligations $ 27 $ 70 Less current portion 27 40 ----- ----- Long-term debt $ - $ 30 ===== ===== 12.875% Subordinated Debentures - During fiscal 2001, the Company purchased an aggregate of $167,000 in principal of its 12.875% Subordinated Debentures. As a result of these purchases, the Company recorded a gain of $9,000, net of related costs. The Company applied the principal amount of the 12.875% Subordinated Debentures against the final payment on these debentures. In September 2001, the Company paid the remaining balance on its 12.875% Subordinated Debentures of $4,180,000 one-month early utilizing its Amended Credit Agreement. 8% Senior Notes - During fiscal 2001, the Company purchased $5,283,000 in principal amount of its 8% Senior Notes. As a result of these transactions, the Company recorded a gain of $473,000, net of related costs. The Company applied the principal amount of the 8% Senior Notes against the final payment. In June 2001, holders of $15,000 in principal amount of the 8% Convertible Senior Notes converted their Notes into 40,000 shares of the Company's common stock. In July 2001, holders of $55,500 in principal amount of the 8% Convertible Senior Notes converted their Notes into approximately 148,000 shares of the Company's common stock. In September 2001, the Company paid the remaining balance on its 8% Senior Notes of $2,284,000 at maturity utilizing its Amended Credit Agreement. 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. Capital Lease Obligations - The fair value of these securities are estimated based on quoted market prices. If no market quotes are available, interest rates that are currently available to the Company for issuance of the debt with similar terms and remaining maturities are used to estimate fair value of debt issues. The carrying value approximates the fair value. F-14 The fair value estimates are based on pertinent information available to management as of June 30, 2003 and 2002. 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 carryforwards. In fiscal 2001, the Company recognized an income tax benefit of $1,237,000 in connection with the complete reversal of the valuation allowance on its deferred tax assets. In the opinion of management, it is more likely than not that such deferred tax assets will be recovered. The income tax effects of significant items, comprising the Company's net deferred tax assets and liabilities, are as follows: June 30, 2003 2002 (In Thousands) Deferred tax liabilities: Differences between book and tax basis of property, plant and equipment $ 40 $ 76 ------ ------ Deferred tax assets: Difference between book and tax basis of inventory 880 854 Reserves not currently deductible 730 723 Operating loss carryforwards 888 2,900 Other 103 103 ------ ------ 2,601 4,580 ------ ------ Net deferred tax asset $2,561 $4,504 ====== ====== The provision for (benefit from) income taxes on continuing operations is comprised as follows: Years Ended June 30, 2003 2002 2001 (In Thousands) Current: Federal $ 126 $ (15) $ (9) State and local 101 22 2 ------ ----- ---- 227 7 (7) ------ ----- ---- Deferred Federal 1,652 300 (551) State and local 291 53 (137) ------ ----- ---- 1,943 353 (688) ------ ----- ---- $2,170 $360 $(695) ====== ===== ===== A tax provision (benefit) of $58,000 and $(218,000) was allocated to discontinued operations for the years ended June 30, 2002 and 2001, respectively. F-15 Reconciliation of the U.S. statutory rate with the Company's effective tax rate is summarized as follows:

Years Ended June 30, 2003 2002 2001 (In Thousands) Federal statutory rate 34.0 % 34.0 % 34.0 % Increase (decrease) in tax resulting from: Valuation allowance - - (143.3) State income taxes (net of federal tax benefits) 4.6 6.4 6.0 Other .1 2.2 .4 ------ ------ ------ Effective rate 38.7 % 42.6 % (102.9)% ====== ====== ======

As of June 30, 2003, the Company has net operating loss carryforwards of approximately $2,215,000 for federal income tax purposes that expire between the years 2009 and 2012 and credit carryforwards of approximately $103,000. 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, 2003 are as follows (in thousands): Fiscal Year Amount 2004 $ 1,178 2005 1,204 2006 1,194 2007 1,141 2008 1,169 Thereafter 3,051 ------- $ 8,937 ======= Rental expense for 2003, 2002 and 2001 was approximately $1,240,000, $1,210,000 and $734,000, respectively. F-16 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 June 30, 2003, the remaining financial liability of this agreement is $2,150,000. 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. On January 28, 2003, Mr. Knigin voluntarily surrendered and forfeited his options. 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. Guarantees - The Company has not provided any financial guarantees as of June 30, 2003. 11. 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 June 30, 2003 and 2002, the current portion, included in "Accrued expenses and other current liabilities," amounted to $12,000 and $10,000, respectively and the long-term portion, classified as "Other long-term liability," amounted to $101,000 and $84,000, 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 are primarily located throughout the United States and are not concentrated in any specific geographic region but are concentrated in the retail industry. One customer accounted for 42%, 32% and 27% of the Company's net sales in fiscal 2003, 2002 and 2001, respectively. Another customer accounted for 10%, 13% and 13% of the Company's net sales in fiscal 2003, 2002 and 2001, respectively, while another customer accounted for 4%, 7% and 11% of the Company's net sales in fiscal 2003, 2002 and 2001, 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 permits 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 F-17 reserves 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 845,000 shares at an exercise price ranging from $.625 to $1.125 per share are outstanding at June 30, 2003. Of the total options granted, 799,000 are presently exercisable. Options to purchase 330,000 shares have been exercised under this plan through June 30, 2003. 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 290,000 shares at an exercise price ranging from $.625 to $1.0625 per share are outstanding at June 30, 2003. Of the total options granted, 184,000 are presently exercisable. The Company also has a Key Employee Stock Option Plan covering the issuance of up to 1,667,000 shares of the Company's common stock. Options to purchase 75,000 shares at an exercise price of $.625 per share are outstanding at June 30, 2003. Of the total options granted, 60,000 are presently exercisable. The options typically vest over five years. Information with respect to stock options is as follows (shares in thousands):

2003 2002 2001 ----------------------- ---------------------- ----------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise FIXED OPTIONS Shares Price Shares Price Shares Price Outstanding - beginning of year 2,420 $ .68 2,560 $ .69 2,185 $.68 Granted 100 .54 100 .50 540 .86 Exercised (310) .67 - - - - Canceled (1,000) .65 (240) .78 (165) .98 -------- ------ ------ ------ ----- ---- Outstanding - end of year 1,210 $ .70 2,420 $ .68 2,560 $.69 ======== ====== ====== ====== ===== ==== Exercisable - end of year 1,043 $ .69 1,866 $ .68 1,576 $.68 ======== ====== ====== ====== ===== ==== Weighted-average fair value of options granted during the year $ .28 $ .22 $.36 ====== ====== ====

The following table summarizes information about stock options outstanding at June 30, 2003 (options in thousands):

Options Outstanding Options Exercisable ------------------------------------------------------------------------------ ------------------------------------ Weighted-Average Number Remaining Weighted- Weighted- Range of Outstanding at Contractual Average Exercisable at Average Exercise Prices June 30, 2003 Life in Yrs Exercise Price June 30, 2003 Exercise Price --------------- ----------------- --------------- -------------- ----------------- -------------- $.625 - $1.125 1,210 4.85 $.70 1,043 $.69

Warrant - In October 1998, in connection with an agreement with a financial consulting firm, the Company granted a warrant to purchase 50,000 shares of its common stock at $.4375 per share to the consultants. The warrant is exercisable at anytime within ninety days F-18 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. 14. 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):

Years Ended June 30, 2003 2002 2001 (In Thousands, Except Per Share) Basic: Income from continuing operations $ 3,431 $ 461 $ 2,040 Income (loss) from discontinued operations - 86 (326) ---------- ------ ------- Net income $ 3,431 $ 547 $ 1,714 ========== ====== ======= Weighted average number of shares outstanding 15,133 15,085 14,899 ========== ====== ======= Basic net income (loss) per share: From continuing operations $ .23 $ .03 $ .14 From discontinued operations - .01 (.02) ---------- ------ ------- Basic net income per share $ .23 $ .04 $ .12 ========== ====== ======= Years Ended June 30, 2003 2002 2001 (In Thousands, Except Per Share) Diluted: Income from continuing operations $ 3,431 $ 461 $ 2,040 Interest Expense on 8% Convertible Senior Notes - - 6 ---------- ------ ------- Adjusted income from continuing operations 3,431 461 2,046 Income (loss) from discontinued operations - 86 (326) ---------- ------ ------- Adjusted net income $ 3,431 $ 547 $ 1,720 ========== ====== ======= Weighted average number of shares outstanding 15,133 15,085 14,899 Shares Issuable Upon Conversion of 8% Convertible Senior Notes - - 187 Shares Issuable Upon Conversion of Stock Options 258 18 197 Shares Issuable Upon Conversion of Warrants 16 9 18 ---------- ------ ------- Total average number of equivalent shares outstanding 15,407 15,112 15,301 ========== ====== ======= Diluted net income (loss) per share: From continuing operations $ .22 $ .03 $ .13 From discontinued operations - .01 (.02) ---------- ------- ------- Diluted net income per share $ .22 $ .04 $ .11 ========== ======= =======

F-19 15. LOSS ON CLOSING OF DISTRIBUTION FACILITY During fiscal 2001, the Company recorded facility closing costs of $273,000 relating to a plan to close the distribution facility in Lebanon, Virginia. The action was taken by the Company to enhance the Company's competitiveness, to reduce expenses and to improve efficiencies. The Company periodically reviews the recorded value of its long-lived assets to determine if the carrying amount of those assets may not be recoverable based upon the future operating cash flows expected to be generated by those assets. In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets to Be Disposed Of," during the second quarter of fiscal 2001, based upon management's decision to close the distribution facility, the Company recorded a non-cash impairment charge of $915,000 related to the write-down of a portion of the recorded property, plant and equipment values. Since the sum of the undiscounted expected future cash flows was less than the carrying amount of the asset, the asset was considered impaired. An impairment loss was measured as the amount by which the carry amount of the asset exceeds the fair value of the asset, which was based upon quoted market price, less the cost to sell the property. The Company discontinued depreciating this asset and it was sold for $630,000 in September 2001. In conjunction with the closing of the facility, the Company eliminated sixty-three positions and provided severance to certain employees. The Company recorded severance and related taxes of $138,000 in fiscal 2001. The Company paid the remaining severance costs in fiscal 2002. The Company recorded exit costs of $135,000 associated with the shutdown of the distribution facility during fiscal 2001. Such costs include employee salaries and benefits and other costs to be incurred after operations cease. The Company completed the closure in the fourth quarter of fiscal 2001. The Company paid the remaining exit costs in fiscal 2002. 16. DISCONTINUED OPERATIONS In December 2000, management authorized the shutdown of the retail segment and ceased all operations in March 2001. Accordingly, operating results of this segment, for the years ended June 30, 2002 and 2001 have been reclassified as income from discontinued operations. The estimated loss on disposal provided for the write-down of assets to the estimated market value of $102,000, the loss on fulfilling lease obligations of $94,000, the costs of disposal of $201,000 and future operating losses of $350,000. Accordingly, the Company had recorded an estimated loss on disposal of $448,000, net of a benefit from income taxes of $299,000, for the year ended June 30, 2001. In fiscal 2002, the Company recorded income on the disposal of its discontinued operations of $144,000. This related primarily to the sale of a retail store in excess of its estimated realizable value and the favorable negotiation on its lease terminations. The Company also reclassified the income from discontinued operations of $86,000 and $122,000, net of income taxes of $58,000 and $81,000 for the years ended June 30, 2002 and 2001, respectively, to income from operations of discontinued retail stores. F-20 Operating results of discontinued operations are as follows (in thousands): Years Ended June 30, 2003 2002 2001 Net sales $ - $ - $4,342 Costs and expenses - (144) 4,886 Income taxes - 58 (218) ------ ------ ------ Net income (loss) from discontinued operations $ - $ 86 $ (326) ====== ====== ====== The net assets and liabilities of discontinued operations included in the accompanying balance sheets are as follows (in thousands): June 30, 2003 2002 Deferred income taxes $ - $160 ---- ---- Total assets of discontinued operations $ - $160 ==== ==== Accounts payable $ - $ 6 ---- ---- Total liabilities of discontinued operations $ - $ 6 ==== ==== 17. UNAUDITED SELECTED QUARTERLY FINANCIAL DATA

Quarter First Second Third Fourth (In Thousands, Except Per Share) Fiscal Year Ended June 30, 2003 Net sales $15,780 $16,689 $16,934 $15,513 Gross profit 4,686 5,263 5,617 5,005 Net income 670 751 961 1,049 Basic net income per share (a): .04 .05 .06 .07 Diluted net income per share (a): .04 .05 .06 .07

F-21

Quarter First Second Third Fourth (In Thousands, Except Per Share) Fiscal Year Ended June 30, 2002 Net sales $14,911 $15,210 $13,528 $10,710 Gross profit 4,150 4,461 3,781 2,810 Income (loss) from continuing operations 258 395 180 (372) Income from discontinued operations 43 - - 43 Net income (loss) 301 395 180 (329) Basic net income (loss) per share (a): From continuing operations .02 .03 .01 (.02) From discontinued operations - - - - Net income (loss) .02 .03 .01 (.02) Diluted income (loss) per share (a): From continuing operations .02 .03 .01 (.02) From discontinued operations - - - - Net income (loss) .02 .03 .01 (.02)

(a) Quarterly net income (loss) per share amounts may not add to the total for the full year amount, due to rounding. ******* F-22 Schedule II MOVIE STAR, INC. VALUATION AND QUALIFYING ACCOUNTS (In Thousands) --------------------------------------------------------------------------------

Column A Column B Column C Column D Column E Additions Balance at Charged to Balance at Beginning Costs and End of Description of Period Expenses Deductions Period FISCAL YEAR ENDED JUNE 30, 2003: Allowance for doubtful accounts $ 406 $ - $ (26) (a) (41) (b) $ 339 Allowance for sales discounts and allowances 915 4,698 (4,562) 1,051 -------- --------- --------- -------- $ 1,321 $ 4,698 $ (4,629) $ 1,390 ======== ========= ========= ======== FISCAL YEAR ENDED JUNE 30, 2002: Allowance for doubtful accounts $ 284 $ 122 $ - $ 406 Allowance for sales discounts and allowances 1,103 3,565 (3,753) 915 -------- --------- --------- -------- $ 1,387 $ 3,687 $ (3,753) $ 1,321 ======== ========= ========= ======== FISCAL YEAR ENDED JUNE 30, 2001: Allowance for doubtful accounts $ 159 $ 248 $ (123) (a) $ 284 Allowance for sales discounts and allowances 1,168 4,514 (4,579) 1,103 ======== ========= ========= ======== $ 1,327 $ 4,762 $ (4,702) $ 1,387 ======== ========= ========= ========

(a) Uncollectible accounts written off. (b) Reduction in allowance. S-1 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ITEM 9A. CONTROLS AND PROCEDURES An evaluation of the effectiveness of the Company's disclosure controls and procedures as of June 30, 2003 was made under the supervision and with the participation of the Company's management, including the chief executive officer and chief financial officer. Based on that evaluation, they concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. During the most recently completed fiscal quarter, there has been no significant change in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. II-14 PART III ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY Director Since Name Age Position -------------- ---- --- -------- 1981 Mark M. David 56 Chairman of the Board 1997 Melvyn Knigin 60 President, Chief Executive Officer and Director 1983 Saul Pomerantz 54 Executive Vice President, Chief Operating Officer, Secretary and Director 1996 Joel M. Simon 58 Director 1996 Gary W. Krat 55 Director 2001 Michael A. Salberg 51 Director Officer Since ------------- 1999 Thomas Rende 42 Chief Financial Officer Mark M. David was re-elected Chairman of the Board on November 19, 2002. Effective as of July 1, 1999, Mr. David retired as a full-time executive employee of the Company. Mr. David relinquished the position of Chief Executive Officer in February 1999, but remained as Chairman of the Board. He had been Chairman of the Board and Chief Executive Officer from December 1985 to August 1995 and from April 1996 until February 1999, President from April 1983 to December 1987 and Chief Operating Officer of the Company since the merger with Stardust Inc. in 1981 until December 1987. Prior to the merger, he was founder, Executive Vice President and Chief Operating Officer of Sanmark Industries Inc. Melvyn Knigin was re-elected Chief Executive Officer and to the Board of Directors on November 19, 2002. Mr. Knigin had been appointed Chief Executive Officer in February 1999. Mr. Knigin was appointed to fill a vacancy on the Board of Directors and promoted to Senior Vice President and Chief Operating Officer on February 5, 1997 and was promoted to President on September 4, 1997. Since joining the Company in 1987, he was the President of Cinema Etoile, the Company's upscale intimate apparel division. Prior to joining the Company, he had spent most of his career in the intimate apparel industry. Saul Pomerantz, CPA, was re-elected to the Board of Directors and Chief Operating Officer on November 19, 2002. Mr. Pomerantz had been appointed Chief Operating Officer in February 1999. Mr. Pomerantz was elected Senior Vice President on December 3, 1987 and was promoted to Executive Vice President on September 4, 1997. Previously, he was Vice President-Finance since 1981. He was Chief Financial Officer from 1982 to February 1999 and has been Secretary of the Company since 1983. Thomas Rende was re-elected Chief Financial Officer on November 19, 2002. Mr. Rende had been appointed Chief Financial Officer in February 1999. Since joining Movie Star in 1989, Mr. Rende has held various positions within the finance department. Gary W. Krat was re-elected to the Board of Directors on November 19, 2002. Mr. Krat is currently Chairman Emeritus of SunAmerica Financial Network. From 1990 and until his retirement in 1999, Mr. Krat was Senior Vice President of SunAmerica Inc. and Chairman and Chief Executive Officer of SunAmerica Financial Network, Inc. and its six NASD broker dealer companies with nearly ten thousand registered representatives. From 1977 until 1990, Mr. Krat was a senior executive with Integrated Resources, Inc. Prior to joining Integrated Resources, Mr. Krat was a practicing attorney. He has a law degree from Fordham University and a Bachelor of Arts degree from the University of Pittsburgh. III-1 Joel M. Simon was re-elected to the Board of Directors on November 19, 2002. Mr. Simon is a principal of Crossroads, LLC, a financial consulting firm. Mr. Simon was the President and Chief Executive Officer of Starrett Corporation, a real estate construction, development and management company from March to December 1998. From 1996 to 1998, Mr. Simon was self-employed as a private investor. Mr. Simon was a practicing CPA and he has a Bachelor of Science degree in accounting from Queens College of the City University of New York. Michael A. Salberg was elected to the Board of Directors on November 19, 2002. Mr. Salberg was appointed to fill a vacancy on the Board of Directors on May 25, 2001. Mr. Salberg is a practicing attorney in New York and was admitted to the New York bar in 1977. Since 1989, he has been a partner in the New York law firm of Graubard Miller and its predecessors. The Graubard Miller firm and its predecessors have represented the Company as legal counsel for many years. Mr. Salberg received his Juris Doctor degree from New York Law School in 1976 and a Bachelor of Arts degree from the University of Cincinnati in 1973. ITEM 11. EXECUTIVE COMPENSATION Report of the Compensation Committee on Executive Compensation -------------------------------------------------------------- Joel M. Simon, Gary W. Krat and Mark M. David were appointed by the Board of Directors, and each of them agreed to serve, as members of the Compensation Committee (the "Committee"). The employment of the Company's President and Chief Executive Office, Melvyn Knigin, is governed by the terms of a written employment agreement that expires on June 30, 2007. Saul Pomerantz, Executive Vice President and Chief Operating Officer and Thomas Rende, Chief Financial Officer of the Company do not have written employment agreements. However, Mr. Pomerantz and the Company entered into a written agreement providing for the payment of severance benefits to Mr. Pomerantz in the event his employment is terminated under certain circumstances. Compensation Policies --------------------- In determining the appropriate levels of executive compensation for fiscal year 2003, the Committee based its decisions on (1) the Company's improved financial condition, (2) the need to retain experienced individuals with proven leadership and managerial skills, (3) the executives' motivation to enhance the Company's performance for the benefit of its shareholders and customers, and (4) the executives' contributions to the accomplishment of the Company's annual and long-term business objectives. Salaries generally are determined based on the Committee's assessment of the value of each executive's contribution to the Company, the results of recent past fiscal years in light of prevailing business conditions, the Company's goals for the ensuing fiscal year and, to a lesser extent, prevailing levels at companies considered to be comparable to and competitors of the Company. In addition to base salary compensation, the Committee has also, from time to time, recommended that stock options be granted to the executive officers in order to reward and reinforce their commitment to maximizing shareholder return and long-term results. Extension of Mr. Knigin's Employment Agreement ---------------------------------------------- The employment agreement between Mr. Knigin and the Company dated as of February 22, 2000, as amended as of April 2001, was scheduled to expire by its terms on June 30, 2004. In December 2002, Mr. Knigin and the Company began discussing the possibility of extending the term of Mr. Knigin's employment agreement. On January 28, 2003, Mr. Knigin and the Company entered into a new written agreement, all of the terms of which were retroactive to July 1, 2002 (the "New Agreement"). In conjunction with his New Agreement, Mr. Knigin relinquished all of his outstanding options for shares of the Company's common stock and all of his rights to receive any portion of the unvested options to which he might III-2 become entitled in the future under the terms of any written option agreements with the Company. Under the significant terms of the New Agreement, (i) the term of Mr. Knigin's employment was extended to June 30, 2007, (ii) the Company agreed to pay the premiums on a policy of life insurance on Mr. Knigin's life providing a death benefit of $1,500,000 to Mr. Knigin's designated beneficiary and a policy of disability insurance providing a benefit of $10,000 per month payable to Mr. Knigin until age sixty-four in the event of his disability, (iii) continued participation in the Company's group medical insurance and Retired Senior Executive Medical Plan, (iv) provided Mr. Knigin retires from employment by the Company at the expiration of the agreement, he may become entitled to a severance payment ranging from $500,000, if cumulative pre-tax profit for fiscal years 2003 through 2007 is at least $6,000,000, to an amount equal to 7.5% of the cumulative pre-tax profit for those fiscal years in excess of $10,000,000, and (v) Mr. Knigin may become entitled to certain substantial payments in the event of a sale of the Company or a sale of substantially all of the Common Stock of the Company owned by Mark David and certain identified members of his family, which payments are to be applied against any severance obligations of the Company to Mr. Knigin. The New Agreement prohibits Mr. Knigin from disclosing confidential information of the Company and limits his right to seek employment with a competitor if his employment is terminated in certain circumstances. Base Salary Compensation ------------------------ Based on recommendations from the Company's Chairman of the Board, the collective business experience of the other Committee members and negotiations with Messrs. Knigin, Pomerantz and Rende, the Committee established the base salaries for each of Messrs. Knigin, Pomerantz and Rende. Mr. Knigin's base salary is set forth in the New Agreement and is fixed at $475,000 for fiscal year 2003 and $500,000 for fiscal year 2004. Under the terms of the employment agreement, Mr. Knigin's base salary is scheduled to increase by $25,000 in each of fiscal years 2005, 2006 and 2007; the base salary in fiscal year 2007 will be $575,000. Mr. Pomerantz's base salary for fiscal year 2004 will remain at $250,000 and Mr. Rende's base salary for fiscal year 2004 will remain at $165,000. The Committee does not utilize outside consultants to obtain comparative salary information, but believes that the salaries paid by the Company are competitive, by industry standards, with those paid by companies with similar sales volume to the Company. The Committee places considerably more weight on each executive's contribution to the Company's development and maintenance of its sources of supply, manufacturing capabilities, marketing strategies and customer relationships than on the compensation policies of the Company's competitors; however, the Committee does not establish or rely on target levels of performance in any of these areas to arrive at its recommendations. The current senior executives of the Company have been associated with the Company in senior management positions for periods ranging from thirteen to more than twenty-three years. They have been primarily responsible for the formulation and implementation of the Company's recent financial and operational restructuring and provide the Company with a broad range of management skills which are considered by the Committee to be an essential source of stability and a base for the Company's future growth. Stock Option Grants ------------------- On July 15, 1994, the Committee adopted a new Incentive Stock Option Plan (the "1994 ISOP") to replace the expired 1983 ISOP. The 1994 ISOP authorized the grant of options to purchase up to 2,000,000 shares of the Company's Common Stock. Options for all of the shares of the Company's Common Stock under the 1994 ISOP have been granted. As a result of forfeitures by participants, there are presently 825,000 shares available to be granted. All of the Company's management and administrative employees are eligible to receive grants under the 1994 ISOP. Subject to shareholder approval of the 1994 ISOP, options under the 1994 ISOP were granted to each of the Company's senior executives (except Mark M. David) on July 15, 1994 at fair market value at that date. As a condition to the grant of options to the Company's senior executives, the Committee required each of the recipients to surrender for cancellation any interest in options granted prior to July 15, 1994. The 1994 ISOP was approved by the Company's shareholders at the Company's Annual Meeting on December 8, 1994. III-3 On February 21, 2000, the Committee adopted a new Performance Equity Plan (including a new Incentive Stock Option Plan) (the "2000 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. The 2000 Plan was approved by the Company's shareholders at the Annual Meeting on November 28, 2000. There are presently 460,000 shares available to be granted. In addition to the ISOP, in 1988, the Committee recommended and the Board of Directors adopted a non-qualified Management Option Plan (the "1988 Non-qualified Plan") to provide an additional continuing form of long-term incentive to selected officers of the Company. The 1988 Non-qualified Plan was approved by the Company's shareholders at the Company's Annual Meeting on December 13, 1988. Generally, options under the 1988 Non-qualified Plan are issued with a 5-year exercise period in order to encourage the executive officers to take a long-term approach to the formulation and accomplishment of the Company's goals. There are presently 1,591,666 shares available to be granted. In January 1997, the independent directors serving on the Committee recommended that the Company grant new options under the 1994 ISOP to Melvyn Knigin, Saul Pomerantz and Thomas Rende at a price equal to the market price for the Company's shares on the date of the grant. The grant of new options to Messrs. Knigin and Pomerantz was also subject to the condition that they surrender for cancellation any interest in options granted to them prior to January 29, 1997. In November 1998, the independent directors serving on the Committee recommended that the Company grant new options to Messrs. Knigin and Pomerantz under the 1994 ISOP and the 1988 Non-qualified Plan and to Mr. Rende under the 1994 ISOP. In February 2000, the Committee recommended that the Company grant additional options to Messrs. Knigin and Pomerantz in conjunction with their respective employment agreements and to Mr. Rende in connection with his promotion to Chief Financial Officer. Pursuant to Mr. Knigin's prior employment agreement, he was granted an additional option to purchase an aggregate of 300,000 shares of the Company's Common Stock. These additional options were to be issued in allotments of 100,000 each on July 1, 2001, July 1, 2002 and July 1, 2003 at a price per share equal to the closing market price of the Company's shares on the American Stock Exchange on the trading day preceding the date of issuance. The first two allotments were issued to Mr. Knigin. The additional options granted to Mr. Knigin were intended to be qualified options under the 1994 ISOP or the 2000 Plan and the Company has agreed that if there are not sufficient shares available under the 2000 Plan, the Company will seek the approval of its shareholders for an amendment of the 2000 Plan providing for an appropriate increase in the number of shares available under the 2000 Plan in order to meet the contractual obligation to Mr. Knigin. All of the options previously granted to Mr. Knigin were relinquished by him pursuant to the New Agreement. Incentive Compensation ---------------------- In September 1998, the Compensation Committee adopted an incentive compensation plan for senior executives, other than Mr. David (the "1998 Incentive Plan"). Under the 1998 Incentive Plan, the Compensation Committee had the discretion to award bonus compensation to senior executives in an amount not to exceed five (5%) percent of any increases in net income before taxes over the base amount of $1,200,000 and up to $3,200,000 and an amount not to exceed six and three quarters (6.75%) percent of any increases in net income before taxes in excess of $3,200,000 (the "Bonus Pool"). Based on the collective efforts of Messrs. Knigin and Pomerantz, the Compensation Committee determined to award bonuses to them under the 1998 Incentive Plan for fiscal year 1999. Mr. Knigin was eligible to receive incentive compensation equal to three (3%) percent and Mr. Pomerantz was eligible to receive two (2%) of net income before taxes in excess of $1,200,000. III-4 In fiscal 2000, the Committee amended the 1998 Incentive Plan to increase the Bonus Pool from 5% to 6.75%. Pursuant to their respective employment agreements, Mr. Knigin was eligible to receive incentive compensation equal to three (3%) percent and Mr. Pomerantz was eligible to receive two (2%) percent of net income before taxes in excess of $1,200,000 for fiscal year 2000. In addition, the Committee determined that Mr. Rende was eligible to participate in the Bonus Pool and awarded him incentive compensation equal to 0.25% of net income before taxes in excess of $1,200,000 for fiscal year 2000. In fiscal year 2001and 2002, Messrs. Knigin, Pomerantz and Rende were eligible to receive incentive compensation in the same percentages as the prior fiscal year. No incentive compensation was paid to the senior executives of the Company for fiscal year 2002. Based on the improved financial performance of the Company, in fiscal 2003, the Committee once again awarded bonuses to Messrs. Knigin, Pomerantz and Rende. The Committee determined that Mr. Knigin was eligible to receive incentive compensation equal to three (3%) percent, Mr. Pomerantz was eligible to receive one and one quarter (1.25%) percent and Mr. Rende was eligible to receive one (1%) percent on the net income before taxes between $1,200,000 and $3,200,000; and Mr. Knigin was eligible to receive three and three quarters (3.75%) percent, Mr. Pomerantz was eligible to receive one and three quarters (1.75%) percent and Mr. Rende was eligible to receive one and one quarter (1.25%) percent on the net income before taxes in excess of $3,200,000. For fiscal 2003, incentive compensation amounted to $287,000. Compensation of the Chief Executive Officer ------------------------------------------- For fiscal year 2003, the annual base salary paid to the Company's Chief Executive Officer, Melvyn Knigin, pursuant to his employment agreement was $475,000. Mr. Knigin's employment agreement provides for an annual base salary of $500,000 in fiscal year 2004. Compensation Committee Interlocks and Insider Participation ----------------------------------------------------------- There are no Compensation Committee interlocks or insider participation. Mark M. David Gary W. Krat Joel M. Simon III-5 Summary Compensation Table

LONG-TERM COMPENSATION ---------------------- ANNUAL RESTRICTED COMPENSATION STOCK OPTIONS ALL OTHER NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY ($) AWARDS($) (# SHARES) COMPENSATION ($) --------------------------- ----------- ---------- ---------- ---------- ---------------- Melvyn Knigin 2003 478,888 - - (1) 188,163 President and Chief 2002 452,790 - 900,000(1) 22,215 Executive Officer; Director 2001 402,340 - 800,000(1) 53,354 Saul Pomerantz 2003 250,807 - 630,000(2) 83,162 Executive Vice President 2002 250,300 - 630,000(2) 13,971 and Chief Operating 2001 250,000 - 630,000(2) 29,384 Officer; Director Thomas Rende 2003 168,351 - 175,000(3) 56,390 Chief Financial Officer 2002 167,898 - 175,000(3) 11,608 2001 167,860 - 175,000(3) 3,283

(1) Represents options to purchase shares of Common Stock under the 1994 Incentive Stock Option Plan (the "1994 Plan") of which 350,000 shares were granted on January 29, 1997, 125,000 shares granted on November 4, 1998; 125,000 shares granted on November 4, 1998, 100,000 shares were granted on July 2, 2001 and 100,000 shares were granted on July 1, 2002 under the Company's Non-Qualified Stock Option Plan (the "1988 Plan") and 200,000 shares granted on February 22, 2000 pursuant to the 2000 Incentive Stock Option Plan (the "2000 Plan"). On January 28, 2003, Mr. Knigin voluntarily surrendered and forfeited his options. (2) Represents options to purchase shares of Common Stock under the 1994 Incentive Stock Option Plan (the "1994 Plan") of which 350,000 shares were granted on January 29, 1997 and 75,000 shares were granted on November 4, 1998; 75,000 shares granted on November 4, 1998 under the Company's Non-Qualified Stock Option Plan (the "1988 Plan") and 130,000 shares granted on February 22, 2000 pursuant to the 2000 Incentive Stock Option Plan (the "2000 Plan"). (3) Represents options to purchase shares of Common Stock under the 1994 Incentive Stock Option Plan (the "1994 Plan") of which 20,000 shares were granted on July 15, 1994, 50,000 shares were granted on January 29, 1997, 35,000 shares were granted on November 4, 1998; and 70,000 shares granted on February 22, 2000 pursuant to the 2000 Incentive Stock Option Plan (the "2000 Plan"). III-6 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AS OF AUGUST 29, 2003. The following table sets forth certain information as of August 29, 2003 with respect to the stock ownership of (i) those persons or groups (as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) who beneficially own more than 5% of the Company's Common Stock, (ii) each director of the Company and (iii) all directors and officers of the Company as a group.

NAME OF BENEFICIAL OWNER AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP PERCENT OF CLASS(1) ------------------------ ----------------------------------------- ------------------- Mark M. David 3,095,428(2) 19.9230% 1115 Broadway New York, NY 10010 Great Bank Trust Co. 436,908 2.8121% as Trustee for the Movie Star, Inc. Employee Stock Ownership Plan 45 Rockefeller Plaza Suite 2055 New York, NY 10011 Melvyn Knigin 115,500(3) .7434% 1115 Broadway New York, NY 10010 Saul Pomerantz 692,910(4) 4.2910% 1115 Broadway New York, NY 10010 Thomas Rende 312,300(5) 1.9912% 1115 Broadway New York, NY 10010 Joel M. Simon 74,166 0.4774% 1115 Broadway New York, NY 10010 Gary W. Krat 253,333 1.6305% 1115 Broadway New York, NY 10010 Michael A. Salberg 72,533(6) .4668% 600 Third Avenue New York, NY 10016 All directors and officers as a group 4,616,170(2)(3)(4)(5)(6) 28.3288% (7 persons) -----------------

(1) Based upon 15,536,975 shares (excluding 2,016,802 treasury shares) outstanding and options, where applicable, to purchase shares of Common Stock, exercisable within 60 days. (2) Includes 336,072 shares owned by his spouse. (3) Includes 100,000 shares owned by Mr. Knigin's spouse. (4) Includes options granted to Saul Pomerantz for 410,000 shares and Shelley Pomerantz for 50,000 shares (his wife who also is employed by the Company) pursuant to the 1994 Plan, 60,000 pursuant to the III-7 1988 Non-Qualified Plan and 91,000 pursuant to the 2000 Plan exercisable within 60 days, and 56,910 shares owned by his spouse and 8,000 shares held jointly with his spouse. (5) Represents options granted to Thomas Rende for 98,000 shares, pursuant to the 1994 Plan, and 49,000 pursuant to the 2000 Plan exercisable within 60 days, 162,000 shares held jointly with his spouse, and 3,300 shares owned by his spouse. (6) Represents 72,533 shares owned by Mr. Salberg's spouse. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Effective as of July 1, 1999, Mr. David retired as a full-time executive employee of the Company. In conjunction with Mr. David's retirement, the Company and Mr. David entered into a series of written agreements providing for the payment to Mr. David of a lump sum retirement benefit of $500,000, the continuation of health insurance benefits and a split dollar life insurance policy on Mr. David's life and the retention of Mr. David's services as a consultant to the Company for a term of five years, expiring on June 30, 2004. Pursuant to the consulting agreement, Mr. David is prohibited from disclosing any confidential information of the Company and from engaging in any business that is competitive with the business of the Company. Effective January 1, 2003, the consulting arrangement between the Company and Mark M. David, Chairman of the Board, was modified and term extended to June 30, 2007. The new agreement is with Mr. David's consulting firm, BENJAM Consulting, LLC. Under the terms of the new agreement, BENJAM Consulting, LLC 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. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. Not applicable for year ended June 30, 2003. III-8 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K Page (a) 1. Financial Statements and Supplementary Data Included in Part II, Item 8 of this report: Independent Auditors' Reports F-1 - F-2 Balance Sheets at June 30, 2003 and 2002 F-3 Statements of Income for the fiscal years ended June 30, 2003, 2002 and 2001 F-4 Statements of Shareholders' Equity for the fiscal years ended June 30, 2003, 2002 and 2001 F-5 Statements of Cash Flows for the fiscal years ended June 30, 2003, 2002 and 2001 F-6 - F-7 Notes to Financial Statements F-8 - F-22 2. Schedule For the fiscal years ended June 30, 2003, 2002 and 2001: 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. IV-1 (a) 3. EXHIBITS Exhibit Number Exhibit Method of Filing ------- ------- ---------------- 3.1 Certificate of Incorporation Incorporated by reference to Form 10-K for fiscal year ended June 30, 1988 and filed on October 13 1988. 3.1.1 Amended Certificate of Incorporated by reference Incorporation to Form 10-K for fiscal year ended June 30, 1992 and filed on September 25, 1992. 3.1.2 Amended Certificate of Incorporated by reference Incorporation to Form 8 Amendment to Form 10-K for fiscal year ended June 30, 1992 and filed on January 19, 1993. 3.2 By-Laws Incorporated by reference to Form 10-K for fiscal year ended June 30, 1988 and filed on October 13, 1988. 4.1 Instruments defining the Incorporated by reference rights of security holders to Exhibits to including indentures Registration Statement on Form S-2 (No. 33-7837) filed October 10, 1986. 4.1.1 Indenture dated as of October Incorporated by reference 1, 1996 between the to Exhibits to Application Company, as Issuer and for Qualification of American Stock Transfer & Indenture under the Trust Trust Company, as Trustee Indenture Act of 1939 on Form T-3 (Commission File No. 22-22243) filed on September 13, 1996. 4.2 Plan of Merger dated November Incorporated by reference 18, 1980, between Stardust to Exhibits to Inc. and Sanmark Industries Registration Statement on Inc. whereby Sanmark Form S-14 (Registration Industries Inc. was merged No. 2-70365) filed by into Stardust Inc. Company's predecessor corporation, Stardust Inc. on February 12, 1981. IV-2 Exhibit Number Exhibit Method of Filing ------- ------- ---------------- 10.1 Agreement of Sale dated Incorporated by reference December 12, 1983, as amended to Exhibits to January 31, 1984, among Registration Statement Industrial Development Form S-2 (No. 33-7837) Authority of Russell County filed October 10, 1986. (Virginia), the Company and the Bankers Trust Company, with attendant Deed and Bill of Sale, Deed of Trust, Assignment, and Promissory Note in the sum of $3,000,000. 10.2 Employee Stock Ownership and Incorporated by reference Capital Accumulation Plan to Exhibits to dated April 17, 1984 as Registration Statement amended on July 1, 1984 Form S-2 (No. 33-7837) between Republic National filed October 10, 1986. Bank of New York, as trustee, and the Company. 10.3 Incentive Stock Option Plan Incorporated by reference Agreement dated June 28, to Exhibits to 1983, as amended on January Registration Statement 13, 1986. Form S-2 (No. 33-7837) filed October 10, 1986. 10.3.1 1994 Incentive Stock Option Incorporated by reference Plan. to Form 10-K for fiscal year ended June 30, 1994 and filed on October 12, 1994. 10.4 Form of Non-Qualified Stock Incorporated by reference Option granted to several to Exhibits to persons who are Registration Statement manufacturer's Form S-2 (No. 33-7837) representatives for the filed October 10, 1986. Company. 10.5 Financing Agreement dated as Incorporated by reference of April 24, 1996 between to Form 10-Q for the Rosenthal & Rosenthal, Inc. quarter ended March 31, and the Company. 1996 and filed on May 15, 1996. 10.5.1 Side Letter re Covenants Incorporated by reference dated as of April 24, 1996 to Form 10-Q for the with Rosenthal & Rosenthal, quarter ended March 31, Inc. 1996 and filed on May 15, 1996. IV-3 Exhibit Number Exhibit Method of Filing ------- ------- ---------------- 10.5.2 Security Agreement dated as Incorporated by reference of April 24, 1996 between to Form 10-Q for the Rosenthal & Rosenthal, Inc. quarter ended March 31, and the Company. 1996 and filed on May 15, 1996. 10.5.3 Security Agreement - Incorporated by reference Inventory dated as of April to Form 10-Q for the 24, 1996 between Rosenthal & quarter ended March 31, Rosenthal, Inc. and the 1996 and filed on Company. May 15, 1996. 10.5.4 Security Agreement and Incorporated by reference Mortgage - Trademarks dated to Form 10-Q for the as of April 24, 1996 between quarter ended March 31, Rosenthal & Rosenthal, inc. 1996 and filed on and the Company. May 15, 1996. 10.5.5 Negative Pledge - Real Incorporated by reference property dated as of April to Form 10-Q for the 24, 1996 between Rosenthal & quarter ended March 31, Rosenthal, Inc. and the 1996 and filed on Company. May 15, 1996. 10.5.6 Assignment of Leases, Rents Incorporated by reference and Security Deposits dated to Form 10-Q for the as of April 24, 1996 between quarter ended March 31, Rosenthal & Rosenthal, Inc. 1996 and filed on and the Company. May 15, 1996. 10.5.7 Letter Agreement dated as of Incorporated by reference to June 28, 1999 between Rosenthal Form 10-K for the fiscal & Rosenthal, Inc. and the Company year ended June 30, 1999 Inc. and the Company modifying and filed on September 28, and extending the Financing 1999. Agreement dated April 24, 1996. 10.5.8 Letter Agreement dated as of Incorporated by reference to September 13, 2000 between Form 10-K for the fiscal Rosenthal & Rosenthal and the year ended June 30, 2000 and Company amending Financing filed on September 27, 2000. Agreement dated April 24, 1996. 10.5.9 Letter Agreement dated as of Incorporated by reference to July 31, 2001 between Form 10-K for the fiscal Rosenthal & Rosenthal, Inc. and year ended June 30, 2001 and the Company further amending, filed on September 26, 2001. modifying and extending the Financing Agreement dated April 24, 1996. 10.5.10 Letter Agreement dated as of Incorporated by reference to August 8, 2001 between Form 10-K for the fiscal Rosenthal & Rosenthal, Inc. and year ended June 30, 2001 and the Company further amending, filed on September 26, 2001. modifying and extending the Financing Agreement dated April 24, 1996. 10.5.11 Letter Agreement dated December Incorporated by reference to 26, 2002, effective November 7, Form 10-Q for the quarter 2002, between Rosenthal & ended December 31, 2002 and Rosenthal, Inc. and the Company filed on February 13, 2003. modifying the Financing Agreement dated April 24, 1996. IV-4 Exhibit Number Exhibit Method of Filing ------- ------- ---------------- 10.5.12 Letter Agreement dated as of Incorporated by reference to December 26, 2002, between Form 10-Q for the quarter Rosenthal & Rosenthal, Inc. ended December 31, 2002 and and the Company modifying the filed on February 13, 2003. Financing Agreement dated April 24, 1996. 10.7 1988 Non-Qualified Stock Incorporated by reference Option Plan. to Form 10-K for fiscal year ended June 30, 1989 and filed on September 27, 1989. 10.8 License Agreement dated Incorporated by reference July 26, 1990 between PGH to Form 8 Amendment to Company, Licensor and Form 10-K for fiscal year Sanmark-Stardust Inc. ended June 30, 1992 and Licensee. filed on January 19, 1993. 10.9 License Agreement dated Incorporated by reference November 14, 1991 between to Form 8 Amendment to BonJour Group, Ltd., Licensor Form 10-K for fiscal year and Sanmark-Stardust Inc., ended June 30, 1992 and Licensee. filed on January 19, 1993. 10.10 Prototype of Contract of Purchase Incorporated by reference to periodically entered into between Form 10-K for fiscal year the Company and Sears, Roebuck ended June 30, 1993 and and Company. filed on September 18, 1993. 10.11 Agreement dated as of July 1, Incorporated by reference to 1999 between Mark M. David and Form 10-K for fiscal year ended the Company providing for June 30, 1999 and filed on retirement benefits to September 28, 1999. Mr. David. 10.12 Agreement dated as of July 1, Incorporated by reference to 1999 between Mark M. David and Form 10-K for fiscal year ended the Company for Mr. David's June 30, 1999 and filed on consulting services. September 28, 1999. 10.13 Employment Agreement dated as of Incorporated by reference to February 22, 2000 between Saul Form 10-Q for the quarter Pomerantz and the Company. ended March 31, 2000 and filed on May 15, 2000. 10.14 Employment Agreement dated as of Incorporated by reference to February 22, 2000 between Melvyn Form 10-Q for the quarter Knigin and the Company. ended March 31, 2000 and filed on May 15, 2000. 10.15 Agreement regarding severance Incorporated by reference to benefits dated as of July Form 10-K for the fiscal year 1, 2001 Between Saul ended June 30, 2001 and Pomerantz and the Company. filed on September 26, 2001. 10.16 Modification and Extension of Incorporated by reference to Employment Agreement dated Form 10-K for the fiscal year as of April 2001 between ended June 30, 2001 Melvyn Knigin and the and filed on September 26, 2001. Company. IV-5 Exhibit Number Exhibit Method of Filing ------- ------- ---------------- 10.17 Agreement dated as of January 1, Incorporated by reference to 2003 between BENJAM Form 10-Q for the quarter Consulting LLC and the Company ended December 31, 2002 and replacing the Agreement dated as filed on February 13, 2003. of July 1, 1999 between Mark M. David and the Company for Mr. David's consulting services. 10.18 Employment Agreement dated as Incorporated by reference to of July 1, 2002 between Melvyn Form 10-Q for the quarter Knigin and the Company replacing ended December 31, 2002 and the Agreement dated as of filed on February 13, 2003. February 22, 2000. 10.19 Letter dated January 28, 2003 Incorporated by reference to from Melvyn Knigin to the Form 10-Q for the quarter the Company for the surrender ended December 31, 2002 and and forfeiture of Mr. Knigin's filed on February 13, 2003. stock options. 23 Independent Auditors' Consent Filed herewith. 28.1 Tender Offer Statement and Incorporated by reference Rule 13E-3 Transaction to Schedule 14D-1 and Rule Statement with respect to 13E-3 Transaction Movie Star, Inc. Acquisition. Statement (No. 1-4585) filed December 18, 1987. 31.1 Rule 13a-14(a)/15d-14(a) Filed herewith. Certification by Chief Executive Officer. 31.2 Rule 13a-14(a)/15d-14(a) Filed herewith. Certification by Principal Financial and Accounting Officer. 32.1 Section 1350 Certification. Filed herewith. (a) 4. Report on Form 8-K None. IV-6 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION 23 Independent Auditors' Consent 31.1 Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer 31.2 Rule 13a-14(a)/15d-14(a) Certification by Principal Financial and Accounting Officer 32.1 Section 1350 Certification MOVIE STAR, INC. THE COMPANY WILL FURNISH A COPY OF THE EXHIBITS TO THIS ANNUAL REPORT UPON THE WRITTEN REQUEST OF A PERSON REQUESTING COPIES THEREOF AND STATING THAT HE IS A BENEFICIAL HOLDER OF THE COMPANY'S COMMON STOCK AT A CHARGE OF $.35 PER PAGE, PAID IN ADVANCE. THE COMPANY WILL INDICATE THE NUMBER OF PAGES TO BE CHARGED FOR UPON SUCH PERSON'S INQUIRY. REQUESTS FOR COPIES AND INQUIRIES SHOULD BE ADDRESSED TO: MOVIE STAR, INC. 1115 BROADWAY NEW YORK, NEW YORK 10010 ATTENTION: CORPORATE SECRETARY SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Company has duly caused this document to be signed on its behalf by the undersigned, thereunto duly authorized. September 25, 2003 MOVIE STAR, INC. By: /s/ MARK M. DAVID ----------------- MARK M. DAVID Chairman of the Board Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and as of the date indicated. /s/MARK M. DAVID Chairman of the Board September 25, 2003 ---------------- MARK M. DAVID /s/ MELVYN KNIGIN President; Chief Executive September 25, 2003 ----------------- Officer; Director MELVYN KNIGIN /s/ SAUL POMERANTZ Executive Vice President; September 25, 2003 ------------------ Chief Operating Officer; SAUL POMERANTZ Secretary & Director /s/ THOMAS RENDE Principal Financial & September 25, 2003 ---------------- Accounting Officer THOMAS RENDE /s/ GARY W. KRAT Director September 25, 2003 ---------------- GARY W. KRAT /s/ JOEL M. SIMON Director September 25, 2003 ----------------- JOEL M. SIMON /s/ MICHAEL A. SALBERG Director September 25, 2003 ---------------------- MICHAEL A. SALBERG