Annual Report — [x] Reg. S-K Item 405 — Form 10-K
Filing Table of Contents
Document/Exhibit Description Pages Size
1: 10-K405 Annual Report -- [x] Reg. S-K Item 405 42 258K
2: EX-10.9 Second Revised and Restated Management Agreement 13 66K
3: EX-21.1 List of Subsidiaries of Cherokee Inc 1 4K
4: EX-23.1 Consent of Independent Accountants 1 7K
5: EX-27.1 Financial Data Schedule 2 6K
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended January 29, 2000 or
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file No. 0-18640
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CHEROKEE INC.
(Exact name of registrant as specified in charter)
[Download Table]
Delaware 95-4182437
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
[Download Table]
6835 Valjean Avenue
Van Nuys, CA (818) 908-9868 91406
(Address of principal executive office) (Registrant's telephone (Zip Code)
number,
including area code)
----------------
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.02 par value per share
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. [X]
Applicable Only to Registrants Involved in Bankruptcy Proceedings During the
Preceding Five Years
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
YES [X] NO [_]
As of April 14, 2000, the registrant had 8,480,705 shares of its Common
Stock, par value $.02 per share, issued and outstanding.
As of April 14, 2000, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $50,168,000 (computed on the
basis of the last trade of the Common Stock on the NASDAQ National Market
System on April 14, 2000).
Certain portions of the registrant's proxy statement for the Annual Meeting
of Stockholders to be held on May 31, 2000 are incorporated by this reference
into Part III as set forth herein.
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CHEROKEE INC.
INDEX
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Page
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PART I
Item 1. Business.............................................................................. 2
Item 2. Properties............................................................................ 11
Item 3. Legal Proceedings..................................................................... 11
Item 4. Submission of Matters to a Vote of Security Holders................................... 11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................. 12
Item 6. Selected Financial Data............................................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.. 14
Item 7A. Qualitative and Quantitative Disclosures of Market Risk............................... 19
Item 8. Consolidated Financial Statements and Supplementary Data.............................. 20
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.. 21
PART III
Item 10. Directors and Executive Officers of the Registrant.................................... 21
Item 11. Executive Compensation................................................................ 22
Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 22
Item 13. Certain Relationships and Related Transactions........................................ 22
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....................... 23
1
PART I
Item 1. BUSINESS
Introduction
Cherokee Inc. (the "Company") is in the business of marketing and licensing
the Cherokee and Sideout brands and related trademarks and other brands it
owns. The Company is one of the leading licensors of brand names and trademarks
for apparel, footwear and accessories in the United States. The Company's
operating strategy emphasizes retail direct, wholesale and international
licensing whereby the Company grants retailers and wholesalers the license to
use the trademarks held by the Company on certain categories of merchandise,
and the licensees are responsible for designing and manufacturing the
merchandise.
The Company and its wholly-owned subsidiary, SPELL C. LLC ("Spell C"), own
several trademarks including Cherokee(R), Sideout(R), Sideout Sport(R), King of
the Beach(R) and others. The Cherokee brand, which began as a footwear brand in
1973, has been positioned to connote quality, comfort, fit, and a "Casual
American" lifestyle with traditional wholesome values. The Sideout brand and
related trademarks, which represent a beach-oriented, active, "California"
lifestyle, were acquired by the Company in November 1997. As of January 29,
2000, the Company had twenty-nine continuing license agreements, covering both
domestic and international markets.
The Company's retail direct licensing strategy is premised on the proposition
that in North America nearly all aspects of the moderately priced apparel,
footwear and accessories business can be sourced most effectively by large
retailers, who not only command significant economies of scale, but also
interact daily with the end consumer. In addition, the Company believes that
these retailers in general may be able to obtain higher gross margins on sales
and increase store traffic by directly sourcing, stocking and selling licensed
products bearing widely recognized brand names, such as the Company's brands,
than through carrying strictly private label goods or branded product from
third-party vendors. The Company's strategy in North America is to capitalize
on these ideas by licensing its portfolio of brands primarily to strong and
growing retailers, who, working in conjunction with Company management, develop
merchandise for their stores.
Beginning in 1995, the Company began to take a number of important steps
designed to implement its retail direct licensing strategy. On August 15, 1995,
the Company entered into a major strategic alliance with one of the largest
retailers in the United States, Target Stores, a division of Target Corp. In
November 1997, the Company reaffirmed its relationship with Target, by entering
into an amended licensing agreement (the "Amended Target Agreement") which
grants Target the exclusive right in the United States to use the Cherokee
trademarks on certain specified categories of merchandise. Under the Amended
Target Agreement, Target is obligated to pay royalties based upon a percentage
of its net sales of Cherokee branded merchandise, with a minimum guaranteed
royalty of $60.0 million over the six-year initial term of the agreement.
During the fiscal year ended January 29, 2000 ("Fiscal 2000"), a wide range of
Cherokee branded merchandise was sold at the 921 Target stores. Due to the
strong presence and sales of Cherokee branded products in Target Stores during
Fiscal 2000, royalty revenues from Target exceeded $16.3 million, which is 81%
over the guaranteed minimum royalty for Fiscal 2000 under the Amended Target
Agreement.
In August 1997, the Company entered into a licensing agreement with one of
Canada's largest retailers, Zellers Inc., a division of the Hudson's Bay
Company, under which Zellers was granted the exclusive right in Canada to use
the Cherokee trademarks in connection with a broad range of categories of
merchandise. Under the Zellers licensing agreement, Zellers is obligated to pay
royalties based upon a percentage of its net sales of Cherokee branded
merchandise with a minimum guaranteed royalty of $10.0 million over the five-
year initial term of the agreement. Zellers commenced the initial sales of
Cherokee branded merchandise in over 350 stores in July 1998 and during Fiscal
2000 royalty revenues from Zellers exceeded $3.6 million, which is 152% over
the guaranteed minimum royalty for Fiscal 2000 under the Zellers license
agreement.
To increase its licensing potential, the Company purchased all of Sideout
Sport Inc.'s trademarks, copyrights, trade secrets and associated license
agreements on November 7, 1997. The trademarks acquired
2
from Sideout Sport Inc. included, among others, Sideout, Sideout Sport and King
of the Beach. Royalty revenues derived from the Sideout brands have grown from
$585,000 during the fiscal year ended January 30, 1999 ("Fiscal 1999") to $2.3
million during Fiscal 2000.
Cherokee was incorporated in Delaware in 1988. Its principal executive
offices are located at 6835 Valjean Avenue, Van Nuys, California 91406,
telephone (818) 908-9868.
History and Restructurings
On November 7, 1994, the Company filed a petition with the United States
Bankruptcy Court in the District of Delaware for relief under Chapter 11 of the
United States Bankruptcy Code. Concurrent with such filing, the Company filed a
"prepackaged" Plan of Reorganization, which was the result of negotiations
among the Company and unofficial representatives of its debt-holders and
stockholders. On December 14, 1994, the Bankruptcy Court confirmed the Plan of
Reorganization, and on December 23, 1994, the Plan of Reorganization became
effective.
Overview of Licensing Business
The Company is one of the leading licensors of brand names and trademarks for
apparel, footwear and accessories in the United States. The Cherokee name,
which began as a footwear brand in 1973, has been positioned to connote
quality, comfort, fit, and a "Casual American" lifestyle with traditional,
wholesome values. The Sideout brand and related trademarks, which represent a
beach-oriented, active, "California" lifestyle, were acquired by the Company in
November 1997. See "Sideout Agreement" below. The Company's primary emphasis
for the past four years has been directed toward retail direct, wholesale and
international licensing. As of January 29, 2000, the Company had twenty-nine
continuing license agreements, covering both domestic and international
markets, fifteen of which pertained to the Cherokee name.
The Company's license agreements are with retailers and wholesalers and are
either international master agreements or category-specific exclusive or non-
exclusive agreements. Of the twenty-nine licensing agreements, ten are with
retailers, seven are with domestic wholesalers and twelve are with
international wholesalers or retailers. In retail direct licensing, the Company
grants retailers a license to use the trademarks on certain categories of
merchandise, generally on a non-exclusive basis, and the retailer is
responsible for designing and manufacturing the merchandise (referred to herein
as "retail direct" licensing strategy). Wholesale licensees manufacture and
import various categories of footwear and accessories under the Company's
trademarks and sell the licensed products to retailers. The Company's retail,
wholesale and international license agreements provide the Company with final
approval of pre-agreed upon quality standards, packaging and marketing of
licensed products. The Company has the right to conduct periodic quality
control inspections to ensure that the image and quality of licensed products
remain consistent. The Company will continue to solicit new licensees through a
small number of executive employees and may retain the services of outside
consultants to assist the Company in this effort.
The Company's current business strategy is to maximize the value of its
existing and future brands by exploiting them in a manner that recognizes the
relative market power, in different areas of the world, of the various
participants--manufacturer, wholesaler and retailer--in the chain of supply to
the ultimate consumer. In North America, market power, and accompanying
economies of scale, is generally and increasingly held by a few dominant
retailers of moderately priced merchandise, and, accordingly, in North America
the Company has pursued its retail direct licensing strategy. In contrast to
the retail market in North America, in selected international markets the
Company has sought to develop its brands through wholesale licenses with
manufacturers or other companies who have market power and economies of scale
in their respective markets. Finally, in some countries, the Company believes
that an owner or licensee of one or more well-known U.S. brands has the
opportunity to become a dominant, vertically integrated manufacturer or
retailer or both of branded apparel, footwear and accessories. Accordingly, in
those countries the Company has begun to pursue licensing or strategic
alignments whereby its brands can become the basis for such a vertically
integrated
3
manufacturer/retailer. This strategy permits the Company to operate with
minimal working capital, virtually no capital expenditures (other than those
associated with acquiring new brands and related trademarks), no production
costs, significantly reduced design, marketing, distribution and other
operating expenses, and a small group of core employees. In addition, the
Company has a global network of finders, suppliers and manufacturers.
North American Retail Direct Licensing
The Company's retail direct licensing strategy is premised on the proposition
that in North America nearly all aspects of the moderately priced apparel,
footwear and accessories business, from product development and design, to
merchandising, to sourcing and distribution, can be executed most effectively
by large retailers, who not only command significant economies of scale, but
also interact daily with the end consumer. In addition, the Company believes
that these retailers in general may be able to obtain higher gross margins on
sales and increase store traffic by directly sourcing, stocking and selling
licensed products bearing widely recognized brand names (such as the Company's
brands) than through carrying strictly private label goods or branded product
from third-party vendors. The Company also expects that the enhanced
profitability to retailers of private label products and in-store brands,
coupled with the substantial and increasing marketing costs to establish and
maintain a widely recognized apparel brand, will result in further erosion of
revenues and profitability for mid-sized and small apparel manufacturers and
corresponding increased desirability to retailers of well-established brands
with broad appeal. The Company's strategy in North America is to capitalize on
these trends by licensing its portfolio of brand names primarily to strong and
growing retailers, who, working in conjunction with the Company's management,
develop merchandise for their stores, and to augment that portfolio by
acquiring additional brands which have high consumer awareness, broad appeal
and applicability to a range of merchandise categories.
On November 12, 1997, the Company reaffirmed its relationship with Target by
entering into the Amended Target Agreement. This agreement was subsequently
assigned to Spell C and pledged as collateral for the Zero Coupon Secured Notes
issued by the Company. See "Recapitalization; Sale of Cherokee Trademarks to
Spell C; Issuance of Secured Notes" below. The Amended Target Agreement grants
Target the exclusive right in the United States to use the Cherokee trademarks
in certain specified categories of merchandise including:
. men's, women's and children's apparel, including intimate apparel,
foundations and sleepwear;
. men's, women's and children's fashion accessories;
. bed and bath products and accessories;
. luggage, sports bags and backpacks;
. home textiles;
. domestics and home decor products;
. home furnishings;
. sporting goods; and
. cosmetics, bath and body products.
Some of the above-listed categories are subject to current license agreements
between the Company and third parties. The Amended Target Agreement provides
that upon the expiration or termination of such agreements, the categories of
merchandise subject to such agreements will become exclusive to Target in the
United States. However, with the consent of Target, the Company and Spell C
could renew and/or extend existing license agreements and Target would receive
50% of the royalties earned under these renewed and extended agreements. Due to
the broad nature of the rights granted to Target in the United States, and the
restrictions contained in the Amended Target Agreement, the Company may not
enter into new licensing agreements in the United States with respect to the
Cherokee brand, except for retail license agreements for cosmetics, bath and
body products with several drug chain stores.
4
Under the Amended Target Agreement, Target has agreed to pay a royalty each
fiscal year, up to and including the fiscal year ending January 31, 2004, based
on a percentage of Target's net sales of Cherokee branded merchandise during
each fiscal year, which percentage varies according to the volume of sales of
merchandise. In any event, Target has agreed to pay a minimum guaranteed
royalty of $9.0 million for each of the two fiscal years ending January 31,
1999 and 2000 and $10.5 million for each of the four fiscal years ending
January 31, 2001 through 2004.
The initial term of the Amended Target Agreement commenced on February 1,
1998 and ends January 31, 2004. If Target is current in its payments of the
minimum guaranteed royalty, the Amended Target Agreement will automatically
renew for the fiscal year ending in 2005, and will continue to automatically
renew for successive fiscal year terms provided that Target has paid a minimum
guaranteed royalty equal to or greater than $9.0 million for the preceding
fiscal year. Target commenced the initial sales of Cherokee branded merchandise
in July 1996. Royalty revenues from Target were $5.9 million during the fiscal
year ended May 31, 1997, $6.4 million during the eight month fiscal period
ended January 31, 1998, $14.6 million during Fiscal 1999 and $16.3 million
during Fiscal 2000, which accounted for 68%, 75%, 76% and 66%, respectively, of
the Company's consolidated revenues during such periods. See "Risk Factors."
On August 22, 1997, the Company entered into an international retail direct
licensing agreement with Zellers Inc., a Canadian corporation and a division of
Hudson's Bay Company. Zellers was granted the exclusive right in Canada to use
the Cherokee brand and related trademarks in connection with a broad range of
categories of merchandise, including women's, men's and children's apparel and
footwear, women's intimate apparel, fashion accessories, home textiles,
cosmetics and recreational products. The term of the agreement is for five
years, with automatic renewal options, provided that specified minimums are met
each contract year. Under the agreement, Zellers agreed to pay the Company a
minimum guaranteed royalty of $10.0 million over the five-year initial term of
the agreement. Zellers commenced the initial sales of Cherokee branded
merchandise in July 1998 and during Fiscal 2000 royalty revenues to the Company
from Zellers totaled $3.6 million.
During Fiscal 2000, North American retail direct licensees, in addition to
Target and Zellers, included Brylane, Pamida, Mervyn's, Gart Sport/Sportmart,
Bob's Stores and The Forzani Group. Generally, royalties on non-exclusive
domestic retail licenses begin at 3% of the retailer's net sales of licensed
products and may decrease depending on the retailer's annual sales of licensed
products and the retailer's guaranteed annual sales of licensed products.
All of the current United States Cherokee brand retail license agreements
will expire during the term of the Amended Target Agreement and due to the
exclusivity provisions contained in the Amended Target Agreement, after 2002,
without Target's consent, the Company will not be permitted to renew or extend
such agreements under the terms of the Amended Target Agreement. With the
consent of Target, the Company may extend any existing United States license
agreement after January 31, 2002, but the Company must assign 50% of the
royalties payable during the extended term to Target. The above restrictions do
not apply to Canada; however, under the Zellers Agreement, Zellers has the
exclusive right to use the Cherokee brand on a broad range of products in
Canada.
During Fiscal 2000 the Company entered into two non-exclusive licensing
agreements for the Sideout brand covering North America, which include The
Casual Male, Inc. and Nirve, Inc. The Company's existing retail direct
licensees launched the Sideout brand in Spring 1999 in categories of
merchandise including men's, women's and children's sportswear; accessories,
luggage, sports bags and backpacks, skin care products and hats. During Fiscal
2000, royalty revenues from retail direct licensees for the Sideout brand
totaled $2.3 million. One of the Company's licensees for the Sideout brand,
Uptons, Inc., closed its doors on December 31, 1999 and as part of the
termination agreement paid to the Company 90% of the remaining minimum
royalties due. The Company incurred no expense with regard to the closing of
Uptons. The Company intends to continue to actively pursue its retail direct
licensing strategy to further develop the Sideout brand in the United States.
5
During Fiscal 2000, the Company and Spell C received $22.6 million in
aggregate royalties from North American retail direct license agreements, which
accounted for 91.3% of the Company's consolidated revenues during such period.
North American Wholesale Licensing
The Company currently has seven wholesale license agreements that grant
unaffiliated manufacturers the license to manufacture and market sunglasses,
watches, luggage, handbags and purses under the Company's Cherokee and Sideout
trademarks in the United States. The Company's wholesale license agreements
typically require the wholesale licensee to pay royalties on revenues against a
guaranteed minimum royalty that generally increases over the term of the
agreement. All of the current United States wholesale license agreements for
the Cherokee brand will expire during the term of the Amended Target Agreement,
and due to the exclusivity provisions contained in the Amended Target
Agreement, after 2002 in many circumstances the Company will not be permitted
to renew or extend such agreements under the terms of the Amended Target
Agreement without the consent of Target.
The Company's wholesale license agreements for the Sideout brand are for
product categories including footwear, volleyballs, sunglasses, watches and
related time products. The agreements have various expiration dates and contain
three-to five-year renewal options. The total number of wholesale licensing
agreements for the Sideout brand was three as of January 29, 2000.
During Fiscal 2000, the Company received $1.3 million in aggregate royalties
from its wholesale licensing agreements, which accounted for 5.4% of the
Company's consolidated revenues during such period.
International Licensing
The Amended Target Agreement grants Target the rights to the Cherokee
trademarks only in the United States. Additionally, the Company sold to Spell C
the United States, but not the international, rights to the Cherokee
trademarks. Therefore, the Company will continue to seek to develop in several
international markets both its Cherokee and Sideout brands through retail
direct or wholesale licenses with manufacturers or other companies that have
market power and economies of scale in their respective markets.
Currently, the Company has seven international wholesale and/or retail
license agreements for the Cherokee brand, which include Japan-based Itochu
Corporation and its sub-licensees Takaya, Sanmoto, and Takaishi, China-based
Shanghai Eesli Trading Company, Philippine-based Mondragon and Mexico-based
Bravo Enterprises. Under the terms of the Itochu licensing agreement, Itochu
will manufacture, promote, sell, distribute and sublicense products bearing the
Cherokee brand in Japan. The term of the agreement is five years and the
aggregate minimum guaranteed royalties for the first three years are $1.1
million. The Company's licensing agreement with Shanghai Eesli is a master
licensing agreement whereby Shanghai Eesli Trading Company will manufacture,
promote, sell and distribute products bearing the Cherokee brand within the
territories of the People's Republic of China, including Shanghai, Jiangsu,
Beijing, Tianjin, Sichuan, Hubei, Gansu, Shanxi, Liaoning, Chongqing and
Guangdong. The agreement covers a broad range of product categories including
women's sportswear and intimate apparel, children's apparel, women and
children's footwear, women's fashion accessories and cosmetics. The Company
also has a master licensing agreement with Mondragon in the Philippines and a
wholesale licensing agreement with Bravo Enterprises in Mexico.
The Company has entered into five international licensing agreements with
respect to the Sideout brand and related trademarks. The Company's
international licensing agreements for the Sideout and King of the Beach brands
are all exclusive and cover countries including Argentina, Uruguay, South
Africa, Japan and Mexico, and product categories including men's, boy's and
women's apparel and footwear. Sideout Mexico, the Company's Mexican licensee,
currently distributes to department and specialty stores and has six Sideout
stores throughout Mexico. The licensing agreement with Tachikara for the
Sideout brand for the category volleyballs, has expired and was not renewed.
6
During Fiscal 2000, the Company received $805,000 in aggregate royalties from
its international license agreements, which accounted for 3.3% of the Company's
consolidated revenues during such period.
Recapitalization; Sale of Cherokee Trademarks to Spell C; Issuance of Secured
Notes
On December 23, 1997, the Company completed a recapitalization that resulted
in the issuance of a special dividend of $5.50 per share on January 15, 1998.
To facilitate the recapitalization, the Company formed Spell C. LLC, a special
purpose, bankruptcy remote, single member Delaware limited liability company,
wholly owned by the Company. The Company assigned to Spell C all of its right,
title and interest in the Amended Target Agreement and sold to Spell C all of
its right, title and interest in the Cherokee brand name and related trademarks
in the United States. The sale of the rights to the Cherokee trademarks in the
United States was subject to certain exceptions which allow the Company to
continue to use the trademarks in the United States in conjunction with the
Company's then-existing license agreements and allow the Company to use the
trademarks in the United States in conjunction with retail license agreements
in the category of cosmetics, bath and body products. The Company may extend
existing Cherokee brand license agreements beyond January 31, 2002 with the
consent of Target; however, the Company must assign 50% of the royalties
payable during the extended term to Target. Except for these exceptions, the
Company no longer has the right to license the Cherokee brand and related
trademarks in the United States, but retains all rights to do so outside of the
United States.
On December 23, 1997 Spell C issued for gross proceeds of $47.9 million,
privately placed Zero Coupon Secured Notes (the "Secured Notes"), yielding 7.0%
interest per annum and maturing on February 20, 2004. The proceeds from the
sale of the Secured Notes were used to pay the special dividend described
above. The Secured Notes amortize quarterly from May 20, 1998 through February
20, 2004, in the amount of $9.0 million per year the first two years and $10.5
million per year the third through sixth years. The Secured Notes are secured
by the Amended Target Agreement and the United States Cherokee trademarks and
brand names. The Secured Notes indenture requires that any proceeds due to
Spell C under the Amended Target Agreement and several other license agreements
must be deposited directly into a collection account controlled by the trustee
under the indenture. The trustee distributes from the collection account the
amount of principal due and payable to the holders of the Secured Notes on
quarterly note payment dates. Excess amounts on deposit in the collection
account may only be distributed to Spell C if the amount on deposit in the
collection account exceeds the amount of principal due and payable on the next
quarterly note payment date. Such excess amounts, if any, may then be
distributed by Spell C to the Company. During Fiscal 2000, of the $16.3 million
in royalty revenues from Target, $9.0 million was paid to the holders of the
Secured Notes and $2.3 million remains in a collection account for the benefit
of the holders of Secured Notes. At various times during Fiscal 2000, Spell C
distributed a total of $9.2 million to the Company (which amount includes
royalty revenues received from Target during both Fiscal 1999 and Fiscal 2000
and interest income earned on royalty revenues). The minimum guaranteed royalty
under the Amended Target Agreement is $9.0 million for each of the two fiscal
years ending January 31, 1999 and 2000 and $10.5 million for each of the four
fiscal years ending January 31, 2001 through 2004. The aggregate scheduled
amortization under the Secured Notes is $60.0 million and equals the aggregate
minimum guaranteed royalty payable under the Amended Target Agreement which is
also $60.0 million. While the Company believes that royalties payable under the
Amended Target Agreement may continue to exceed the minimum guaranteed
royalties payable in upcoming fiscal years, the Company cannot predict with
accuracy whether such royalties will exceed the minimum guaranteed royalties
payable during such years, and if they do not, the Company will not receive
further distributions from Spell C during the term of the Amended Target
Agreement. See "Risk Factors."
Sideout Agreement
On November 7, 1997, the Company entered into an Agreement of Purchase and
Sale of Trademarks and Licenses (the "Sideout Agreement") with Sideout Sport
Inc., pursuant to which the Company agreed to purchase all of Sideout Sport
Inc.'s trademarks, copyrights, trade secrets and associated license agreements.
7
The trademarks acquired from Sideout Sport Inc. include, among others,
Sideout(R), Sideout Sport(R) and King of the Beach(R). Pursuant to the Sideout
Agreement, Cherokee paid $1.5 million at the closing of the acquisition and
agreed to pay an additional $500,000 upon release of liens on the assets which
were purchased. Most of the liens have since been released and $495,000 of the
$500,000 holdback has been paid. Under the terms of the Sideout Agreement, the
Company will also pay Sideout Sport Inc., on a quarterly basis, 40% of the
first $10.0 million, 10% of the next $5.0 million and 5% of the next $20.0
million, of royalties and license fees received by the Company through
licensing of the Sideout trademarks. Upon the earlier of such time as Cherokee
has paid Sideout a total of $7.5 million or October 22, 2004, Cherokee will
have no further obligation to pay Sideout Sport Inc. During Fiscal 2000, the
Company made payments exceeding $757,000 under the Sideout Agreement.
Trademarks
The Company holds various trademarks including Cherokee(R), Sideout(R),
Sideout Sport(R), King of the Beach(R) and others, in connection with numerous
categories of apparel and other goods. These trademarks are registered with the
United States Patent and Trademark Office and in a number of other countries.
The Company also holds trademark applications for Cherokee, Sideout, Sideout
Sport and King of the Beach in numerous countries. The Company intends to renew
these registrations as appropriate prior to expiration. The Company monitors on
an ongoing basis unauthorized uses of its trademarks, and the Company relies
primarily upon a combination of trademark, copyright, know-how, trade secrets,
and contractual restrictions to protect its intellectual property rights both
domestically and internationally. See " Risk Factors."
Marketing
The Company has positioned the Cherokee name to connote quality, comfort, fit
and a "Casual American" lifestyle with traditional, wholesome values. The
Sideout brand and related trademarks represent a beach-oriented, active,
"California" lifestyle. The Company integrates its advertising, product,
labeling and presentation to reinforce these brand images. The Company intends
to continue to promote a positive image in marketing the Cherokee and Sideout
brands through licensee-sponsored advertising. The Company's retail, wholesale
and international license agreements provide the Company with final approval of
pre-agreed upon quality standards, packaging and marketing of licensed
products. The Company principally relies on its licensees to advertise the
Cherokee and Sideout brands, and as a result the Company's advertising costs
have been minimal.
The Company developed a Web site (www.americasbrands.com), which utilizes a
business-to-business E-commerce strategy. The Company's goal in developing the
Web site is to enhance communication, information flow and networking with
existing and prospective licensees. The Web site currently includes the
profiles of the Company and its brands, certain of the Company's financial
statements and press releases, as well as a secured area to support the
Company's licensees with graphics, packaging and trim items, design concepts,
new developments and other administrative needs.
Internationally, the Company intends to continue to seek to develop both of
its principal brands through license agreements and strategic alliances with
manufacturers or other companies who have market power and economies of scale
in their respective markets. The Company is also seeking to represent other
companies in licensing their brands around the world, on a shared revenue
basis. The Company will continue to market its brands and solicit new licensees
through a small number of executive employees and may retain the services of
outside consultants to assist the Company in this effort.
Competition
Royalties paid to the Company under its licensing agreements are generally
based on a percentage of the licensee's net sales of licensed products.
Cherokee and Sideout brand footwear, apparel, and accessories, which are
manufactured and sold by both domestic and international wholesalers and retail
licensees, are subject to
8
extensive competition by numerous domestic and foreign companies. Such
competitors with respect to the Cherokee brand include Levi Strauss & Co., The
Gap, Old Navy, Liz Claiborne and VF Corp. and private labels developed for
retailers. Competitors with respect to the Sideout brand include Quicksilver,
Mossimo, Nike and other activewear companies. Factors which shape the
competitive environment include quality of garment construction and design,
brand name, style and color selection, price and the manufacturer's ability to
respond quickly to the retailer on a national basis. In recognition of the
increasing trend towards consolidation of retailers and greater emphasis by
retailers on the manufacture of directly sourced merchandise, in the United
States the Company's business plan focuses on creating strategic alliances with
major retailers for their sale of products bearing the Company's brands through
the licensing of the Company's trademarks directly to retailers. Therefore, the
success of the Company is dependent on its licensees' ability to design,
manufacture and sell products bearing the Company's brands and to respond to
ever-changing consumer demands. Other companies owning established trademarks
could also enter into similar arrangements with retailers. See "Risk Factors."
Employees
As of January 29, 2000, the Company employed 14 persons. None of the
Company's employees are represented by labor unions and the Company believes
that its employee relations are satisfactory.
Risk Factors
This Risk Factors section has been written with the goal of being responsive
to the Security and Exchange Commission's "Plain English" guidelines. In this
section the words "we", "our", "ours" and "us" refer only to the Company and
not any other person.
Payments to us from our subsidiary, Spell C, are subject to a number of
restrictions under the Amended Target Agreement.
We cannot assure you that our subsidiary, Spell C, will continue to
distribute any significant amount of cash or property to us until after the
maturity of the Secured Notes, if then. The Secured Notes indenture provides
that any royalties payable under the Amended Target Agreement will be deposited
directly into a collection account controlled by the trustee under the Secured
Notes indenture. The trustee will distribute from the collection account the
amount of principal due and payable to the holders on the Secured Notes on
quarterly note payment dates. Excess amounts in the collection account may only
be distributed to Spell C if the amount in the collection account exceeds the
aggregate amount of principal due and payable on the next quarterly note
payment date. Such excess amounts, if any, may then be distributed by Spell C
to us. The aggregate scheduled amortization under the Secured Notes is $60.0
million and equals the aggregate minimum guaranteed royalty payable under the
Amended Target Agreement, which is also $60.0 million. See "Recapitalization;
Sale of Cherokee Trademarks to Spell C; Issuance of Secured Notes" and "North
American Retail Direct Licensing." There is no assurance, therefore, that in
the future there will be any excess amounts available to be distributed to us.
We do not expect revenues deposited in the collateral account from sources
other than the Amended Target Agreement to be significant during fiscal year
2001. We cannot predict with accuracy whether payments under the Amended Target
Agreement will exceed the minimum guaranteed royalty, and if they do not, no
distribution will be made to Spell C from the collateral account, and in turn,
Spell C will have no funds available to distribute to us. If Spell C does not
distribute any funds to us during the balance of the initial term of the
Amended Target Agreement it could have a material adverse effect on our
business, financial condition and results of operations.
Our efforts to develop and market the Sideout brand may not be successful.
We acquired the Sideout brand and related trademarks in November 1997. See
"Sideout Agreement." We are attempting to develop the Sideout brand through
both domestic and international retail direct and wholesale licensing. Although
the Sideout brand is a well-recognized, beach volleyball brand, there can be no
assurance that our efforts to develop and market the Sideout brand will result
in significant increases in royalty payments.
9
Our failure to increase royalty payments from the Sideout brand could have a
material adverse effect on the growth of our business.
Our business is subject to intense competition.
Royalties paid to us under our licensing agreements are generally based on a
percentage of our licensee's net sales of licensed products. Cherokee and
Sideout brand footwear, apparel, and accessories, which are manufactured and
sold by both domestic and international wholesalers and retail licensees, are
subject to extensive competition by numerous domestic and foreign companies.
Such competitors with respect to the Cherokee brand include Levi Strauss & Co.,
The Gap, Old Navy, Liz Claiborne and VF Corp. and private labels developed for
retailers. Competitors with respect to the Sideout brand include Quicksilver,
Mossimo, Nike and other activewear companies. Factors which shape the
competitive environment include quality of garment construction and design,
brand name, style and color selection, price and the manufacturer's ability to
respond quickly to the retailer on a national basis. In recognition of the
increasing trend towards consolidation of retailers and greater emphasis by
retailers on the manufacture of private label merchandise, in the United States
our business plan focuses on creating strategic alliances with major retailers
for their sale of products bearing our brands through the licensing of our
trademarks directly to retailers. Therefore, our success is dependent on our
licensees' ability to design, manufacture and sell products bearing our brands
and to respond to ever-changing consumer demands, and any significant failure
by our licensees to do so could have a material adverse effect on our business,
financial condition and results of operations. Other companies owning
established trademarks could also enter into similar arrangements with
retailers. See "Competition."
Our business is dependent on Target Stores, which accounted for 66% of our
consolidated licensing revenues in Fiscal 2000.
During Fiscal 2000, 66% of our and Spell C's consolidated licensing revenues
were generated from a single source, Target Stores, a division of Target Corp.
See "North American Retail Direct Licensing." We have assigned all our rights
in the Amended Target Agreement to Spell C, which has in turn pledged the
Amended Target Agreement as collateral for the Secured Notes. Spell C will be
dependent on revenues from the Amended Target Agreement for most, if not all,
of its revenues. Although the Amended Target Agreement provides for minimum
annual royalty payments, if for any reason Target does not pay the minimum
royalties, Spell C will likely be unable to meet, and will default on, its
payment obligations under the indenture for the Secured Notes. We are not a
guarantor of the Secured Notes; however, the United States Cherokee trademarks
have been pledged as security for the Secured Notes and the permanent loss of
such trademarks as a result of a default would have a material adverse effect
on our business, financial condition and results of operations. The Secured
Notes mature and the initial term of the Amended Target Agreement expires at
approximately the same time. At such time payments from the Amended Target
Agreement, if extended or renewed, may be distributed by Spell C to us. If
Target elects not to extend or renew the Amended Target License Agreement upon
the expiration of its initial term, it could have a material adverse effect on
our business, financial condition and results of operations. There can be no
guarantee that we would be able to replace the Target royalty payments from
other sources.
We are dependent on our intellectual property and we cannot assure you that we
will be able to successfully protect our rights.
We and Spell C hold various trademarks including Cherokee, Sideout, Sideout
Sport, King of the Beach and others in connection with apparel, footwear and
accessories. These trademarks are vital to the success and future growth of our
business. These trademarks are registered with the United States Patent and
Trademark Office and in several other countries. We and Spell C also hold
numerous trademark applications for Cherokee, Sideout, Sideout Sport and King
of the Beach in numerous countries. We monitor on an ongoing basis unauthorized
uses of our trademarks, and we rely primarily upon a combination of trademark,
copyright, know-how, trade secrets, and contractual restrictions to protect our
intellectual property rights. We believe that such measures afford only limited
protection and, accordingly, there can be no assurance that the actions taken
by us
10
to establish and protect our trademarks and other proprietary rights will
prevent imitation of our products or infringement of our intellectual property
rights by others, or prevent the loss of licensing revenue or other damages
caused thereby. The United States Patent and Trademark Office is participating
in an ongoing study directed to the protectability of Native American Indian
signs. The United States Patent and Trademark Office could determine that
American Indian insignias should not be federally registered. We cannot dismiss
the possibility that legislation resulting from the study would not have a
material impact upon us. In addition, the laws of several countries in which we
have licensed our intellectual property may not protect our intellectual
property rights to the same extent as the laws of the United States. Despite
our efforts to protect our intellectual property rights, unauthorized parties
may attempt to copy aspects of our intellectual property, which could have a
material adverse effect on our business, financial condition and results of
operations. However, in the future we may be required to assert infringement
claims against third parties, and there can be no assurance that one or more
parties will not assert infringement claims against us. While we currently have
the resources to pursue or defend most infringement claims, any resulting
litigation could result in significant expense and divert the efforts of our
management personnel whether or not such litigation is determined in our favor.
We are dependent on our key management personnel.
Our overall business and marketing strategy and current direction was
principally conceived and implemented by Robert Margolis, our Chairman and
Chief Executive Officer, with the assistance of Patricia Warren, our former
President and Carol Gratzke, our Chief Financial Officer. On March 3, 1998,
Patricia Warren resigned as President of the Company. Howard Siegel was
appointed President of Operations in June 1998. Steven Ascher, the founder and
former President of Sideout Sport Inc., was also appointed Executive Vice
President in June 1998. Despite the recent hires, the loss of the services of
Mr. Margolis could have a material adverse effect on our business, financial
condition and results of operations.
Item 2. PROPERTIES
The Company leases a 14,700 square foot office facility in Van Nuys,
California. The initial term of the lease is for three years, expiring in July
2001. The monthly rent is $8,500 and the Company has an option to extend the
term of the lease for two additional three-year periods.
Item 3. LEGAL PROCEEDINGS
In the ordinary course of business, the Company from time to time becomes
involved in legal claims and litigation. In the opinion of management, based on
consultations with legal counsel, the disposition of litigation currently
pending against the Company is unlikely to have, individually or in the
aggregate, a materially adverse effect on its business financial position or
results of operations.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 14, 1999, the Board of Directors of the Company furnished to each
stockholder, as of the record date December 8, 1999, a Notice of Solicitation
of Consents and an accompanying Consent Solicitation Statement asking the
holders of Cherokee's common stock to take action without a stockholder's
meeting. The holders of Cherokee's common stock were asked to approve by means
of written consent Sections 3.2 and 3.3 of the Second Revised and Restated
Management Agreement between The Newstar Group and Cherokee Inc. and the
performance goals contained therein.
Consent cards representing 55% of the total issued and outstanding Cherokee
common stock were tabulated on January 20, 2000. Holders on the record date of
shares representing approximately 52% of the issued and outstanding Cherokee
common stock, which is 94.5% of the total shares voted, had delivered unrevoked
consents approving Sections 3.2 and 3.3 of the Revised Management Agreement and
the performance goals contained therein. Of the 4,713,618 shares voted,
4,405,180 shares voted yes, 305,878 shares voted no and 2,560 shares abstained.
11
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock traded on the NASDAQ Small Cap Issues Market under the
symbol CHKE until October 28, 1998. On October 29, 1998, the Company's Common
Stock began trading on the Nasdaq National Market System. The Company's Nasdaq
trading symbol has remained CHKE. The table below sets forth for each of the
fiscal quarters during the Company's last two fiscal years the range of the
high and low bid information for the Common Stock and the cash dividends paid.
[Download Table]
Dividends
High Low Paid
-------- ----- ---------
Fiscal 1999
-----------
Quarter ended May 2, 1998........................... 8 3/4 7 3/8 0.50
Quarter ended August 1, 1998........................ 11 5/8 8 3/4 0.25
Quarter ended October 31, 1998...................... 10 7/8 7 5/8 0.25
Quarter ended January 30, 1999...................... 9 1/2 7 5/8 0.25
Fiscal 2000
-----------
Quarter ended May 1, 1999........................... 8 1/4 7 3/4 0.25
Quarter ended July 31, 1999......................... 9 11/16 7 1/2 0.25
Quarter ended October 30, 1999...................... 8 5/8 7 1/2 --
Quarter ended January 29, 2000...................... 9 1/2 7 5/8 --
On April 14, 2000, the latest bid price for the Common Stock, reported on the
NASDAQ National Market System, was $7.25 per share. As of April 14, 2000, the
number of stockholders of record of the Common Stock was 163. This figure does
not include beneficial holders whose shares may be held of record by brokerage
firms and clearing agencies.
Through May 1999, the Company paid a quarterly dividend. However, the payment
of any future dividends will be at the discretion of the Company's Board and
will be dependent upon the Company's financial condition, results of
operations, capital requirements and other factors deemed relevant by the
Company's Board.
On July 22, 1999, the Company's Board of Directors authorized the repurchase
of up to one million shares or approximately 11.5% of its outstanding common
stock. Pursuant to this directive, the Company repurchased and retired 233,000
shares of its common stock during Fiscal 2000. Continued repurchases of the
Company's stock, if any, will be made from time to time in the open market at
prevailing market prices or privately negotiated transactions.
12
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information, except as noted,
has been taken or derived from the audited consolidated financial statements of
the Company and should be read in conjunction with the consolidated financial
statements included elsewhere in this Form 10-K. See "--Item 8. Consolidated
Financial Statements and Supplementary Data."
Given the developments involving the Company during the last three fiscal
years, such as the assignment of the Amended Target Agreement to Spell C, the
sale of the rights to the Cherokee trademarks in the United States to Spell C
and the issuance of the Secured Notes, the future results of the Company are
expected to differ significantly from the Company's historical results in the
years ended May 31, 1997 and June 1, 1996, and therefore undue reliance should
not be placed on the following selected consolidated financial information
regarding such periods as indicative of future results.
[Download Table]
Eight
Months Year Year
Year Ended Year Ended Ended Ended Ended
January 29, January 30, January 31, May 31, June 1,
2000 1999 1998 1997 1996
----------- ----------- ----------- ------- -------
($ In Thousands Except Per Share Data)
Statement of Operations
Data:
Royalty revenues/Net
sales.................. $ 24,714 $ 19,307 $ 8,553 $ 8,718 $13,899
Cost of goods sold...... -- -- -- 184 10,445
-------- -------- -------- ------- -------
Gross profit............ 24,714 19,307 8,553 8,534 3,454
Selling, general and
administrative
expenses............... 7,225 6,428 4,192 3,406 4,460
Performance option
expense................ -- -- -- -- 4,567(1)
Amortization of
trademarks and goodwill
....................... 260 200 43 -- --
Forgiveness of note
receivable from
Stockholder ........... 1,891(2) -- -- -- --
-------- -------- -------- ------- -------
Operating income
(loss)................. 15,338 12,679 4,318 5,128 (5,573)
Other (income) expense.. -- -- (422) (75) (96)
Interest expense........ 2,817 3,247 330 3 355
Investment and interest
income................. (399) (638) (525) (460) (543)
Gain on sale of Uniform
Div and other assets... -- -- -- (220) (3,840)
-------- -------- -------- ------- -------
Income (loss) before
income taxes........... 12,920 10,070 4,935 5,880 (1,449)
Income tax expense
(benefit) ............. 4,859 3,982 (782) (771) --
-------- -------- -------- ------- -------
Net income (loss)....... 8,061 6,088 5,717 6,651 (1,449)
======== ======== ======== ======= =======
Basic earnings (loss)
per share.............. $ 0.94 $ 0.70 $ 0.73 $ 0.87 $ (0.22)
Diluted earnings (loss)
per share.............. $ 0.94 $ 0.70 $ 0.68 $ 0.82 $ (0.22)
Cash distribution of
capital per share...... -- -- $ 5.50 -- $ 0.60
Cash dividends per
share.................. $ 0.50 $ 1.25 $ 0.20 $ 0.35 --
January 29, January 30, January 31, May 31, June 1,
2000 1999 1998 1997 1996
----------- ----------- ----------- ------- -------
Balance Sheet Data:
Working capital
(deficiency)........... $ (2,237) $ (2,242) $ 4,445 $ 9,148 $ 227
Total assets............ 17,518 19,529 24,471 13,601 8,320
Long-term debt, net of
current maturities..... 28,389 35,697 41,675 -- --
Stockholders' (deficit)
equity................. (24,133) (29,879) (25,646) 12,224 6,070
--------
Notes to Selected Financial Data
(1) Represents a non-cash charge of $4.6 million resulting from the exercise of
The Newstar Group, Inc. d/b/a The Wilstar Group ("Wilstar") performance
options. Wilstar is a related party, and Robert Margolis is the majority
shareholder and Chief Executive Office of Wilstar.
(2) Represents a non-cash charge of $1.9 million resulting from the partial
forgiveness and cancellation of note receivable from stockholder per
Section 3.2(a)(ii) of The Second Revised and Restated Management Agreement
between Wilstar and the Company.
13
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
Overview
Since May 1995, the Company has principally been in the business of marketing
and licensing the Cherokee brand and related trademarks and other brands it
owns. The Company's operating strategy emphasizes domestic and international
wholesale and retail direct licensing, whereby the Company grants wholesalers
and retailers the license to use its trademarks on certain categories of
merchandise.
In November 1997, the Company reaffirmed its strategic relationship with
Target Stores, a division of Target Corp., by entering into the Amended Target
Agreement, which grants Target the exclusive right in the United States to use
the Cherokee trademarks in certain categories of merchandise. See "--Item 1.
Business. North American Retail Direct Licensing." Under the Amended Target
Agreement, Target will pay a royalty each fiscal year, up to and including the
fiscal year ending January 31, 2004, based on a percentage of Target's net
sales of Cherokee branded merchandise during each fiscal year, which percentage
varies according to the volume of sales of merchandise. In any event, Target
has agreed to pay a minimum guaranteed royalty of $9.0 million for each of the
two fiscal years ending January 31, 1999 and 2000 and $10.5 million for each of
the four fiscal years ending January 31, 2001 through 2004. Under the Amended
Target Agreement, in most cases, the Company or Spell C must receive Target's
consent to enter into additional licensing agreements in the United States with
respect to the Cherokee brand during the term of the agreement. Therefore, the
Company's current focus with respect to the Cherokee brand is to continue to
develop that brand in several international markets through retail direct or
wholesale licenses with manufacturers or other companies who have market power
and economies of scale in the respective markets.
As part of a recapitalization that occurred in September 1997, the Company
sold to Spell C, its wholly-owned subsidiary, all of its rights to the Cherokee
brand and related trademarks in the United States and assigned to Spell C all
of its rights in the Amended Target Agreement in exchange for the proceeds from
the sale of the Secured Notes. See "Item 1. Business. Recapitalization; Sale of
Cherokee Trademarks to Spell C; Issuance of Secured Notes." Spell C issued for
an aggregate of $47.9 million, privately placed Zero Coupon Secured Notes,
yielding 7.0% interest per annum and maturing on February 20, 2004. The Secured
Notes amortize quarterly from May 20, 1998 through February 20, 2004, in the
amount of $9.0 million per year the first two years and $10.5 million per year
the third through sixth years. The Secured Notes are secured by the Amended
Target Agreement and the United States Cherokee brand name and trademarks. The
Secured Notes indenture provides that any royalties generated by the Amended
Target Agreement must be deposited directly into a collection account
controlled by the trustee under the indenture for distribution to holders of
the Secured Notes. Excess amounts in the collection account may be distributed
to Spell C only if the excess amounts exceed the aggregate amount of principal
due and payable on the next quarterly note payment date. Such excess amounts,
if any, will then be distributed by Spell C to the Company. Since the aggregate
payments due under the Amended Target Agreement are $60 million and equal the
aggregate minimum guaranteed royalty payable under the Amended Target
Agreement, which is also $60 million, there is no assurance that there will be
any excess amounts to be distributed. See "Item 1. Risk Factors."
Target commenced the initial sales of Cherokee branded merchandise in July
1996. Royalty revenues from Target were $5.9 million during the fiscal year
ended May 31, 1997, $6.4 million during the eight month fiscal period ended
January 31, 1998, $14.6 million during Fiscal 1999 and $16.3 million during
Fiscal 2000, which accounted for 68%, 75%, 76% and 66%, respectively, of the
Company's consolidated revenues during such periods. While all royalties paid
under the Amended Target Agreement appear in the Company's consolidated
financial statements, since the issuance of the Secured Notes, most of such
royalties have been, and most, if not all of such royalties received until the
maturity of the Secured Notes, will be distributed to the holders of the
Secured Notes. See "Item 1. Risk Factors." Prior to the maturity of the Secured
Notes, royalties from the Amended Target Agreement will be offset by principal
payments to the holders of the Secured Notes in the amount of $9.0 million per
year during the first two years and $10.5 million per year during the third
through sixth years of the term of the indenture. During Fiscal 2000, of the
$16.3 million in royalty revenues received
14
Target, $9.0 million was paid to the holders of the Secured Notes. At various
times during Fiscal 2000, Spell C distributed a total of $9.2 million to the
Company (which amount includes royalty revenues received from Target during
both Fiscal 1999 and Fiscal 2000 and interest income earned on royalty
revenues). While the Company believes that royalties payable under the Amended
Target Agreement may continue to exceed the minimum guaranteed royalty payable
thereunder, the Company cannot predict this with any accuracy. The revenues
generated from all other licensing agreements during the fiscal year ended May
31, 1997 were $2.8 million, during the eight month fiscal period ended January
31, 1998 were $2.1 million, during Fiscal 1999 were $4.7 million and during
Fiscal 2000 were $8.4 million, which accounted for 32%, 25%, 24% and 34%,
respectively, of the Company's revenues during such periods.
In November 1997, the Company purchased the Sideout brand and related
trademarks from Sideout Sport, Inc. for approximately $2.0 million and a
portion of the future royalties generated by the Sideout brand. Under the terms
of the Sideout Agreement, the Company agreed to pay Sideout Sport Inc., on a
quarterly basis, 40% of the first $10.0 million, 10% of the next $5.0 million
and 5% of the next $20.0 million, of royalties and license fees received by the
Company through licensing of the Sideout trademarks. Upon the earlier of such
time as Cherokee has paid Sideout a total of $7.5 million or October 22, 2004,
Cherokee will have no further obligation to pay Sideout Sport Inc. During
Fiscal 2000, the Company made additional contingent payments of $757,000 under
the Sideout Agreement. The Sideout brand generated licensing revenues from
existing contracts of approximately $2.9 million during Fiscal 2000. See "Item
1. Business. Sideout Agreement."
As of November 29, 1999, the Company and The Newstar Group, d/b/a The Wilstar
Group ("Wilstar") entered into a Second Revised and Restated Management
Agreement (the "Revised Management Agreement") which substantially revised and
restated the terms under which Wilstar will continue to provide the executive
management services of Robert Margolis to the Company. Mr. Margolis is
currently the sole stockholder of Wilstar. As base compensation for services
rendered, Wilstar will be paid $587,450 per fiscal year, subject to annual cost
of living increases. Wilstar is also eligible for annual performance bonuses.
Section 3.2 of the Revised Management Agreement provides that if the Company's
consolidated pre-tax earnings during the fourth quarter of Fiscal 2000, were no
less than $1,674,710, then Wilstar would receive a performance bonus equal to
(x) 10% of the Company's EBITDA for Fiscal 2000 in excess of $2.5 million, plus
(y) 15% of the Company's EBITDA during Fiscal 2000 in excess of $10.0 million.
Subject to meeting the $1,674,710 threshold, the Company also agreed to forgive
approximately $1.89 million of the principal amount of the Promissory Note,
dated December 23, 1997 made by Mr. Margolis in favor of the Company. The
Revised Management Agreement provides that for purposes of determining if the
$1,674,710 threshold was met, any portion of the Promissory Note that is
forgiven will not reduce the calculation of the Company's consolidated pre-tax
earnings for the fourth quarter of Fiscal 2000. The Company's consolidated pre-
tax earnings during the fourth quarter exceeded the $1,674,710 threshold as
calculated pursuant to the Revised Management Agreement. As a result, the
Company will pay Wilstar a bonus of $1.78 million and forgive approximately
$1.89 million of the principal amount of the Promissory Note. The payments and
loan cancellation have been accrued for in the Company's financial statements
for Fiscal 2000.
Section 3.3 of the Revised Management Agreement provides, that, for each
fiscal year after Fiscal 2000, if the Company's EBITDA for such fiscal year is
no less than $5.0 million, then Wilstar will receive a performance bonus equal
to (x) 10% of the Company's EBITDA for such fiscal year in excess of $2.5
million up to $10.0 million, plus (y) 15% of the Company's EBITDA for such
fiscal year in excess of $10.0 million. As a result, if the Company's EBITDA
continues to increase, the bonus payable to Wilstar under the Revised
Management Agreement will also increase.
The Company is frequently approached by parties seeking to sell their brands
and related trademarks. Should an established and marketable brand become
available on favorable terms, the Company would be interested in pursuing such
an acquisition. In addition to acquiring brands, the Company is seeking to
represent and manage, as an exclusive agent, other brands with respect to
international marketing, licensing and distribution. As an exclusive agent,
Cherokee would expect to perform services, including solicitation, contract
completion, maintenance, development and administration of license or
distribution agreements. The Company
15
would receive a certain percentage of net royalties for the services it
rendered as an exclusive agent. Cherokee intends to use its newly developed
Web-site (www.americasbrands.com) to enhance its licensing activities.
In 1997, the Company's Board changed the fiscal year end of the Company to a
52 or 53 week fiscal year ending on the Saturday nearest to January 31 in order
to better align the Company with its licensees who generally also operate and
plan using such a fiscal year. Prior to this change the Company's fiscal year
was a 52 or 53 week fiscal year ending on the Saturday nearest May 31. As a
result, the 1997 fiscal year ended on May 31, 1997 and included 52 weeks, the
eight month fiscal period ended on January 31, 1998 and included 35 weeks,
Fiscal 1999 ended on January 30, 1999 and included 52 weeks and Fiscal 2000
ended on January 29, 2000 and included 52 weeks.
Results of Operations
The following table sets forth for the periods indicated certain consolidated
financial data of the Company. The Company's historical financial statements
(presented below) relating to the year ended May 31, 1997, include operating
results relating to the Uniform Division, which has been sold. In December
1997, the Company assigned the Amended Target Agreement to Spell C and Spell C
entered into the Indenture. As a result, during Fiscal 1999, $6.75 million in
royalty revenues, and during Fiscal 2000, $9.0 million in royalty revenues,
were distributed to the holders of the Secured Notes.
[Download Table]
Eight
Months
Year Ended Year Ended Ended Year Ended
January 30, January 30, January May 31,
2000 1999 31, 1998 1997
----------- ----------- ---------- ----------
Royalty Revenues/Net Sales:
Licensing Division......... $24,714,000 $19,307,000 $8,553,000 $8,333,000
Other/Uniforms............. -- -- -- 385,000
----------- ----------- ---------- ----------
Total Company............ $24,714,000 $19,307,000 $8,553,000 $8,718,000
=========== =========== ========== ==========
Gross Profit:
Licensing Division......... $24,714,000 $19,307,000 $8,553,000 $8,333,000
Other/Uniforms............. -- -- -- 201,000
----------- ----------- ---------- ----------
Total Company............ $24,714,000 $19,307,000 $8,553,000 $8,534,000
=========== =========== ========== ==========
Selling, general,
administrative and
Amortization expenses ...... $ 7,486,000 $ 6,628,000 $4,235,000 $3,406,000
Forgiveness of note
receivable ................. 1,890,000(1) -- -- --
----------- ----------- ---------- ----------
Operating income (loss) ..... $15,338,000 $12,679,000 $4,318,000 $5,128,000
=========== =========== ========== ==========
--------
(1) A non-cash charge of $1.9 million resulting from the partial forgiveness
and cancellation of the note receivable from Mr. Margolis during the year
ended January 29, 2000.
Fiscal 2000 Compared to Fiscal 1999
In Fiscal 2000, revenues increased 28% to $24.7 million from $19.3 million
for Fiscal 1999. Revenues for both Fiscal 2000 and Fiscal 1999 were generated
solely from licensing the Company's trademarks. Revenues from Target for Fiscal
2000 and Fiscal 1999 were $16.3 million or 66% of revenues and $14.6 million or
76% of revenues, respectively. Revenues from all other sources for Fiscal 2000
and Fiscal 1999 were $8.4 million or 34% of revenues and $4.7 million or 24% of
revenues, respectively. Zellers paid royalties of approximately $3.6 million
Fiscal 2000 compared to $1.1 million in Fiscal 1999. The increase in royalties
is mainly due to the increased acceptance by Canadian consumers of merchandise
bearing the Cherokee brand and Zellers' expansion of the Cherokee brand into
additional product categories. In Fiscal 2000, its first full year of sales of
Sideout merchandise, Mervyn's paid royalties of $1.7 million during. One of the
Company's licensees, Uptons, Inc., closed on December 31, 1999 and as part of
the termination agreement paid, in Fiscal 2000, 90% of the remaining minimum
royalties due, which amounted to $336,000.
16
Selling, general and administrative expenses for Fiscal 2000 were $9.4
million or 38% of revenues compared to $6.6 million or 34% of revenues for
Fiscal 1999. During Fiscal 2000, selling, general and administrative expenses
increased due to expenses of approximately $300,000 in marketing and finders
fees, additional bonus expense of $573,000 and the forgiveness and cancellation
of $1.9 million of the note receivable from Mr. Margolis, a one-time event.
Finder fee expenses are expected to increase as Sideout royalties increase and
management and staff bonus expenses are expected to rise as EBITDA rises.
The Company's interest expense for Fiscal 2000 was $2.8 million compared to
$3.2 million for Fiscal 1999. The interest expense is attributable to the
Secured Notes. Interest expense is expected to decrease as the Company
continues to make quarterly payments on the Secured Notes. The Company's
investment and interest income for Fiscal 2000 was $399,000 compared to
$638,000 for Fiscal 1999. The reduction in investment and interest income is
due to less cash being available for investment.
The Company's net income for Fiscal 2000 was $8.1 million or $0.94 per
diluted share compared to a net income of $6.1 million or $0.70 per diluted
share for Fiscal 1999. For Fiscal 2000, the Company booked for GAAP purposes a
tax provision of $4.9 million or $0.56 per diluted share, compared to $4.0
million or $0.46 per diluted share for Fiscal 1999, which amounts were offset
against the Company's deferred tax asset account. In Fiscal 2000, the Company
utilized $5.3 million of its federal net operating loss carryovers ("NOL's")
and $780,450 of its limited Internal Revenue Code Section 382 (1)(6) NOL's for
both federal and state. At January 29, 2000, the Company had fully utilized the
NOL's generated subsequent to the Company's 1994 reorganization, which were not
subject to Section 382 limitations.
Fiscal 1999 Compared to Comparative 1998
In Fiscal 1999, revenues increased 58% to $19.3 million from $12.2 million
for the unaudited 12 month period ended January 30, 1998, used for comparative
purposes ("Comparative 1998"). Revenues for both Fiscal 1999 and Comparative
1998 were generated solely from licensing the Company's trademarks. Revenues
from Target for Fiscal 1999 and Comparative 1998 were $14.6 million or 76% of
revenues and $8.9 million or 73% of revenues, respectively. Revenues from all
other sources for Fiscal 1999 and Comparative 1998 were $4.7 million or 24% of
revenues and $3.3 million or 27% of revenues, respectively.
Selling, general and administrative expenses for Fiscal 1999 were $6.6
million or 34% of revenues compared to $5.9 million or 49% of revenues for
Comparative 1998. During Fiscal 1999, selling, general and administrative
expenses increased due to expenses of approximately $200,000 in amortization of
the Company's trademarks, $260,000 in salaries for additional marketing staff
to intensify the Company's domestic and international efforts to negotiate
contracts, $206,000 in amortization of the securitization fees, which were
incurred by Spell C in completing the recapitalization and $1.8 million in
accrued management bonus.
The Company's interest expense for Fiscal 1999 and Comparative 1998 was $3.2
million and $330,000, respectively. The interest expense is attributable to the
Secured Notes. The Company's investment and interest income for Fiscal 1999 and
Comparative 1998 was $638,000 and $690,000, respectively.
The Company's net income for Fiscal 1999 was $6.1 million or $0.70 per
diluted share compared to a net income of $8.9 million or $1.05 per diluted
share for Comparative 1998, a period in which an income tax benefit of $1.5
million or $0.18 per diluted share was booked due to utilization of NOL's. For
Fiscal 1999, the Company booked for GAAP purposes a tax provision of $4.0
million or $0.46 per diluted share, which amounts were offset against the
Company's deferred tax asset account.
For Fiscal 1999, the income tax provision was calculated using an effective
tax rate of 39.5%. At January 30, 1999, the Company has federal NOL's,
generated subsequent to the Company's 1994 reorganization, of approximately
$5.2 million, which will begin to expire in 2011. The Company believes
utilization of these losses is not subject to Internal Revenue Code Section 382
limitations. The Company has fully utilized the California NOL's generated
after the 1994 reorganization.
17
Eight Months Ended January 31, 1998 Compared to Eight Months Ending February 1,
1997
Revenues for the Eight Month Fiscal Period ended January 31, 1998 were $8.6
million, 100% of which represented licensing revenues. In comparison, net sales
for the unaudited eight months ended February 1, 1997 (the "1997 Eight Months")
were $5.1 million, which included $4.7 million in licensing revenues with the
remaining sales from the liquidations of apparel and footwear inventories. As a
percentage of total revenues for the 1997 Eight Months, licensing revenues
represented 93%. Revenues from Target for the Eight Month Fiscal Period were
$6.4 million, which represented 75% of net revenues. Revenues from all other
sources for the Eight Month Fiscal Period were $2.2 million, which represented
25% of net revenues.
The Company's gross profit margin for the Eight Month Fiscal Period was $8.6
million or 100% of net revenues compared to $4.9 million or 96% of net sales
for the 1997 Eight Months. The gross profit percentage is not comparable to
historical levels as a result of the Company ceasing to manufacture and import
apparel and footwear and selling its inventories.
Selling, general and administrative expenses for the Eight Month Fiscal
Period were $4.2 million or 49% of net revenues compared to $1.8 million (net
of certain other liabilities totaling $700,000 which were deemed no longer
necessary), or 35% of net sales for the 1997 Eight Months. During the Eight
Month Fiscal Period, selling, general and administrative expenses increased due
to the payment of $474,000 in financial advisory services, $240,000 in staff
bonuses, the addition of marketing staff to intensify the Company's
international efforts to negotiate contracts, and the development of
advertising materials to expand the Company's global marketing and to maintain
the synergy of the Cherokee brand image on a worldwide basis. Selling, general
and administrative expenses for the Eight Month Fiscal Period included certain
non-recurring expenses totaling $474,000.
Liquidity and Capital Resources
On January 29, 2000 the Company had $4.6 million in cash and cash
equivalents, including restricted cash of $2.3 million. Cash flow needs over
the next twelve months are expected to be met through the operating cash flows
generated from licensing revenues and the Company's cash and cash equivalents.
During Fiscal 2000, cash provided by operations was $14.2 million, compared
to $12.8 million in Fiscal 1999. During Fiscal 2000, cash used in investing
activities was $1.7 million due mainly to trademark purchases and registration
fees, compared to $957,000 in Fiscal 1999, relating to the purchase of
trademarks and property and equipment. During Fiscal 2000, cash used in
financing activities was $13.1 million compared to $19.3 million in Fiscal
1999. Cash used in financing activities in Fiscal 2000 represents a decrease in
restricted cash of $2.2 million, offset by the purchase of treasury shares
totaling $1.9 million, the Secured Notes payments of $9.0 million and the cash
dividend distributions of $4.3 million made during Fiscal 2000.
Inflation and Changing Prices
Inflation, traditionally, has not had a significant effect on the Company's
operations. Since most of the Company's future revenues are based upon a
percentage of sales of the licensed products by the Company's licensees, the
Company does not anticipate that inflation will have a material impact on
future operations.
Year 2000 Compliance
Because the Company's primary business is marketing and licensing its
trademarks, the Company has only modest information technology requirements and
resources, none of which is critical to the Company's day-to-day operations.
Further, the Company's computer hardware and software systems were Year 2000
compliant prior to December 31, 1999 and the costs to upgrade the Company's
systems were insignificant. To date, the Company has not experienced any Year
2000 issues with its internal computer hardware or software systems or with its
licensees. In addition, the Company has not experienced any interruptions of
royalty payments or lower royalty payments due from its licensees as a result
of Year 2000 issues.
18
New Accounting Pronouncements
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements",
which gives the Securities and Exchange Commission's views on certain revenue
recognition issues. Management does not believe the impact of this
pronouncement will have any material effect on the Company's financial
statements.
Subsequent Events
On March 27, 2000, Mossimo, Inc. and the Company entered into the Cherokee-
Mossimo Finders' Agreement to assist and advise on a licensing deal with Target
with respect to the Mossimo trademarks. In the Finders' Agreement, Mossimo,
Inc. agreed to pay to the Company in perpetuity finder's fees equal to 15% of
net revenues its receives from Target. On March 29, 2000, the Company announced
the successful completion of a licensing agreement between Mossimo, Inc. and
Target Corporation. The Company does not expect to receive any Finders Fees
until June 2001, at the earliest.
Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES OF MARKET RISK
Market risk generally represents the risk that losses may occur in the values
of financial instruments as a result of movements in interest rates, foreign
currency exchange rates and commodity prices. The Company does not enter into
derivatives or other financial instruments for trading or speculative purposes.
Interest: From time to time the Company invests its excess cash in interest-
bearing temporary investments of high-quality issuers. Due to the short time
the investments are outstanding and their general liquidity, these instruments
are classified as cash equivalents in the consolidated balance sheet of the
Company and do not represent a material interest rate risk to the Company. The
Company's only long-term debt obligations are the Secured Notes, which are
zero-coupon secured notes yielding interest of 7.0% interest per annum. This
long-term debt obligation does not represent a material interest rate risk to
the Company.
Foreign Currency: The Company conducts business in various parts of the
world. The Company is exposed to fluctuations in exchange rates to the extent
that the foreign currency exchange rate fluctuates in countries where the
Company's licensees do business. For Fiscal 2000, a hypothetical 10%
strengthening of the US dollar relative to the foreign currencies of countries
where the Company operates was not material.
Special Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking statements,
including without limitation, statements containing the words, "believes,"
"anticipates," "estimates," "expects," and words of similar import. Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements
of the Company to be materially different from any future results, performance
or achievements expressed or implied by such forward-looking statements. The
Company is subject to certain risk factors, which include, but are not limited
to, restrictions on distributions by Spell C, uncertainty regarding the Sideout
brand, competition, dependence on a single licensee, dependence on intellectual
property rights, and dependence on key management and other factors referenced
in this Form 10-K. Certain of these factors are discussed in more detail
elsewhere in this Form 10-K, including without limitation under the captions,
"Item 1. Business-Risk Factors" and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations." The forward-looking
information provided by the Company pursuant to the safe harbor established
under the Private Securities Litigation Reform Act of 1995 should be evaluated
in conjunction with the risk factors listed under "Item 1. Business-Risk
Factors." Given the known and unknown risks and uncertainties, undue reliance
should not be placed on the forward-looking statements contained herein. In
addition, the Company disclaims any intent or obligation to update any of the
forward-looking statements contained herein to reflect future events and
developments.
19
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
[Download Table]
Page
----
CHEROKEE INC.
Report of Independent Accountants......................................... F-1
Consolidated Balance Sheets At January 29, 2000 and January 30, 1999 ..... F-2
Consolidated Statements of Operations For the Years Ended January 29, 2000
and January 30, 1999, the Eight Months Ended January 31, 1998 and the
Year Ended May 31, 1997.................................................. F-3
Consolidated Statements of Stockholders' Equity (Deficit) For the Years
Ended January 29, 2000 and January 30, 1999, the Eight Months Ended
January 31, 1998 and the Year Ended May 31, 1997......................... F-4
Consolidated Statements of Cash Flows For the Years Ended January 29, 2000
and January 30, 1999, the Eight Months Ended January 31, 1998 and the
Year Ended May 31, 1997.................................................. F-5
Notes to Financial Statements............................................. F-6
SCHEDULES
II Valuations and Qualifying Accounts and Reserves...................... F-16
All other schedules for which provision is made in the applicable accounting
regulation of the SEC have been omitted since the required information is not
applicable or is not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the Consolidated
Financial Statements and related notes.
20
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders of
Cherokee Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Cherokee Inc. and its subsidiaries at January 29, 2000 and
January 30, 1999, and the results of their operations and their cash flows for
the two years ended January 29, 2000 and January 30, 1999, the eight month
period ended January 31, 1998, and the year ended May 31, 1997, in conformity
with accounting principles generally accepted in the United States. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index, presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. 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 of these statements in
accordance with auditing standards generally accepted in the United States
which 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
March 31, 2000
F-1
CHEROKEE INC.
CONSOLIDATED BALANCE SHEETS
[Download Table]
January 29, January 30,
2000 1999
------------ ------------
Assets
Current assets:
Cash and cash equivalents....................... $ 2,253,000 $ 2,847,000
Restricted cash................................. 2,324,000 4,500,000
Receivables, net................................ 4,841,000 3,232,000
Prepaid expenses and other current assets....... 28,000 29,000
Deferred tax asset.............................. 1,579,000 861,000
------------ ------------
Total current assets.......................... 11,025,000 11,469,000
Securitization fees, net of accumulated
amortization of $429,000 and
$223,000, respectively........................... 812,000 1,018,000
Deferred tax asset................................ 797,000 3,527,000
Property and equipment, net of accumulated
depreciation of $156,000 and $95,000,
respectively..................................... 203,000 233,000
Trademarks, net................................... 4,666,000 3,176,000
Other assets...................................... 15,000 106,000
------------ ------------
Total assets.................................. $ 17,518,000 $ 19,529,000
============ ============
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable................................ $ 600,000 $ 280,000
Dividends payable............................... -- 2,176,000
Other accrued liabilities....................... 2,286,000 1,755,000
Current portion of long term notes payable...... 10,125,000 9,000,000
------------ ------------
Total current liabilities..................... 13,011,000 13,211,000
Other liabilities................................. 250,000 500,000
Notes payable less current portion................ 28,389,000 35,697,000
------------ ------------
Total liabilities............................. 41,650,000 49,408,000
------------ ------------
Commitments and Contingencies (Note 8)
Stockholders' Deficit
Common stock, $.02 par value, 20,000,000 shares
authorized, 8,472,428 and 8,705,428 shares issued
and outstanding at January 29, 2000 and
January 30, 1999, respectively................... 170,000 174,000
Accumulated deficit............................... (23,937,000) (27,919,000)
Note receivable from stockholder.................. (365,000) (2,134,000)
------------ ------------
Total stockholders' deficit................... (24,132,000) (29,879,000)
------------ ------------
Total liabilities and stockholders' deficit... $ 17,518,000 $ 19,529,000
============ ============
The accompanying notes are an integral part of these financial statements.
F-2
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
[Download Table]
Eight Months
Year Ended Year Ended Ended Year Ended
January 29, January 30, January 31, May 31,
2000 1999 1998 1997
----------- ----------- ------------ ----------
Revenues:
Product sales, net........ $ -- $ -- $ -- $ 385,000
Licensing revenues........ 24,714,000 19,307,000 8,553,000 8,333,000
----------- ----------- ---------- ----------
Total net revenues...... 24,714,000 19,307,000 8,553,000 8,718,000
Cost of goods sold.......... -- -- -- 184,000
----------- ----------- ---------- ----------
Gross profit............ 24,714,000 19,307,000 8,553,000 8,534,000
Selling, general and
administrative expenses.... 9,115,000 6,428,000 4,192,000 3,406,000
Amortization of trademarks.. 261,000 200,000 43,000 --
----------- ----------- ---------- ----------
Operating income............ 15,338,000 12,679,000 4,318,000 5,128,000
Other income (expenses):
Interest expense.......... (2,817,000) (3,247,000) (330,000) (3,000)
Investment and interest
income................... 399,000 638,000 525,000 460,000
Gain on sale of Uniform
Division and other
assets................... -- -- -- 220,000
Other income.............. -- -- 422,000 75,000
----------- ----------- ---------- ----------
Total other income
(expenses), net........ (2,418,000) (2,609,000) 617,000 752,000
Income before income taxes.. 12,920,000 10,070,000 4,935,000 5,880,000
Income tax provision
(benefit).................. 4,859,000 3,982,000 (782,000) (771,000)
----------- ----------- ---------- ----------
Net income.............. $ 8,061,000 $ 6,088,000 $5,717,000 $6,651,000
=========== =========== ========== ==========
Basic earnings per
share.................. $ 0.94 $ 0.70 $ 0.73 $ 0.87
=========== =========== ========== ==========
Diluted earnings per
share.................. $ 0.94 $ 0.70 $ 0.68 $ 0.82
=========== =========== ========== ==========
Weighted average shares
outstanding:
Basic..................... 8,618,053 8,683,601 7,866,862 7,688,521
Diluted................... 8,620,553 8,706,011 8,412,768 8,154,311
The accompanying notes are an integral part of these financial statements.
F-3
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)
[Enlarge/Download Table]
Common Stock Accumulated Notes
------------------- Additional (Deficit)/ Receivable
Par Paid-in Retained from
Shares Value Capital Earnings Stockholder Total
--------- -------- ------------ ------------ ----------- ------------
Balance at June 1,
1996................... 7,650,813 $153,000 $ 11,977,000 $ (5,916,000) $ (144,000) $ 6,070,000
Exercise of director
warrants and employee
stock options.......... 95,000 2,000 404,000 -- -- 406,000
Cancellation of shares
held and returned by
disbursing agent....... (18,827) -- -- -- -- --
Cash dividend
distributions.......... -- -- (2,529,000) -- -- (2,529,000)
Utilization of pre-
bankruptcy NOL
carryforwards.......... -- -- 1,482,000 -- -- 1,482,000
Repayment on note
receivable............. -- -- -- -- 144,000 144,000
Net income for the year
ended May 31, 1997..... -- -- -- 6,651,000 -- 6,651,000
--------- -------- ------------ ------------ ----------- ------------
Balance at May 31,
1997................... 7,726,986 155,000 11,334,000 735,000 -- 12,224,000
Exercise of director
warrants and employee
stock options.......... 885,671 18,000 2,850,000 -- -- 2,868,000
Cash dividend
distributions.......... -- -- (18,661,000) (30,258,000) -- (48,919,000)
Utilization of pre-
bankruptcy NOL
carryforwards.......... -- -- 1,727,000 -- -- 1,727,000
Stock option tax
benefit................ -- -- 2,750,000 -- -- 2,750,000
Note receivable from
stockholder............ -- -- -- -- (2,013,000) (2,013,000)
Net income for the eight
months ended January
31, 1998............... -- -- -- 5,717,000 -- 5,717,000
--------- -------- ------------ ------------ ----------- ------------
Balance at January 31,
1998................... 8,612,657 173,000 -- (23,806,000) (2,013,000) (25,646,000)
Exercise of director
warrants and employee
stock options.......... 92,771 1,000 667,000 -- -- 668,000
Cash dividend
distributions.......... -- -- (667,000) (10,210,000) -- (10,877,000)
Utilization of pre-
bankruptcy NOL
carryforwards.......... -- -- -- 9,000 -- 9,000
Note receivable from
stockholder............ -- -- -- -- (121,000) (121,000)
Net income for the year
ended January 30,
1999................... -- -- -- 6,088,000 -- 6,088,000
--------- -------- ------------ ------------ ----------- ------------
Balance at January 30,
1999................... 8,705,428 174,000 -- (27,919,000) (2,134,000) (29,879,000)
Purchase and retirement
of treasury shares..... (233,000) (4,000) -- (1,903,000) -- (1,907,000)
Cash dividend
distributions.......... -- -- -- (2,176,000) -- (2,176,000)
Forgiveness of note
receivable from
stockholder............ -- -- -- -- 1,890,000 1,890,000
Note receivable from
stockholder............ -- -- -- -- (121,000) (121,000)
Net income for the year
ended January 29,
2000................... -- -- -- 8,061,000 -- 8,061,000
--------- -------- ------------ ------------ ----------- ------------
Balance at January 29,
2000................... 8,472,428 $170,000 $ -- $(23,937,000) $ (365,000) $(24,132,000)
========= ======== ============ ============ =========== ============
The accompanying notes are an integral part of these financial statements.
F-4
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
[Download Table]
Eight Months
Year Ended Year Ended Ended Year Ended
January 29, January 30, January 31, May 31,
2000 1999 1998 1997
------------ ------------ ------------ -----------
Operating activities
Net income............. $ 8,061,000 $ 6,088,000 $ 5,717,000 $ 6,651,000
Adjustments to
reconcile net income
to net cash provided
by operating
activities:
Depreciation and
amortization........ 61,000 32,000 23,000 19,000
Amortization of
trademarks.......... 260,000 200,000 43,000 --
Amortization of
securitization
fees................ 206,000 206,000 17,000 --
Amortization of debt
discount............ 2,817,000 3,247,000 330,000 --
Provision for bad
debts............... -- -- -- (112,000)
Interest income on
note receivable from
stockholder......... (121,000) (121,000) (13,000) --
Deferred taxes....... 2,012,000 3,197,000 (3,058,000) (926,000)
Stock option tax
benefit............. -- -- 2,367,000 --
Forgiveness of note
receivable.......... 1,890,000 -- -- --
Changes in current
assets and
liabilities:
Receivables......... (1,609,000) (885,000) (1,573,000) (218,000)
Inventories......... -- 45,000 35,000 176,000
Prepaids and other
current assets..... 1,000 191,000 (190,000) (20,000)
Accounts payable.... 320,000 (365,000) 435,000 (122,000)
Accrued payroll and
related expenses... 531,000 1,233,000 105,000 --
Other liabilities... (250,000) (250,000) -- (750,000)
------------ ------------ ------------ -----------
Net cash provided
by operating
activities....... 14,179,000 12,818,000 4,238,000 4,698,000
Investing activities
Purchases of
trademark............. $ (1,750,000) $ (673,000) $ (2,169,000) $ (458,000)
Purchase of property
and equipment......... (31,000) (216,000) (24,000) (23,000)
Proceeds from sales of
assets held for sale.. -- -- -- 3,576,000
Restricted cash........ -- -- -- 310,000
Repayment on note
receivable from
stockholder........... -- -- -- 144,000
Change in other
assets................ 91,000 (68,000) 5,000 99,000
Collection of notes
receivable............ -- -- 250,000 1,961,000
------------ ------------ ------------ -----------
Net cash (used in)
provided by
investing
activities....... (1,690,000) (957,000) (1,938,000) 5,609,000
Financing activities
Decrease (increase) in
restricted cash....... 2,176,000 (4,500,000) -- --
Payment of long-term
debt.................. (9,000,000) (6,750,000) -- --
Net proceeds from the
issuance of long-term
debt.................. -- -- 47,870,000 --
Debt issuance costs.... -- (6,000) (1,235,000) --
Note receivable from
stockholder........... -- -- (2,000,000) --
Proceeds from exercise
of stock options...... -- 668,000 2,786,000 336,000
Proceeds from exercise
of warrants........... -- -- 82,000 70,000
Purchase of treasury
shares................ (1,907,000) -- -- --
Cash distributions and
dividends............. (4,352,000) (8,701,000) (48,919,000) (2,529,000)
------------ ------------ ------------ -----------
Net cash used in
financing
activities....... (13,083,000) (19,289,000) (1,416,000) (2,123,000)
------------ ------------ ------------ -----------
(Decrease) increase in
cash and cash
equivalents........... (594,000) (7,428,000) 884,000 8,184,000
Cash and cash
equivalents at
beginning of period... 2,847,000 10,275,000 9,391,000 1,207,000
------------ ------------ ------------ -----------
Cash and cash
equivalents at end of
period................ $ 2,253,000 $ 2,847,000 $ 10,275,000 $ 9,391,000
============ ============ ============ ===========
Total paid during
period:
Income taxes......... $ 3,143,000 $ 221,000 $ 64,000 $ 4,600
Interest............. $ 900,000 $ 298,000 $ -- $ 3,000
Non-cash transactions:
Declaration of cash
dividend............ $ -- $ 2,176,000 $ -- $ --
Utilization of pre-
bankruptcy NOL
carryforwards....... $ -- $ 9,000 $ 1,727,000 $ 1,482,000
The accompanying notes are an integral part of these financial statements.
F-5
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business
Cherokee Inc. (the "Company") is in the business of marketing and licensing
the Cherokee and Sideout brands and related trademarks and other brands it
owns. The Company is one of the leading licensors of brand names and trademarks
for apparel, footwear and accessories in the United States.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, SPELL C. LLC, a Delaware limited liability
corporation. All significant intercompany accounts and transactions have been
eliminated in consolidation.
Company Year End
On December 19, 1997, the Company changed its fiscal year to a 52 or 53 week
fiscal year ending on the Saturday nearest to January 31 in order to better
align the Company with its licensees who also generally operate and plan using
a fiscal year ending nearest to January 31. Prior to this change, the Company's
fiscal year was a 52 or 53 week fiscal year ending on the Saturday nearest to
May 31.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the dates of the financial statements and
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased and money
market funds with an original maturity date of three months or less to be cash
equivalents.
The Secured Notes indenture requires the trustee to retain in the collection
account certain amounts sufficient to meet the quarterly note payments.
Revenue Recognition
Royalty revenues are recognized when earned based upon contractual agreement.
Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Maintenance and repairs are expensed as incurred. The cost and
related accumulated depreciation of property and equipment sold or retired are
removed from the accounts and the resulting gains or losses are included in
current operations. Depreciation is provided on a straight line basis over the
estimated useful life of the related asset ranging from three to eight years.
Trademarks
Trademark registrations, renewal fees and acquired trademarks are stated at
cost and are amortized over fifteen years.
F-6
CHEROKEE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Securitization Fees
Securitization fees are the costs associated with the leveraged
recapitalization which have been capitalized and are being amortized over the
term of the Secured Notes indenture.
Long-Lived Assets
The carrying value of long-lived assets is periodically reviewed by
management, and impairment losses, if any, are recognized when the expected
nondiscounted future operating cash flows derived from such assets are less
than their carrying value. Based on current information management believes no
impairment exists.
Income Taxes
Income tax expense is the tax payable for the period and the change during
the period in deferred tax assets and liabilities. Deferred income taxes are
determined based on the difference between the financial reporting and tax
bases of assets and liabilities using enacted rates in effect during the year
in which the differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized.
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to concentration
of credit risk consist principally of cash and cash equivalents and trade
receivables. The Company limits its credit risk with respect to cash by
maintaining cash balances with quality financial institutions. At January 29,
2000 and January 30, 1999, the Company's cash and cash equivalents exceeded
FDIC limits. Concentrations of credit risk with respect to trade receivables
are minimal due to the limited amount of open receivables and due to the nature
of the Company's licensing royalty revenue program. Generally, the Company does
not require collateral or other security to support customer receivables.
One customer accounted for approximately 68% and 76%, respectively, of the
Company's trade receivables at January 29, 2000, and January 30, 1999 and
approximately 66%, 76% and 75% respectively, of the Company's revenues during
the fiscal periods ended January 29, 2000, January 30, 1999 and January 31,
1998.
Stock-Based Compensation
SFAS No. 123 "Accounting for the Awards of Stock-Based Compensation to
Employees" encourages, but does not require companies to record compensation
cost for stock-based compensation plans at fair value. The Company has adopted
the disclosure requirements of SFAS No. 123, which involves proforma disclosure
of net income under SFAS No. 123 and a detailed description of plan terms and
assumptions used in valuing stock option grants. The Company has chosen to
continue to account for stock-based compensation awards in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees".
Advertising
The Company's retail direct licensees fund their own advertising programs.
The Company's advertising and promotional costs are immaterial and are expensed
as incurred.
Earnings Per Share
Basic earnings per share is computed by dividing the net income attributable
to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is
F-7
CHEROKEE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
computed by dividing the net income attributable to common shareholders by the
weighted average number of common and common equivalent shares outstanding
during the period. Common share equivalents included in the diluted computation
represent shares issuable upon assumed exercise of stock options using the
treasury stock method.
Comprehensive Income
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income,"
which establishes standards for reporting and displaying comprehensive income
and its components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. Comprehensive income includes net income
and other comprehensive income components which under generally accepted
accounting principles ("GAAP") bypass the income statement and are reported in
the balance sheet as a separate component of equity. For the two years ended
January 29, 2000 and January 30, 1999, the eight months ended January 31, 1998
and the year ended May 31, 1997, the Company had no other comprehensive income
components as defined in SFAS No. 130, and accordingly, net income equals
comprehensive income.
Segment Reporting
The Company adopted SFAS No. 131. "Disclosures about Segments of an
Enterprise and Related Information" for the year ended January 30, 1999. SFAS
No. 131 supercedes SFAS No. 14, "Financial
Reporting for Segments of a Business Enterprise", replacing the "industry
segment" approach with the "management" approach. The management approach
designates the internal organization that is used by management for making
operating decisions and assessing performance as the source of the Company's
reportable segments. SFAS No. 131 also requires disclosures about products or
services, geographic areas and major customers. The adoption of SFAS No. 131
did not affect the results of operations or financial position nor the the
disclosure of segment information, as the Company's reporting structure
provides for only one segment--the marketing and licensing of its trademarks.
Reclassifications
Certain prior year amounts have been reclassified to conform with current
period presentation.
New Accounting Pronouncements
In December 1999, the Securities and Exchange Commission (the "SEC") issued
Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial
Statements", which gives the SEC's views on certain revenue recognition issues.
Management does not believe the impact of this pronouncement will have any
material effect on the Company's financial statements.
3. Receivables
Receivables consist of the following:
[Download Table]
January 29, January
2000 30, 1999
----------- ----------
Trade................................................. $ 4,258,000 $3,223,000
Other................................................. 583,000 9,000
----------- ----------
$ 4,841,000 $3,232,000
=========== ==========
F-8
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Trademarks
Intangible and other assets consist of the following:
[Download Table]
January 29, January
2000 30, 1999
----------- ----------
Trademarks......................................... $5,169,000 $3,419,000
Accumulated amortization........................... (503,000) (243,000)
---------- ----------
Total............................................ $4,666,000 $3,176,000
========== ==========
In November 1997, the Company entered into an agreement with Sideout Sport
Inc. (the "Sideout Agreement") to purchase trademarks and licenses related to
Sideout(R), Sideout Sport(R) and King of the Beach(R). Pursuant to the Sideout
Agreement the Company paid $1.5 million at the closing date of the acquisition
and agreed to pay $500,000 upon the release of liens, of which $495,000 was
paid during Fiscal 1999. The Company will also pay Sideout Sport Inc., on a
quarterly basis, additional consideration contingent upon a formula of
licensing revenues, as defined in the Sideout Agreement. Such contingent
consideration is limited to a maximum of $5.5 million, or the lesser amount
which may be earned through October 22, 2004.
5. Long-Term Debt
On December 23, 1997, the Company completed the recapitalization described
below and publicly announced that it would declare a special dividend of $5.50
per share, which was subsequently paid on January 15, 1998.
As part of the recapitalization, the Company, in exchange for the proceeds
from the Secured Notes (as defined below), sold to its wholly-owned subsidiary,
Spell C, all its rights to the Cherokee brand and related trademarks in the
United States and assigned to Spell C all of its rights in an amended licensing
agreement (the "Amended Target Agreement") with Target Stores, a division of
Target Corporation ("Target"). Spell C issued for gross proceeds of $47.9
million, privately placed Zero Coupon Secured Notes (the "Secured Notes"),
yielding 7.0% interest per annum and maturing on February 20, 2004. The Secured
Notes amortize quarterly from May 20, 1998 through February 20, 2004. The
Secured Notes are collateralized by the Amended Target Agreement and the
domestic Cherokee brand name and trademarks. The Secured Notes indenture
requires that any proceeds due to Spell C under the Amended Target Agreement
must be deposited directly into a collection account controlled by the trustee
under the indenture. The trustee will distribute from the collection account
the amount of principal due and payable on the Secured Notes to the holders
thereof on quarterly note payment dates. Excess amounts on deposit in the
collection account may only be distributed to Spell C if the amount on deposit
in the collection account exceeds the aggregate amount of principal due and
payable on the next quarterly note payment date. Such excess amounts, if any,
may then be distributed by Spell C to the Company. The minimum guaranteed
royalty under the Amended Target Agreement is $9.0 million for each of the two
fiscal years ending January 29, 1999 and 2000 and $10.5 million for each of the
four fiscal years ending January 31, 2001 through 2004. The aggregate scheduled
amortization under the Secured Notes is $60.0 million and equals the aggregate
minimum guaranteed royalty payable under the Amended Target Agreement which is
also $60.0 million. During Fiscal 2000, the trustee distributed from the
collection account $9.0 million to the holders of the Secured Notes.
F-9
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Maturity Schedule of Secured Notes is as follows:
[Download Table]
Face Value
-----------
2001............................................................ $10,125,000
2002............................................................ 10,500,000
2003............................................................ 10,500,000
2004............................................................ 10,500,000
Thereafter...................................................... 2,625,000
-----------
Total......................................................... $44,250,000
Less unamortized note discount.................................. 5,736,000
-----------
38,514,000
Less current portion of long term debt.......................... 10,125,000
-----------
Long term obligation.......................................... $28,389,000
===========
6. Income Taxes
The income tax benefit as shown in the statements of operations includes the
following:
[Download Table]
Eight
Months Year
Year Ended Year Ended Ended Ended
January January January 31, May 31,
29, 2000 30, 1999 1998 1997
---------- ---------- ----------- ---------
Current:
Federal...................... $1,139,000 $ 229,000 $ 1,892,000 $ 96,000
State........................ 1,077,000 410,000 353,000 32,000
Foreign...................... 427,000 155,000 31,000 27,000
---------- ---------- ----------- ---------
2,643,000 794,000 2,276,000 155,000
Deferred:
Federal...................... 2,179,000 2,923,000 (3,058,000) (785,000)
State........................ 37,000 265,000 -- (141,000)
---------- ---------- ----------- ---------
2,216,000 3,188,000 (3,058,000) (926,000)
---------- ---------- ----------- ---------
$4,859,000 $3,982,000 $ (782,000) $(771,000)
========== ========== =========== =========
Deferred income taxes are comprised of the following:
[Download Table]
January 29, 2000 January 30, 1999
---------------------- --------------------
Current Non-Current Current Non-Current
---------- ----------- -------- -----------
Deferred tax assets:
Fixed assets.............. $ -- $ -- $ -- $ 11,000
Accrued liabilities....... 978,000 -- 776,000 --
Tax effect of NOL
carryovers............... 334,000 2,655,000 -- 5,070,000
AMT credit carryforward... -- -- -- 352,000
Other..................... 267,000 -- 85,000 (48,000)
Valuation allowance....... -- (1,858,000) -- (1,858,000)
---------- ----------- -------- -----------
Total deferred tax
assets................. $1,579,000 $ 797,000 $861,000 $ 3,527,000
========== =========== ======== ===========
The Company's deferred tax asset is primarily related to accrued liabilities
and net operating loss carryforwards. For the year ended January 29, 2000, no
adjustment was made to the valuation allowance. The
F-10
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
valuation allowance relates to amounts attributable to Internal Revenues
Service ("IRC") Section 382 net operating losses (as described below), which
the Company believes may expire unused.
A reconciliation of the actual income tax rates to the federal statutory rate
follows:
[Download Table]
Eight
Months Year
Year Ended Year Ended Ended Ended
January 29, January 30, January 31, May 31,
2000 1999 1998 1997
----------- ----------- ----------- -------
Tax expense at U.S. Statutory
rate......................... 34.0% 34.0% 34.0% 34.0%
Additional paid-in-capital.... -- -- 35.2 25.2
Utilization of net operating
loss carryforward............ -- -- -- (33.6)
Valuation allowance........... -- -- (93.8) (41.0)
Foreign taxes................. -- 1.6 .6 .5
State income tax benefit net
of federal income tax........ 5.7 4.5 4.8 .4
Others........................ (2.1) (.6) 3.4 1.4
---- ---- ----- -----
Tax provision (benefit)..... 37.6% 39.5% (15.8)% (13.1)%
==== ==== ===== =====
At January 29, 2000, the Company had fully utilized the federal net operating
loss carryovers ("NOL's") generated subsequent to the Company's 1994
reorganization. These losses are not subject to IRC Section 382 limitations.
In 1994, the Company filed a prepackaged plan of reorganization pursuant to
Chapter 11 of the United States Bankruptcy Code. As a result of the Plan, an
ownership change occurred and the annual limitation of pre-reorganization NOL's
and built-in losses (i.e. the tax bases of assets exceeded their fair market
value at the date of the ownership change) has been substantially limited under
IRC Section 382. The annual limitation amount, computed pursuant to IRC Section
382(1)(6), is approximately $780,000. Any unused IRC Section 382 annual loss
limitation amount may be carried forward to the following year. Those unused
limitation losses are then added to the current IRC Section 382 annual
limitation amount. Given the IRC Section 382 limitations, a substantial portion
of the pre-reorganization losses will expire unused. Such deferred tax assets
have been written off.
F-11
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. Earnings Per Share
The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for the two years
ended January 29, 2000 and January 30, 1999, the eight month period ended
January 31, 1998 and the year ended May 31, 1997:
[Download Table]
Per
Income Shares Share
(Numerator) (Denominator) Amount
----------- ------------ ------
For the year ended January 29, 2000:
Basic earnings per share................ $8,061,000 8,618,053 $0.94
Effect of dilutive securities--stock
options and warrants................... 2,500
---------- --------- -----
Dilutive earnings per share........... $8,061,000 8,620,553 $0.94
========== ========= =====
For the year ended January 31, 1999:
Basic earnings per share................ $6,088,000 8,683,601 $0.70
Effect of dilutive securities--stock
options and warrants................... 22,410
---------- --------- -----
Dilutive earnings per share........... $6,088,000 8,706,011 $0.70
========== ========= =====
For the eight month period ended January
31, 1998:
Basic earnings per share................ $5,717,000 7,866,862 $0.73
Effect of dilutive securities--stock
options and warrants................... 545,906
---------- --------- -----
Dilutive earnings per share........... $5,717,000 8,412,768 $0.68
========== ========= =====
For the year ended May 31, 1997:
Basic earnings per share................ $6,651,000 7,688,521 $0.87
Effect of dilutive securities--stock
options and warrants................... 465,790
---------- --------- -----
Dilutive earnings per share........... $6,651,000 8,154,311 $0.82
========== ========= =====
The computation for diluted number of shares excludes unexercised stock
options and warrants which are anti-dilutive. The number of such shares for the
two years ended January 29, 2000 and January 30, 1999, the eight month period
ended January 31, 1998 and the year ended May 31, 1997 were 503,702, 173,655,
290,000 and zero, respectively.
8. Commitments and Contingencies
Leases
The Company leases its current facility under an operating lease expiring on
July 31, 2001. The Company has an option to extend the term of the lease for
two additional three-year periods. The future minimum non-cancellable lease
payments are as follows:
[Download Table]
Operating
Leases
---------
2001............................................................... $102,000
2002............................................................... 51,000
--------
Total future minimum lease payments.............................. $153,000
========
Total rent expense was $102,000, $91,000, $48,000 and $60,000 for the years
ended January 29, 2000 and January 30, 1999, the eight months ended January 31,
1998 and the year ended May 31, 1997, respectively.
F-12
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Related Party Transactions
In 1995, the Company entered into a Management Agreement (the "Agreement")
with The Newstar Group d/b/a The Wilstar Group ("Wilstar"), pursuant to which
Wilstar agreed to provide management services to the Company by providing the
services of Mr. Robert Margolis as Chief Executive Officer. The Agreement, as
amended, terminates on February 2, 2002 and provides for certain base
compensation and bonuses, as defined, payable to Wilstar. The Agreement will
automatically be extended for each consecutive one year period in the event of
pre-tax earnings, as defined, exceed specified levels as agreed upon by the
Company's Compensation Committee. The Agreement also provides that Wilstar may
elect two directors to the Board of Directors. The Agreement may be terminated
at any time without cause or in the event of certain circumstances, as defined.
For the years ended January 29, 2000 and January 30, 1999, the eight months
ended January 31, 1998 and the year ended May 31, 1997, respectively, the
Company paid to Wilstar $4.0 million, $2.0 million, $689,000 and $778,000 of
contractual base compensation and bonuses.
On December 23, 1997 the Company loaned $2.0 million to Robert Margolis. The
loan, which yields 6.0% interest per annum, has been recorded as a reduction to
stockholders' equity. The principal amount of the note and all accrued interest
thereon is due and payable on December 23, 2002.
In connection with the amendment of the Agreement, the Company's stockholders
approved the forgiveness and cancellation of approximately $1.9 million of the
note should the Company meet certain performance goals during the fourth
quarter ended January 29, 2000. The Company recorded the partial forgiveness
and cancellation of $1.9 million of the note receivable from stockholder as a
charge against income.
10. Stock Option Plan
The Company's 1995 Incentive Stock Option Plan (the "Plan") was approved at
the October 30, 1995 Annual Meeting of Stockholders. The purpose of the Plan is
to further the growth and development of the
Company by providing an incentive to officers and other key employees who are
in a position to contribute materially to the prosperity of the Company. Two
types of stock options (the "Option") may be granted
under the plan--Incentive and Non-Qualified stock options. The Options are
vested in equal installments over a three year period starting at the grant
date and have a term of ten years. The maximum number of shares authorized for
grants of options under the 1995 Plan is 900,000.
SFAS No. 123 "Accounting for the Awards of Stock-Based Compensation to
Employees" encourages, but does not require companies to record compensation
cost for stock based compensation plans at fair value. The Company has chosen
to continue to account for stock based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations. Had compensation
costs for the Company's stock option plan been determined based upon the
methodology prescribed under SFAS No. 123, the Company's net income would
approximate the pro forma amounts below:
[Download Table]
2000 1999 1998 1997
----------- ----------- ----------- -----------
Pro Forma net income....... $ 7,606,000 $ 5,480,000 $ 5,179,000 $ 6,546,000
Pro Forma basic earnings
per share................. $ 0.88 $ 0.63 $ 0.66 $ 0.85
Pro Forma diluted earnings
per share................. $ 0.88 $ 0.63 $ 0.62 $ 0.85
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions: for 1997,
risk-free interest rates ranging between 5.27% and 6.57%; dividend yields of
12.80%; volatility of 99.24%; and expected life of the option of three years;
for 1998, risk-
F-13
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
free interest rates ranging between 5.80% and 6.35%; dividend yields of 7.50%;
volatility of 68.97%; and expected life of the option of three years; for 1999,
risk-free interest rates ranging between 4.57% and 5.56%; dividend yields of
12.50%; volatility of 56.67%; and expected life of the option of three years;
and for 2000, risk-free interest rates ranging between 4.82% and 5.82%;
dividend yields of zero percent; volatility of 47.5%; and expected life of the
option of three years. Because additional stock options are expected to be
granted each year, the above pro forma disclosures are not representative of
pro forma effects on pro forma financial results for future years.
A summary of the Company's stock option activity, and related information for
the years ended January 29, 2000 and January 30, 1999, the eight months ended
January 31, 1998 and the year ended May 31, 1997 follows:
[Download Table]
2000 1999
------------------ ------------------
Weighted Weighted
Average Average
Exercise Exercise
Options Price Options Price
-------- -------- -------- --------
Outstanding at beginning of year..... 561,059 $9.06 480,083 $9.46
Granted............................ 155,000 8.33 230,000 8.88
Exercised.......................... -- -- (10,000) 10.50
Forfeited.......................... (128,190) 8.39 (139,024) 10.03
-------- ----- -------- -----
Outstanding at end of year........... 587,869 9.01 561,059 9.06
======== ===== ======== =====
Exerciseable at end of year.......... 320,904 $8.90 276,292 $8.61
Weighted average grant date fair
value of options granted during the
year................................ $2.76 $1.75
1998 1997
------------------ ------------------
Weighted Weighted
Average Average
Exercise Exercise
Options Price Options Price
-------- -------- -------- --------
Outstanding at beginning of year..... 180,000 $3.91 180,000 $3.29
Granted............................ 480,083 9.46 35,000 6.25
Exercised.......................... (180,000) 3.91 (20,000) 3.03
Forfeited.......................... -- -- (15,000) 3.13
-------- ----- -------- -----
Outstanding at end of year........... 480,083 9.46 180,000 3.91
======== ===== ======== =====
Exerciseable at end of year.......... 78,635 $9.46 45,003 $3.35
Weighted average grant date fair
value of options granted during the
year................................ $4.23 $2.43
[Enlarge/Download Table]
Options Outstanding Options Exercisable
----------------------------------------- --------------------------
Number of Weighted Weighted Number of Weighted
shares average average shares average
Range outstanding remaining life exercise price outstanding exercise price
----- ----------- -------------- -------------- ----------- --------------
$7.00-$8.00............. 97,501 9.24 years $ 7.87 27,500 $ 7.99
$8.00-$9.00............. 279,768 7.99 years $ 8.52 199,770 $ 8.52
$9.00-$10.00............ 114,466 7.93 years $ 9.71 78,634 $ 9.86
$10.00-$11.00........... 96,134 7.49 years $10.79 15,000 $10.50
------- -------
587,869 320,904
======= =======
F-14
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Selected Quarterly Financial Data (Unaudited):
The following table summarizes certain financial information by quarter for
2000 and 1999:
[Download Table]
Fiscal year ended January 29, 2000
---------------------------------------------
May 1, July 31, October 31, January 29,
1999 1999 1999 2000
---------- ---------- ----------- -----------
Net Sales.................... $6,917,000 $6,382,000 $5,674,000 $5,741,000
Earnings before taxes........ 4,406,000 3,630,000 3,401,000 1,483,000
Net Income................... 2,643,000 2,178,000 2,038,000 1,202,000
Net income per share--basic.. 0.30 0.25 0.24 0.14
Net income per share--
diluted..................... 0.30 0.25 0.24 0.14
Fiscal year ended January 30, 1999
---------------------------------------------
May 2, August 1, October 31, January 30,
1998 1998 1998 1999
---------- ---------- ----------- -----------
Net Sales.................... $5,296,000 $4,879,000 $5,133,000 $3,999,000
Earnings before taxes........ 3,379,000 2,153,000 2,641,000 1,897,000
Net Income................... 2,027,000 1,292,000 1,582,000 1,187,000
Net income per share--basic.. 0.23 0.15 0.18 0.14
Net income per share--
diluted..................... 0.23 0.15 0.18 0.14
F-15
CHEROKEE INC.
SCHEDULE II--VALUATIONS AND QUALIFYING ACCOUNTS AND RESERVES
[Download Table]
Charged/
(Credited)
Balance at to Costs Charged to Balance at
Beginning and Other End of
Description of Period Expenses Accounts Deductions Period
----------- ----------- ---------- ---------- ---------- ----------
Deducted from assets to
which they apply:
Allowance for doubtful
accounts:
Year ended January
29, 2000........... $ -- $ -- $ -- $ -- $ --
Year ended January
30, 1999........... $ -- $ -- $ -- $ -- $ --
Year ended January
31, 1998........... $ -- $ -- $ -- $ -- $ --
Year ended May 31,
1997............... $ 591,000 $ (112,000) $ -- $479,000(1) $ --
Tax Valuation
Allowance:
Year ended January
29, 2000........... $ 1,858,000 $ -- $ -- $ -- $1,858,000
Year ended January
30, 1999........... $ 1,858,000 $ -- $ -- $ -- $1,858,000
Year ended January
31, 1998........... $ 6,458,000 $2,559,000 $2,041,000 $ -- $1,858,000
Year ended May 31,
1997............... $10,714,000 $2,408,000 $1,848,000 $ -- $6,458,000
--------
(1) Uncollectible accounts receivable written off against the allowance.
F-16
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to directors and
compliance with Section 16(a) of the Exchange Act is incorporated herein by
reference to the information contained in the Proxy Statement relating to the
Company's 2000 Annual Meeting of Stockholders scheduled to be held on May 31,
2000, which will be filed with the SEC no later than 120 days after the close
of the fiscal year ended January 29, 2000. The following table sets forth
information with respect to each of the Company's current executive officers.
[Download Table]
Principal Occupation for Past
Name, Age and Five Years;
Present Position with the Company Business Experience
--------------------------------- -----------------------------
Robert Margolis, 52 Mr. Margolis was appointed
Director, Chairman of the Board of Directors Chairman of the Board and Chief
and Chief Executive Officer Executive Officer of the Company
on May 5, 1995. Mr. Margolis was
the co-founder of the Company's
Apparel Division in 1981. He had
been the Co-Chairman of the
Board of Directors, President
and Chief Executive Officer of
the Company since June 1990 and
became Chairman of the Board on
June 1, 1993. Mr. Margolis
resigned all of his positions
with the Company on October 31,
1993 and entered into a one-year
consulting agreement with the
Company. The Newstar Group d/b/a
The Wilstar Group provides
Mr. Margolis' services as Chief
Executive Officer of the Company
pursuant to the terms of a
management agreement between the
Company and Wilstar .
Howard Siegel, 44 Mr. Siegel has been employed by
President-Operations Cherokee since January 1996 as
Vice President of Operations and
administration and became
President of Operations on June
1, 1998. Prior to January 1996,
Mr. Siegel had a long tenure in
the apparel business industry
working as a Senior Executive
for both Federated Department
stores and Carter Hawley Hale
Broadway stores.
Carol Gratzke, 51 Ms. Gratzke returned to Cherokee
Chief Financial Officer in November 1995 as its Chief
Financial Officer. From August
1986 to July 1994, she was the
Controller and, for a portion of
such period, the Chief Financial
Officer of the Apparel & Uniform
Divisions. From July 1994 to
September 1995, she was
Executive Vice President of
Finance for a Los Angeles based
apparel manufacturing company.
Stephen Ascher, 37 Mr. Ascher joined Cherokee in
Executive Vice President, North America November 1997 when the worldwide
rights of the Sideout brand were
purchased in November 1997. In
November 1983, Mr. Ascher
founded Sideout Sport, Inc. He
was the President and CEO of
Sideout Sport through October
1997. and the former President
of Sideout Sport Inc.
21
[Download Table]
Principal Occupation for
Name, Age and Past Five Years;
Present Position with the Company Business Experience
--------------------------------- ------------------------
Oliver E. Wood, Jr., 57 Mr. Wood joined Cherokee in
Executive Vice President, International Marketing March 1999 as Executive
Vice President of
International Marketing.
From March 1996 to March
1999, he was president of
his own international
consulting firm. From 1987
to March 1996, Mr. Wood was
Corporate Vice President,
International division of
Oshkosh B'Gosh, Inc.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to
the information contained in the Proxy Statement relating to the Company's 2000
Annual Meeting of Stockholders scheduled to be held on May 31, 2000, which will
be filed with the SEC no later than 120 days after the close of the fiscal year
ended January 29, 2000.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference to
the information contained in the Proxy Statement relating to the Company's 2000
Annual Meeting of Stockholders scheduled to be held on May 31, 2000, which will
be filed with the SEC no later than 120 days after the close of the fiscal year
ended January 29, 2000.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference to
the information contained in the Proxy Statement relating to the Company's 2000
Annual Meeting of Stockholders scheduled to be held on May 31, 2000, which will
be filed with the SEC no later than 120 days after the close of the fiscal year
ended January 29, 2000.
22
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The List of Financial Statements are filed as Item 8 of Part II of
this Form 10-K.
(2) List of Financial Statement Schedules.
II. Valuations and Qualifying Accounts and Reserves [included in the
Financial Statements filed as Item 8 of Part II of this Form 10-K].
(3) List of Exhibits.
The exhibits listed in the accompanying Index to Exhibits are filed as part
of this Form 10-K.
[Download Table]
Exhibit
Number Description of Exhibit
------- ----------------------
2.1 Plan of Reorganization of Cherokee Inc. as confirmed on December 14,
1994 (incorporated by reference from Exhibit 2.1 to Cherokee Inc.'s
Current Report on Form 8-K dated January 5, 1995).
3.1 Amended and Restated Certificate of Incorporation of Cherokee Inc.
(incorporated by reference from Exhibit 3.1 of Cherokee Inc.'s Form
10 dated April 24, 1995).
3.2 Bylaws of Cherokee Inc. (incorporated by reference from Exhibit 3.2 of
Cherokee Inc.'s Form 10 dated April 24, 1995).
4.1 Indenture, dated December 23, 1997, among SPELL C. LLC, as issuer, and
Wilmington Trust Company, as trustee, with respect to the Zero Coupon
Secured Notes (incorporated by reference from Exhibit 4.3 of Cherokee
Inc.'s Form 10-K dated January 31, 1998).
4.2 Security Agreement dated December 23, 1997, between SPELL C. LLC and
Wilmington Trust Company (incorporated by reference from Exhibit 4.4
of Cherokee Inc.'s Form 10-K dated January 31, 1998).
10.1 Form of Director Warrant (incorporated by reference from Exhibit 10.3
of Cherokee Inc.'s Form 10 dated April 24, 1995).
10.2 License Agreement between Cherokee Inc. and Target Stores, a division
of Dayton-Hudson Corporation, dated August 15, 1995 (incorporated by
reference from Exhibit 10.9 of Cherokee Inc.'s Form 10-K dated June
3, 1995).
10.3 Agreement of Purchase and Sale of Trademarks and Licenses between
Cherokee Inc. and Sideout Sport, Inc. dated November 7, 1997
(incorporated by reference from Exhibit 2.1 of Cherokee Inc.'s
Current Report on Form 8-K dated November 7, 1997).
10.4 License Agreement between Cherokee Inc. and Dayton Hudson Stores dated
November 12, 1997 (incorporated by reference from Exhibit 10.1 of
Cherokee Inc.'s Current Report on Form 8-K dated November 7, 1997).
10.5 Note Purchase Agreement dated December 23, 1997, between SPELL C. LLC
and the purchasers listed on the signature pages thereto
(incorporated by reference from Exhibit 10.16 of Cherokee Inc.'s Form
10-K dated January 31, 1998).
10.6 Trademark Purchase and License Assignment Agreement dated December 23,
1997 between SPELL C. LLC and Cherokee Inc. (incorporated by
reference from Exhibit 10.17 of Cherokee Inc.'s Form 10-K dated
January 31, 1998).
10.7 Administrative Services Agreement dated December 23, 1997, between
SPELL C. LLC and Cherokee Inc. (incorporated by reference from
Exhibit 10.18 of Cherokee Inc.'s Form 10-K dated January 31, 1998).
23
[Download Table]
Exhibit
Number Description of Exhibit
------- ----------------------
10.8 Limited Liability Company Agreement of SPELL C. LLC dated as of
December 23, 1997, between SPELL C. LLC and Cherokee Inc.
(incorporated by reference from Exhibit 10.19 of Cherokee Inc.'s
Form 10-K dated January 31, 1998).
10.9 Second Revised and Restated Management Agreement dated as of November
29, 1999 between Cherokee Inc. and The Newstar Group d/b/a The
Wilstar Group ("Wilstar").
21.1 Subsidiaries of Cherokee Inc.
23.1 Consent of Independent Auditors dated April 14, 2000.
27.1 Article 5 of Regulation S-X--Financial Data Schedule
(b) Reports on Form 8-K.
On January 25, 2000, the Company filed a report on Form 8-K incorporating its
press release concerning the approval by stockholders of Sections 3.2 and 3.3
of the Revised Management Agreement and the performance goals contained
therein.
24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
CHEROKEE INC.
By /s/ Robert Margolis
-----------------------------------
Robert Margolis
Chairman and Chief Executive Officer
Date: April 17, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
[Download Table]
Signature Title Date
--------- ----- ----
/s/ Robert Margolis Chairman and Chief Executive April 17, 2000
____________________________________ Officer and Director
Robert Margolis
/s/ Carol Gratzke Chief Financial April 17, 2000
____________________________________ Officer/Chief Accounting
Carol Gratzke Officer
/s/ Timothy Ewing Director April 17, 2000
____________________________________
Timothy Ewing
/s/ Keith Hull Director April 17, 2000
____________________________________
Keith Hull
/s/ Douglas Weitman Director April 17, 2000
____________________________________
Douglas Weitman
/s/ Jess Ravich Director April 17, 2000
____________________________________
Jess Ravich
25
Dates Referenced Herein and Documents Incorporated by Reference
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