Document/Exhibit Description Pages Size
1: 10-KT Transition Report for Form 10-K 51 360K
2: EX-4.3 Indenture Dated as of December 23, 1997 74 225K
3: EX-4.4 Security Agreement Dated December 23, 1997 11 36K
4: EX-10.16 Note Purchase Agreement Dated December 23, 1997 29 100K
5: EX-10.17 Trademark Purchase and License Assignment 12 37K
6: EX-10.18 Administrative Services Agreement 10 45K
7: EX-10.19 Limited Liability Company Agreement 25 88K
8: EX-21.1 Subsidiaries of Cherokee Inc. 1 5K
9: EX-23.1 Consent of Independent Auditors 1 7K
10: EX-27.1 Article 5 Financial Data Schedule 2 7K
11: EX-27.2 Article 5 Financial Data Schedule 2 8K
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
----------------
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM JUNE 1, 1997 TO
JANUARY 31, 1998
COMMISSION FILE NO. 0-18640
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CHEROKEE INC.
(Exact name of registrant as specified in charter)
DELAWARE 95-4182437
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
6835 VALJEAN AVENUE
VAN NUYS, CA 91406
(Address of principal executive (Zip Code)
office)
(818) 908-9868
(Registrant's telephone 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 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.
(1) 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. [_]
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 15, 1998, the registrant had 8,612,657 shares of its Common
Stock, par value $.02 per share, issued and outstanding.
As of April 15, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $66,724,000 (computed on
the basis of the last trade of the Common Stock on the NASDAQ Small Cap Issue
Market on April 15, 1998).
Certain portions of the registrant's proxy statement for the Annual Meeting
of Stockholders to be held on June 8, 1998 are incorporated by this reference
into Part III as set forth herein.
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CHEROKEE INC.
INDEX
[Download Table]
PAGE
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PART I
Item 1. Business...................................................... 3
Item 2. Properties.................................................... 14
Item 3. Legal Proceedings............................................. 14
Item 4. Submission of Matters to a Vote of Security Holders........... 14
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters........................................... 15
Item 6. Selected Financial Data....................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation...................................... 17
Item 7A. Qualitative and Quantitative Risk............................. 23
Item 8. Consolidated Financial Statements and Supplementary Data...... 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 25
PART III
Item 10. Executive Officers of the Registrant.......................... 25
Item 11. Executive Compensation........................................ 26
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................... 26
Item 13. Certain Relationships and Related Transactions................ 26
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K........................................................... 26
2
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"), hold several trademarks including Cherokee(TM), Sideout(TM),
Sideout Sport(TM), King of the Beach(TM) 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 31, 1998, the Company had twenty-five continuing
license agreements, covering both domestic and international markets.
In November 1997 the Company reaffirmed its relationship with Target Stores,
a division of Dayton Hudson Corporation ("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 a royalty based upon a percentage of its
net sales of Cherokee brand products, with a minimum guaranteed royalty of
$60.0 million over the six-year initial term of the agreement.
In December 1997 the Company completed a series of transactions whereby it
sold its rights to the Cherokee brand and related trademarks in the United
States to Spell C, its wholly-owned subsidiary, and also assigned to Spell C
its rights in the Amended Target Agreement. In return the Company received the
gross proceeds resulting from the sale by Spell C, for an aggregate of $47.9
million, of privately placed Zero Coupon Secured Notes (the "Secured Notes"),
which yield 7.0% interest per annum, mature February 20, 2004 and are secured
by the Amended Target Agreement and by the United States Cherokee trademarks.
The aggregate scheduled amortization under the Secured Notes ($60.0 million)
equals the aggregate minimum guaranteed royalty payable under the Amended
Target Agreement ($60.0 million). Therefore, unless royalties under the
Amended Target Agreement exceed the minimum guaranteed royalty, no revenues
derived from the Amended Target Agreement can be distributed to the Company by
Spell C. Using the proceeds from the sale of the Secured Notes, the Company's
Board declared a special dividend of $5.50 per share which was paid on January
15, 1997.
At a meeting held December 19, 1997, the Board of Directors of the Company
(the "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 also generally 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 to May 31. This
Transition Report on Form 10-K is made with respect to the eight (8) month
fiscal period beginning June 1, 1997 and ending January 31, 1998, (referred to
herein as the "Eight Month Fiscal Period") resulting from such change.
HISTORY AND RESTRUCTURINGS
On April 24, 1995, a group including Robert Margolis, who founded the
Company's Apparel Division in 1981, and who had been the Company's Chairman
and Chief Executive Officer from May 1989 to October 1993, purchased 1,358,000
shares, or approximately 22.3% of the Company's then outstanding Common Stock
("Common Stock"). On May 5, 1995, Mr. Margolis was appointed Chairman and
Chief Executive Officer of the Company. After a period of assessment, Mr.
Margolis set in motion a strategy which resulted in the
3
Company's principal business being a marketer and licensor of the Cherokee
brand and other brands it owns or may acquire in the future. The Company
stopped manufacturing and importing apparel and footwear, sold its inventories
of apparel and footwear, and on July 28, 1995 sold the assets of its Uniform
Division. The proceeds from these sales were used to pay off all of the
Company's indebtedness. As a result of discontinuing the apparel and footwear
business and selling the Uniform Division, the number of employees was reduced
from approximately 345 on May 28, 1994 to 15 by November 1, 1995.
Prior to this major strategic change, the Company was a designer,
manufacturer, and marketer of casual apparel and footwear primarily under the
Cherokee name. The Company operated four divisions during the fiscal year
ended June 3, 1995 ("Fiscal 1995"): the Apparel Division, the Footwear
Division, the Uniform Division, and the Licensing Division. The Apparel
Division designed, manufactured, imported and marketed moderately priced,
natural fiber women's and young girls' clothing. The Footwear Division
designed, arranged for the manufacture, imported and marketed Cherokee brand
and a broad line of private label footwear for women, men and children. The
Uniform Division designed, manufactured and marketed Cherokee brand uniforms
primarily for the medical industry. The Licensing Division continues to
license the use of the Company's proprietary brand names to domestic and
international licensees for a variety of apparel, footwear, accessories, home
products and other lifestyle related products.
The 1993 Plan
The Company, which was founded in 1973 and whose shares first became
publicly traded in 1983, was acquired in a leveraged buy-out in 1989. In
connection with the acquisition, the Company incurred substantial debt. As a
result of a significant decrease in its earnings, the Company was unable to
service its debt. On April 23, 1993, the Company and its then wholly-owned
operating subsidiary, The Cherokee Group ("Group"), filed a petition with the
United States Bankruptcy Court in the District of Delaware (the "Bankruptcy
Court") for relief under Chapter 11 of the United States Bankruptcy Code
("Chapter 11"). Concurrent with such filing, the Company and Group filed a
joint "prepackaged" Plan of Reorganization (the "1993 Plan") which was the
result of negotiations among the Company and unofficial representatives of its
subordinated debt-holders and stockholders. On May 28, 1993, the Bankruptcy
Court confirmed the 1993 Plan, and on June 1, 1993, the 1993 Plan became
effective. As a result of the 1993 Plan, Group was merged into the Company.
Furthermore, subsequent to the effective date of the 1993 Plan, the Apparel
Division (including the Uniform Division), the Footwear Division, the
Licensing Division, and prior to its sale in May 1994, the Priority Finishing
Division, were operated by the Company.
The 1994 Plan
It became apparent by October 1994 that the Company's business was not
generating sufficient cash flow to service its existing debt. On November 7,
1994, the Company filed a petition with the Bankruptcy Court for relief under
Chapter 11. Concurrent with such filing, the Company filed a "prepackaged"
Plan of Reorganization (the "1994 Plan") 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 1994
Plan, and on December 23, 1994, the 1994 Plan became effective (the "Effective
Date"). For financial statement purposes the effective date of the 1994 Plan
was assumed to be February 25, 1995.
The consummation of the 1994 Plan resulted in the following: (1) a new
credit agreement with the Company's sole secured creditor, the CIT
Group/Business Credit, Inc. ("CIT"), the proceeds of which were used to
satisfy the claims of the secured creditor under the prior credit facility;
(2) the cancellation of all outstanding shares of the Company's common stock,
par value $.01 (the "Old Common Stock") and the Series A, B, and C warrants to
purchase Old Common Stock; (3) the issuance of 4,900,000 shares of Common
Stock to the holders of 11% Senior Subordinated Notes due 2004 (the "Old
Notes") in exchange for the principal amount of $76,565,000 (with accrued and
unpaid interest of approximately $4,211,000 as of November 1, 1994) of Old
Notes; (4) the issuance of 100,000 shares of Common Stock to the holders of
Old Common Stock; and (5) the
4
agreement to issue to the Company's general unsecured creditors 60.5504 shares
of Common Stock for each $1,000 of such creditors' claims which were allowed
by the Bankruptcy Court.
RECENT DEVELOPMENTS
Recapitalization; Sale of Cherokee Trademarks to Spell C; Issuance of Secured
Notes
In September 1997, the Company's Board authorized Libra Investments, Inc.
("Libra"), to explore ways to maximize shareholder value, including a
recapitalization and sale of the Company. 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.
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. Pursuant to a Trademark Purchase and
License Assignment Agreement, dated December 23, 1997, between the Company and
Spell C (the "Assignment Agreement") the Company assigned to Spell C all of
its right, title and interest in the Amended Target Agreement and sold to
Spell C all if 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 (i) allow the Company to continue to use the trademarks in the United
States in conjunction with the Company's then-existing license agreements, and
(ii) 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 only if the Company assigns 50% of the royalties payable during the
extended term to Spell C. Pursuant to the Assignment Agreement, 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. Concurrently with the Assignment
Agreement, the Company and Spell C entered into an administrative services
agreement under which the Company will perform certain administrative duties
on behalf of Spell C in connection with, among other things, the Cherokee
trademarks and the Assignment Agreement for a nominal administrative fee.
On December 23, 1997 Spell C also issued for gross proceeds 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 trademarks and brand names. The
Secured Notes indenture (the "Indenture") requires that any proceeds due to
Spell C under the Amended Target Agreement and certain other license
agreements 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 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 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 ($60.0 million)
equals the aggregate minimum guaranteed royalty payable under the Amended
Target Agreement ($60.0 million). While the Company believes that royalties
payable under the Amended Target Agreement may exceed the Minimum Guaranteed
Royalty, the Company cannot predict with accuracy whether such royalties will
exceed the Minimum Guaranteed Royalty, and if they do not, the Company will
not receive distributions from Spell C during the term of the Amended Target
Agreement. See "--Certain Business Considerations and Risk Factors--
Restrictions on Distributions by Spell C."
Pursuant to the Assignment Agreement, the gross proceeds of the Secured
Notes, which totaled approximately $47.9 million were paid to the Company. On
December 23, 1997 the Company's Board declared
5
a special dividend of $5.50 per share which was paid on January 15, 1997. The
aggregate amount of the dividend paid was approximately $47.4 million.
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 license agreements with
respect thereto (the "Assets"). The trademarks acquired from Sideout Sport
Inc. include, among others, Sideout, Sideout Sport and King of the Beach.
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
certain liens on the Assets. Most of the liens have since been released and
$450,000 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 royalties to Sideout.
The Sideout brand currently generates licensing revenues from existing
contracts of approximately $500,000 per year. The Company intends to further
develop the Sideout brand through retail direct, wholesale and international
licensing; however, there can be no assurance that the Company's efforts will
result in significant increases in royalty payments. See "--Certain Business
Considerations and Risk Factors--Uncertainty Regarding Development of Sideout
Brand." The Company is currently in discussions with prospective licensees
concerning significant new licensing agreements for the Sideout brand. There
can be no assurance, however, that these discussions will result in definitive
agreements.
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 Company's primary emphasis for the past three years has
been directed toward retail direct, wholesale and international licensing. As
of January 31, 1998, the Company had twenty-five continuing license
agreements, including both domestic and international markets, seventeen of
which pertained to the Cherokee name. The Sideout brand and related
trademarks, which represent a beach-oriented, active, "California" lifestyle,
were acquired by the Company in November 1997.
The Company's license agreements are with wholesalers and retailers and are
either international masters or category-specific exclusives or non-
exclusives. Of the twenty-five licensing agreements, five are with retailers,
seven are with domestic wholesale licensees and thirteen are with
international wholesale and/or retail licensees. Wholesale licensees
manufacture and import various categories of apparel, footwear and accessories
under the Company's trademarks which include Cherokee, Sideout, Sideout Sport,
King of the Beach and others, and sell the licensed products to retailers. In
retail direct licensing, the Company grants retailers the license to use the
trademarks on certain categories of merchandise, including those products that
the Company previously manufactured, generally on a non-exclusive basis, and
the retailer is responsible for designing and manufacturing the merchandise
(the "Retail Direct" licensing strategy). The Company's license agreements,
wholesale, retail and international, 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 regard.
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
6
the United States and Canada, that 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 retailing
market in North America, in certain 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 certain 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 and/or retailer of
branded apparel, footwear and accessories. Accordingly, in those areas the
Company has begun to pursue licensing or strategic alignments whereby its
brands can become the basis for such a vertically integrated
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.
NORTH AMERICAN RETAIL DIRECT LICENSING
The Company's Retail Direct licensing strategy is premised on the
proposition that in the United States and Canada 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 through stocking and selling "quasi-
private label" licensed products bearing widely recognized brand names (such
as the Company's brands) than through carrying strictly private label goods on
the one hand or branded product from third-party vendors on the other. 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 the United States and Canada is to capitalize on these
trends by licensing its portfolio of brand names primarily directly to strong
and growing retailers for their in-store branded merchandise, 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 August 15, 1995, the Company entered into a major strategic alliance with
Target Stores, a division of Dayton Hudson Corporation. Target was granted the
exclusive right in the United States to use the Cherokee trademarks in
connection with the sale of the following female products in Target Stores: 5-
pocket denim jeans and shorts, all female footwear, all 0-14 girlswear, and
all women's and girls fashion accessories. On November 1, 1995, the Company
entered into a second agreement with Target, whereby Target was granted a non-
exclusive right to use the Cherokee trademarks in connection with the sale of
merchandise in the following categories in Target Stores: women's casual denim
& sportswear, activewear, golfwear, tenniswear, bodywear, careerwear, daywear,
sleepwear, robes, loungewear, boys' activewear sizes 0-7, junior casual &
denim sportswear, activewear, swimwear, dresses, and home textiles. The August
15, 1995 and November 1, 1995 agreements with Target expired as of February 1,
1998.
On November 12, 1997, the Company entered into the Amended Target Agreement
with Target. This agreement was subsequently assigned to Spell C and pledged
as collateral for the Secured Notes. 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 (i) men's, women's
and children's apparel, including intimate apparel, foundations and sleepwear,
(ii) men's, women's and children's fashion accessories, (iii) bed and bath
products and accessories, (iv) luggage, sports bags and backpacks, (v) home
textiles, (vi) domestics and home decor, (vii) home furnishings, (viii)
sporting goods, and (ix) cosmetics, bath and body products (collectively, the
"Merchandise"). Certain of the above-listed categories are subject to
unexpired license agreements
7
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. Also, the Company and Spell C cannot license the Cherokee
trademark, and/or renew or otherwise extend existing license agreements
relating to the Cherokee trademark with third parties, in the United States,
in any merchandise category whatsoever except for certain limited exceptions
covering (a) existing license agreements with Brylane L.P. ("Brylane"), The
Caldor Corporation ("Caldor") or Pamida, Inc. ("Pamida"), (b) retail license
agreements with certain drug store chains and (c) certain then-existing
wholesale license 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, neither the Company nor Spell C anticipate entering into
additional licensing agreements in the United States with respect to the
Cherokee brand during the term of the Amended Target Agreement (except for
those specifically allowed above) and are in fact prohibited from doing so in
most instances.
Under the terms of the Amended Target Agreement, Target will pay a royalty
each fiscal year for the fiscal years ending January 31, 1999 through 2004
equal to the greater of (i) the Minimum Guaranteed Royalty (as defined below)
for such year or (ii) a percentage of Target's net sales of Merchandise during
such fiscal year which percentage varies according to the volume of sales of
Merchandise during such fiscal year. The "Minimum Guaranteed Royalty" 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 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
brand merchandise in July 1996 and paid the Company $5,935,000 during the
fiscal year ended May 31, 1997, and $6,428,000 during the Eight Month Fiscal
Period, which accounted for 68% and 75%, respectively, of the Company's
revenues during such periods. See "--Certain Business Considerations and Risk
Factors--Dependence on a Single Licensee."
On August 22, 1997, the Company entered into an international retail direct
licensing agreement (the "Hudson's Bay Agreement") with Hudson's Bay Company
and Zellers Inc., a Canadian corporation ("Hudson's Bay"). Hudson's Bay 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 contract is for five years, with automatic renewal
options, provided that certain minimums are met each contract year. Under the
Hudson Agreement, Hudson's Bay will pay the Company a minimum guaranteed
royalty of $10.0 million over the five-year initial term of the agreement.
Other than the Amended Target Agreement, the Company currently has five
retail direct non-exclusive Cherokee brand licensing agreements covering the
United States and Canada ("North America"). North American retail licensees
include, among others, Caldor, Brylane, Pamida and Hudson's Bay. Generally,
royalties on non-exclusive domestic retail licenses begin at 3% of the
retailer's net sales of licensed product and may decrease depending on the
retailer's annual sales of licensed products and/or the retailer's guaranteed
annual sales of licensed product. 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, there is no assurance the Company will renew or
extend such Agreements after 2002 and in many circumstances will not be
permitted to do so under terms of the Amended Target Agreement. Further, under
the Assignment Agreement, if the Company extends any existing United States
license agreement after January 31, 2002, the Company must assign 50% of the
royalties payable during the extended term to Spell C. The above restrictions
under the Amended Target Agreement and Assignment Agreement do no apply to
Canada; however, under the Hudson's Bay Agreement, Hudson's Bay has the
exclusive right to use the Cherokee brand on a broad range of products in
Canada.
8
The Company currently has no retail direct non-exclusive Sideout brand
licensing agreements covering the United States. All categories of merchandise
are still available for domestic non-exclusive retail license agreements and
the Company intends to actively pursue its Retail Direct licensing strategy to
further develop the Sideout brand in the United States.
During the Eight Month Fiscal Period, the Company received $7,492,000 in
aggregate royalties from its United States retail license agreements, which
accounted for 87.6% of the Company's revenues during such periods.
NORTH AMERICAN WHOLESALE LICENSING
The Company currently has four Cherokee brand wholesale license agreements
that grant unaffiliated manufacturers the license to manufacture and market
women's intimate apparel, socks, sunglasses, watches, and men's activewear
under the Cherokee 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 will expire during the term of the Amended Target Agreement, and
due to the exclusivity provisions contained in the Amended Target Agreement,
there is no assurance the Company will renew or extend such agreements and in
many circumstances will not be permitted to do so under terms of the Amended
Target Agreement
Pursuant to the Sideout Agreement, the Company acquired several existing
wholesale licensing contracts. The Company terminated or amended certain of
these agreements and, as a result, the net number of wholesale licensing
agreements acquired by the Company was three.
The Company's wholesale license agreements for the Sideout brand are for
product categories including menswear, childrens wear, toddlers and boys 4-7,
footwear, volleyballs, bags and accessories. The agreements have various
expiration dates and contain three to five-year renewal options. One of the
wholesale licensees is currently manufacturing Sideout brand men's and boys
activewear and sportswear for several department stores. The footwear licensee
sells men's, women's and children's footwear to many of the better department
and specialty stores, including Nordstrom, Sportmart, Champs, Lady Footlocker,
Bob's Stores and Miller's Outpost. The footwear license has experienced
substantial growth during the last two years. Minimum royalty guarantees total
$877,500 for the remaining term of these agreements. Renewal options held both
by the licensee and the Company provide for minimum guaranteed royalties of
$3,126,000 to the Company if such contracts are renewed.
During the Eight Month Fiscal Period, the Company received $513,000 in
aggregate royalties from its wholesale licensing agreements, which accounted
for 6% of the Company's revenues during such period.
INTERNATIONAL LICENSING
The Amended Target Agreement only grants Target exclusive rights to the
Cherokee trademarks in the United States with respect to certain product
categories. Additionally, the Company sold Spell C the United States but not
the international rights to the Cherokee trademarks. Therefore, the Company
will continue to seek to develop in certain international markets both its
Cherokee and Sideout brands through wholesale licenses with manufacturers or
other companies who have market power and economies of scale in their
respective markets. In certain countries, the Company believes that an owner
or licensee of one or more well-known United States brands has the opportunity
to become a dominant, vertically integrated manufacturer and/or retailer of
branded apparel, footwear and accessories. Accordingly, in those areas the
Company has begun to pursue licensing or strategic alignments whereby its
brands can become the basis for such a vertically integrated
manufacturer/retailer.
9
Suzuya Co. Ltd. ("Suzuya"), the Company's Far East licensee for the past ten
years, operated twenty-one Cherokee retail stores in Japan, and had eight sub-
licensees that manufactured and sold Cherokee brand apparel and accessories to
the Cherokee stores and to other unaffiliated retailers. In April 1997, the
Suzuya licensing agreement was terminated and a new master licensing agreement
was signed with Vantex, Inc ("Vantex"). Under the new agreement Vantex will
pay the Company a minimum guaranteed royalty of $5.0 million over the five-
year term of the agreement. During the Eight Month Fiscal Period, Vantex
entered into three sub-licensing agreements for the further development of the
Cherokee brand in Japan. The Company currently has thirteen international
wholesale and/or retail license agreements, which include a master licensing
agreement for South Korea with Kum Kyung Co., Ltd., a South Korean based
company, a wholesale licensing agreement with Joosung Enterprises Co., Ltd., a
South Korean based company which manufactures handbags and handbag related
items, and a master license agreement with Mondragon, a Philippines based
company. Due to the poor economy in Korea, the Company expects to terminate
the licensing agreements with Kum Kyung Co. Ltd. and Joosung Enterprises Co.,
Ltd.
Pursuant to the Sideout Agreement, the Company acquired five international
licensing agreements with respect to the Sideout brand and related trademarks.
The Company's international licensing agreements for the Sideout brand are all
exclusive and cover countries including Argentina, Uruguay, Japan, Italy,
Mexico, Australia and New Zealand for product categories for the Sideout and
King of the Beach brands for volleyballs, 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 flagship
stores throughout Mexico. Minimum guaranteed royalties for the remaining
initial term of the current licensing agreements total $1,974,000.
During the Eight Month Fiscal Period, the Company received $548,000 in
aggregate royalties from the Sideout international license agreements, which
accounted for 6.4% of the Company's revenues during such period.
TRADEMARKS
The Company holds various trademarks including Cherokee, Sideout, Sideout
Sport, King of the Beach and others, in connection with certain apparel and
other goods. These trademarks are registered with the United States Patent and
Trademark Office and in certain 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 "--Certain Business Considerations and Risk Factors--
Dependence on and Protection of Intellectual Property Rights."
MARKETING
The Cherokee name has been positioned by the Company 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. Advertising, product, labeling and
presentation are integrated 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
wholesale, retail and international license agreements provide the Company
with final approval of pre-agreed upon quality standards, packaging and
marketing of licensed product. The Company has the right to conduct periodic
quality control inspections to ensure that the image and quality of licensed
products remain consistent. Historically, the Company spent between 3% and 4%
of its revenues on advertising. Since the time the Company switched its
principal business to that of a marketer and licensor of its brands, it has
principally relied on its licensees to advertise the Cherokee brand, and as a
result the Company's advertising costs have been minimal.
10
The Company intends to attempt to implement its Retail Direct licensing
strategy in the United States with respect to the Sideout brand; however,
there can be no assurance that the Company's efforts will result in
significant increases in royalty payments. Internationally, the Company
intends to continue to seek to develop both of its 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 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 regard. The Company recently hired
additional marketing staff to intensify the Company's international efforts to
negotiate new license agreements and provide support and advice regarding
advertising and merchandising concepts to existing licensees.
COMPETITION
Although the Company no longer manufactures or sells products, 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 extensive competition by numerous domestic and foreign companies.
Such competitors with respect to the Cherokee brand include Levi Strauss &
Co., Liz Claiborne and VF Corp. and private labels developed for retailers and
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 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 "--Certain
Business Considerations and Risk Factors--Competition."
EMPLOYEES
As of January 31, 1998, the Company employed 12 persons all of whom are
involved in the Company's licensing business. None of the Company's employees
are represented by labor unions and the Company believes that its employee
relations are satisfactory.
CERTAIN BUSINESS CONSIDERATIONS AND RISK FACTORS
Restrictions on Distributions by Spell C: There is no assurance that Spell C
will distribute any significant amount of cash or property to the Company
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 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
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 the Company. The aggregate scheduled
amortization under the Secured Notes ($60.0 million) equals the aggregate
minimum guaranteed royalty payable under the Amended Target Agreement ($60.0
million). See "--Recent Developments" and "--North American Retail Direct
Licensing." There is no assurance, therefore, that there will be any excess
amounts to be distributed to the Company. The Company does not expect revenues
deposited in the collateral account from sources other than the Amended Target
Agreement to be significant during Fiscal year 1999. The Company 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
11
to Spell C from the collateral account, and in turn, Spell C will have no
funds available to distribute to the Company. Further, the initial term of the
Amended Target Agreement expires concurrently with the maturity of the Secured
Notes. Therefore, even after the maturity of the Secured Notes, the likelihood
of significant distributions from Spell C to the Company is contingent upon
the extension of the Amended Target Agreement. See "--North American Retail
Direct Licensing."
Uncertainty Regarding Development of Sideout Brand: The Sideout brand and
related trademarks were acquired by the Company in November 1997. See "--
Recent Developments--Sideout Agreement." The Company intends to develop the
Sideout brand through both domestic and international retail direct and
wholesale licensing. Although the Sideout brand is a well recognized,
authentic beach volleyball brand, there can be no assurance that the Company's
efforts to develop and market the Sideout brand will result in significant
increases in royalty payments.
Competition: Although the Company no longer manufactures or sells products,
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 extensive competition by numerous domestic
and foreign companies. Such competitors with respect to the Cherokee brand
include Levi Strauss & Co., Liz Claiborne and VF Corp. and private labels
developed for retailers and 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 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; failure by
the Company's licensees to do so could have a material adverse effect on the
Company's business or financial condition. Other companies owning established
trademarks could also enter into similar arrangements with retailers. See "--
Competition."
Dependence on Single Licensee: During the Eight Month Fiscal Period 75% of
the Company's and Spell C's consolidated licensing revenues were generated
from a single source, Target Stores, a division of Dayton Hudson Corporation.
See "--North American Retail Direct Licensing." Under the Assignment Agreement
the Company assigned all its rights in the Amended Target Agreement to Spell
C, which 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. The Company currently has no reason to anticipate or expect a
default by Target as it has timely paid all of the royalty commitments due
under the prior Target Agreements. The Cherokee marks are diversified over a
broad range of categories of merchandise presently manufactured and marketed
by Target. Therefore, while it is possible that Target could altogether cease
manufacturing and marketing Cherokee brand products, the Company believes that
is unlikely to happen. The Company is 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 the Company's business or
financial condition. 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 the Company. If Target elects not to extend or renew
the Amended Target License Agreement upon the expiration of its initial term,
the Company's business and operations could be adversely affected. There can
be no guarantee that the Company could be able to replace the Target royalty
payments from other sources.
12
Dependence on and Protection of Intellectual Property Rights: The Company
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
the Company's business. These trademarks are registered with the United States
Patent and Trademark Office and in certain other countries. The Company and
Spell C also hold several trademark applications for Cherokee, Sideout,
Sideout Sport and King of the Beach in numerous countries. 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. The Company believes that such measures afford only limited
protection and, accordingly, there can be no assurance that the actions taken
by the Company to establish and protect its trademarks and other proprietary
rights will prevent imitation of its products or infringement of its
intellectual property rights by others, or prevent the loss of licensing
revenue or other damages caused thereby. In addition, the laws of certain
countries in which the Company has licensed its intellectual property may not
protect the Company's intellectual property rights to the same extent as the
laws of the United States. Despite the Company's efforts to protect its
intellectual property rights, unauthorized parties may attempt to copy aspects
of the Company's intellectual property which could have a material adverse
effect on the Company's business or financial condition. The Company is
currently involved in one infringement action with respect to the use by a
third party of the name Cherokee on two-way radios, which it believes will not
have a material adverse effect on the Company's business or financial
condition. However, in the future the Company 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 the Company.
While the Company currently has the resources to pursue or defend most
infringement claims, any resulting litigation could result in significant
expense to the Company and divert the efforts of the Company's management
personnel whether or not such litigation is determined in favor of the
Company.
Dependence on Key Management: The overall business and marketing strategy
and current direction of the Company was principally conceived and implemented
by Robert Margolis, its current Chairman and Chief Executive Officer, Patricia
Warren, its former President and Carol Gratzke, its current Chief Financial
Officer. On March 3, 1998, the Company announced the resignation of Patricia
Warren as President of the Company. Ms. Warren will continue to work with the
Company through 1998 in selected special projects. Mr. Margolis will assume
Ms. Warren's responsibilities until a new president is appointed. Because Ms.
Warren will still be available through 1998 for selected special projects and
because the Company believes that it has sufficiently implemented the business
plan set in motion by its management team over the last three years, the
Company believes that it can successfully continue to implement its business
plans notwithstanding the departure of Ms. Warren. Prior to the hiring and
training of a new president, the loss of the services of either Robert
Margolis or Carol Gratzke could have a material adverse effect upon the
Company's business or financial condition.
ITEM 2. PROPERTIES
The Company owned a building of approximately 100,000 square feet on ten
acres of land in Sunland, California, which housed its principal offices and
fabric cutting facility. The property was sold for $3,900,000 in April 1997.
By October 15, 1995, the Company moved all its employees out of this facility
and into a 3,000 square foot office facility in Van Nuys, California. This
facility is leased by The Wilstar Group ("Wilstar"), a business name used by
The Newstar Group, to which Mr. Margolis serves as Chief Executive Officer.
The Company uses approximately one-half of such space and pays Wilstar for
such usage at the rate of $.75 per square foot or $1,125 per month. In
addition, the Company reimbursed Wilstar for one-half of certain costs
relating to this office space. Beginning November 1, 1997, the Company
increased its rental space to 3,685 square feet and currently pays Wilstar
$2,762 in rent per month (which includes costs relating to the office space).
The Company believes that its rental of such space from Wilstar is on terms of
no less favorable than could be obtained from an unaffiliated third party. The
Company believes this facility is currently adequate for its expected
requirements for the next few years and when the lease held by Wilstar has
expired, the Company currently anticipates negotiating a new lease with the
facility's owner. The Company leases a 1,158 square foot showroom facility in
Dallas, Texas, which it no longer occupies. The Company has subleased this
facility. The lease expired
13
on February 28, 1998. The Company also rents 4,000 square feet of Wilstar's
warehouse as a storage facility and pays rent at a rate of $.50 per square
foot.
ITEM 3. LEGAL PROCEEDINGS
In connection with the 1994 Plan, the Company has settled all claims
submitted by trade creditors and other claimants. A Final Decree was entered
by the Company and approved by the Bankruptcy Judge on August 15, 1996.
In the ordinary course of business, the Company becomes involved in certain
legal claims and litigation. In the opinion of Management, based upon
consultations with legal counsel, the disposition of litigation currently
pending against the Company will not have, individually or in the aggregate, a
materially adverse effect on its consolidated financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of holders of Common Stock
during the final quarter of the Eight Month Fiscal Period.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock trades on the NASDAQ Small Cap Issues Market under the
symbol 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.
[Download Table]
HIGH LOW
------ ------
FISCAL 1997
Quarter ended August 31, 1996.............................. 6 1/2 4 1/2
Quarter ended November 30, 1996............................ 6 7/8 5 1/4
Quarter ended March 1, 1997................................ 7 3/4 5 1/4
Quarter ended May 31, 1997................................. 7 1/8 5 3/4
FISCAL 1998
Quarter ended August 30, 1997.............................. 12 6 3/4
Quarter ended November 29, 1997............................ 15 1/8 10 3/4
Two months ended January 31, 1998.......................... 17 1/4 7 1/4*
On April 15, 1998, the latest bid price for the Common Stock reported on the
NASDAQ Small Cap Issues Market was $9.50 per share.
As of April 15, 1998, the number of stockholders of record of the Common
Stock was 151. This figure does not include beneficial holders whose shares
may be held of record by brokerage firms and clearing agencies.
On January 28, 1997, the Company's Board established a quarterly dividend
policy of $0.15 per share. The first dividend payment was made on March 17,
1997 to all shareholders of record as of February 25, 1997. Subsequent
dividend payments of $0.20 per share were made on May 30, 1997 and August 29,
1997 to shareholders of record as of May 14, 1997 and August 15, 1997,
respectively. On December 23, 1997, the Company's Board declared a special
dividend of $5.50 per share, which was paid on January 15, 1998 to all
shareholders of record as of January 2, 1998. On April 6, 1998, the Company's
Board declared a cash dividend of $0.50 per share payable on May 1, 1998 to
shareholders of record as of April 17, 1998. On April 6, 1998 the Company's
Board established a quarterly dividend policy of $0.25 per share through its
fiscal year ended January 30, 1999; however, the payment of such 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 May 30, 1996, the Company made a distribution of capital to all
shareholders of record as of May 15, 1996. The distribution was $0.60 per
share on Common Stock and was made in accordance with Section 316 of the
Internal Revenue Code of 1986.
--------
*The current stock price reflects a $5.50 price adjustment due to the payment
of the $5.50 special dividend on January 15, 1998.
15
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information, except as noted
herein, has been taken or derived from the audited consolidated financial
statements of the Company and its predecessor and should be read in
conjunction with the consolidated financial statements included elsewhere
herein. See "--Item 8. Consolidated Financial Statements and Supplementary
Data."
Given the recent developments involving the Company, such as the assignment
of the Amended Target Agreement to Spell C, the sale of the rights to the
Cherokee trademarks in the United States to Spell C and the issuance of the
Secured Notes, the future results of the Company are expected to differ
significantly from the Company's historical results, and therefore undue
reliance should not be placed on the following selected consolidated financial
information as indicative of such future results.
[Enlarge/Download Table]
SUCCESSOR COMPANY PREDECESSOR COMPANY
----------------------------------------- ---------------------
EIGHT MONTHS YEAR YEAR 3 MONTHS 9 MONTHS YEAR
ENDED ENDED ENDED ENDED ENDED ENDED
JANUARY 31, MAY 31, JUNE 1, JUNE 3, FEB. 25, MAY 28,
1998 1997 1996 1995 1995 1994
------------ ------- ------- -------- ----------- --------
STATEMENT OF OPERATIONS
DATA:
($ IN THOUSANDS EXCEPT PER SHARE
DATA)
Royalty revenues/Net
sales.................. $ 8,553 $ 8,718 $13,899 $20,264 $65,623 $114,087
Cost of goods sold...... -- 184 10,445 16,310 54,994 83,225
-------- ------- ------- ------- ------- --------
Gross profit............ 8,553 8,534 3,454 3,954 10,629 30,862
Selling, general and
administrative
expenses............... 4,192 3,406 4,460 5,153 19,097 30,974
Performance option
expense................ -- -- 4,567(4) -- -- --
Amortization of
trademarks and
goodwill............... 43 -- -- -- 819 1,691
Operational
restructuring.......... -- -- -- 3,165 -- 6,052
Write-off of
reorganization value in
excess of amounts
allocable to
identifiable assets.... -- -- -- -- -- 9,281
-------- ------- ------- ------- ------- --------
Operating income (loss). 4,318 5,128 (5,573) (4,364) (9,287) (17,136)
Other (income) expense.. (422) (75) (96) (116) (167) 141
Interest expense........ 330 3 355 587 5,467 11,914(1)
Investment and interest
income................. (525) (460) (543) (24) (107) (55)
Gain on sale of Uniform
Div. and other assets . -- (220) (3,840) -- -- --
Reorganization items.... -- -- -- -- 54,093(2) --
-------- ------- ------- ------- ------- --------
Income (loss) before
income taxes........... 4,935 5,880 (1,449) (4,811) (68,573) (29,136)
Income tax benefit...... (782) (771) -- (400) (5,230) (4,306)
-------- ------- ------- ------- ------- --------
Income (loss) before
extraordinary item..... 5,717 6,651 (1,449) (4,411) (63,343) (24,830)
Extraordinary item (net
of income taxes)....... -- -- -- -- 88,291(2) --
-------- ------- ------- ------- ------- --------
Net income (loss)....... 5,717 6,651 (1,449) (4,411) 24,948 (24,830)
Preferred dividend
requirement............ -- -- -- -- -- --
Net income (loss)
applicable to common
stock.................. $ 5,717 $ 6,651 $(1,449) $(4,411) $24,948 $ 24,830)
Basic earnings (loss)
per share (3).......... $ 0.73 $ 0.87 $ (0.22) $ (0.72) -- (3) -- (3)
Diluted earnings (loss)
per share.............. $ 0.68 $ 0.82 $ (0.21) $ (0.72) -- --
Cash distribution of
capital per share...... $ 5.50 -- $ 0.60 -- -- --
Cash dividends per
share.................. $ 0.20 $ 0.35 -- -- -- --
JANUARY 31, MAY 31, JUNE 1, JUNE 3, FEB. 25,(2) MAY 28,
1998 1997 1996 1995 1995 1994
------------ ------- ------- -------- ----------- --------
BALANCE SHEET DATA:
Working capital......... $ 4,445 $ 9,148 $ 227 $ 2,836 $27,321 $ 26,517
Total assets............ 24,471 13,601 8,320 28,260 41,527 93,700
Long-term debt, net of
current maturities..... 41,675 -- -- -- 18,995 83,204
Stockholders' equity
(deficit).............. (25,646) 12,224 6,070 7,222 11,825 (11,630)
16
NOTES TO SELECTED FINANCIAL DATA
(1) Interest expense includes non-cash charges of $9,420 for the year ended
May 28, 1994 and $4,361 for the nine months ended February 25, 1995.
(2) On December 14, 1994, the 1994 Plan was confirmed by the Bankruptcy Court
and became effective on December 24, 1994. For financial statement
purposes the effective date of the 1994 Plan was assumed to be February
25, 1995, the last day of the third quarter of the Company's fiscal 1994
year. The Company has implemented "fresh start" reporting; therefore all
assets and liabilities have been restated to reflect the reorganization
value of the Company and as such the June 3, 1995 balance sheet is that of
a successor company. See Notes 1 and 2 to the accompanying Financial
Statements.
(3) Earnings per share for periods subsequent to the adoption of fresh-start
reporting as of February 25, 1995 is based on the weighted average number
of common shares, including those yet to be distributed by the Disbursing
Agent during the relevant periods. (See Note 1 to the Financial
Statements). Per share data is not presented for periods ending prior to
June 3, 1995, due to the general lack of comparability as a result of the
revised capital structure of the Company under the 1994 Plan.
(4) Represents a non-cash charge of $4,567,000 resulting from the exercise of
Wilstar performance options. Wilstar is a related party, and Robert
Margolis is the majority shareholder and Chief Executive Officer of
Wilstar.
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. Prior to May 1995, the Company's principal business was
manufacturing, importing and wholesaling casual apparel and footwear primarily
under the Cherokee brand, and licensing the Cherokee trademark to unaffiliated
manufacturers for the production and marketing of apparel, footwear, and
accessories that the Company did not manufacture, import or market. In
previous years, the Company's licensing division operated primarily a
wholesale licensing program; it licensed the Cherokee trademarks to
unaffiliated manufacturers for the production and marketing of apparel,
footwear, and accessories that the Company did not manufacture, import or
market. In May 1995, the Company stopped manufacturing and importing apparel
and footwear, sold most of its inventories, and on July 28, 1995, sold the
assets of its uniform division.
The Company's current operating strategy emphasizes domestic and
international wholesale and retail direct licensing, whereby the Company
grants wholesalers and retailers the license to use its trademark on certain
categories of merchandise. The Company's current licensing agreements are
either non-exclusive, category-specific exclusive or international masters,
and all 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. Under this operating
strategy, the Company has been able to significantly reduce its overhead and
ongoing operating costs as compared to before May 1995.
In November 1997, the Company reaffirmed its strategic relationship with
Target Stores, a division of Dayton Hudson Corporation, 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."
Target will pay a royalty each fiscal year for the fiscal years ending January
31, 1999 through 2004, equal to the greater of (i) the Minimum Guaranteed
Royalty for such year, or (ii) a percentage of Target's net sales of
Merchandise during such fiscal year which percentage varies according to the
volume of sales of Merchandise during such fiscal year. The Minimum Guaranteed
Royalty is
17
$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.
In September 1997, the Company's Board authorized Libra Investment, Inc. to
explore ways to maximize shareholder value, including a recapitalization and
sale of the Company. 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. See "--Item 1. Business. Recent Developments."
As part of the recapitalization, 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. Recent Developments." 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 ($60.0
million) match the aggregate Minimum Guaranteed Royalty under the Amended
Target Agreement ($60.0 million), there is no assurance that there will be any
excess amounts to be distributed. While the Company believes that royalties
payable under the Amended Target Agreement may exceed the Minimum Guaranteed
Royalty, the Company cannot predict with accuracy whether royalties will
exceed the Minimum Guaranteed Royalty.
Target commenced the initial sales of Cherokee brand merchandise in July
1996, and paid the Company $5,935,000 million during the fiscal year ended May
31, 1997, and $6,428,000 million during the Eight Month Fiscal Period, which
accounted for 68% and 75%, respectively, of the Company's revenues during such
periods. Royalties payable under the Amended Target Agreement appear in the
Company's consolidated financial statements for the Eight Month Fiscal Period.
However, on a going-forward basis, most, if not all of such royalties will be
distributed to the holders of the Secured Notes. See "Item 1. Business.
Certain Business Considerations and Risk Factors Restrictions on Distributions
by Spell C." 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
Spell C's obligations under the Indenture. The revenues generated from all
other licensing agreements during the fiscal year ended May 31, 1997 were
$2,783,000 and during the Eight Month Fiscal Period were $2,125,000, which
accounted for 32% and 25% 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. The Sideout
brand represents a beach-oriented active, "California" lifestyle. As part of
the purchase, the Company acquired several existing domestic and international
retail and wholesale license agreements. The Sideout brand currently generates
licensing revenues from existing contracts of approximately $500,000 per year.
See "--Item 1. Business. Recent Developments."
The Company intends to further develop the Sideout brand both in the United
States and internationally through retail direct and wholesale licensing. Due
to the restrictions in the Amended Target Agreement, neither the Company nor
Spell C anticipate entering into additional licensing agreements in the United
States with respect to the Cherokee brands during the term of the agreement.
The Company's current focus with respect to the Cherokee brand is to continue
to develop that brand in certain international markets through retail direct
or
18
wholesale licenses with manufacturers or other companies who have market power
and economies of scale in the respective markets. In April 1997, the Company
entered into a new master licensing agreement for Japan with Vantex under
which the Company is to receive a minimum guaranteed royalty of $5.0 million
over the five year term of the agreement. In August 1997, the Company also
entered into an international retail direct licensing agreement granting
Hudson's Bay the exclusive right in Canada to use the Cherokee brand in
connection with a broad range of categories of merchandise. Hudson's Bay will
pay the Company a minimum guaranteed royalty of $10.0 million over the five
year initial term of the agreement.
Currently, the Company is not actively seeking to acquire other brands,
however, the Company is frequently approached by parties seeking to sell
brands and related trademarks. Should an established and marketable brand
become available on favorable terms, the Company currently has significant
assets with which to pursue such an acquisition.
At a meeting held December 19, 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.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain
consolidated financial data of the Company. In December 1997, the Company
entered into the Assignment Agreement and Spell C entered into the Indenture.
In addition, the Company's historical financial statements (presented below)
relating to the Year Ended May 31, 1997 and the Year Ended June 1, 1996,
include operating results relating to the Apparel Division, Footwear Division
and Uniform Division, all of which have been terminated or sold. Therefore,
the historical financial statements are not indicative of the results of
operations attributable to the ongoing Licensing Division or after giving
effect to the Assignment Agreement or the Indenture. Further, during the
fiscal year ended January 31, 1999, $9.0 million in royalty revenues from the
Licensing Division are expected to be distributed to the holders of the
Secured Notes.
[Download Table]
EIGHT MONTHS
EIGHT MONTHS ENDED
ENDED FEBRUARY 1, YEAR ENDED YEAR ENDED
JANUARY 31, 1997 MAY 31, JUNE 1,
1998 (UNAUDITED) 1997 1996
------------ ------------ ---------- -----------
ROYALTY REVENUES/NET SALES
Apparel Division......... $ -- $ -- $ -- $ 7,846,000
Footwear Division........ -- -- -- 2,331,000
Licensing Division....... 8,553,000 4,723,000 8,333,000 1,421,000
Other(2)/Uniforms........ -- 366,000 385,000 2,301,000
---------- ---------- ---------- -----------
Total Company.......... $8,553,000 $5,089,000 $8,718,000 $13,899,000
========== ========== ========== ===========
GROSS PROFIT
Apparel Division......... $ -- $ -- $ -- $ 1,217,000
Footwear Division........ -- -- -- 56,000
Licensing Division....... 8,553,000 4,723,000 8,333,000 1,421,000
Other(2)/Uniforms........ -- 183,000 201,000 760,000
---------- ---------- ---------- -----------
Total Company.......... $8,553,000 $4,906,000 $8,534,000 $ 3,454,000
========== ========== ========== ===========
SELLING, GENERAL ,
ADMINISTRATIVE AND
AMORTIZATION EXPENSES..... $4,235,000 $1,778,000 $3,406,000 $ 4,460,000
PERFORMANCE OPTION EXPENSE. -- -- -- $ 4,567,000(1)
OPERATING INCOME (LOSS).... $4,318,000 $3,128,000 $5,128,000 $(5,573,000)
19
--------
(1) A non-cash charge of $4,567,000 resulting from the exercise of performance
options for the year ended June 1, 1996.
(2) Other sales include the liquidation of the remaining sweatshirt inventory
during fiscal year ended May 31, 1997.
EIGHT MONTHS ENDED JANUARY 31, 1998 COMPARED TO EIGHT MONTHS ENDING FEBRUARY
1, 1997
Net revenues for the Eight Month Fiscal Period ended January 31, 1998 were
$8,553,000, 100% of which represented licensing revenues. In comparison, net
sales for the eight months ended February 1, 1997 (the "1997 Eight Months")
were $5,089,000, which included $4,723,000 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
$6,428,000, which represented 75% of net revenues. Revenues from all other
sources for the Eight Month Fiscal Period were $2,125,000, which represented
25% of net revenues.
The Company's gross profit margin for the Eight Month Fiscal Period was
$8,553,000 or 100% of net revenues compared to $4,906,000 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 (excluding amortization expense
of $43,000) for the Eight Month Fiscal Period were $4,192,000 or 49% of net
revenues compared to $1,778,000 (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. The Company anticipates that selling, general and
administrative expenses for fiscal year ("Fiscal") 1999 will account for a
lower percentage of net revenues than in the Eight Month Fiscal Period due to
the absence of certain extraordinary expenses totaling $474,000 incurred in
the Eight Month Fiscal Period.
Based on the Company's anticipated results for Fiscal 1999, management
believes that the Company's tax liabilities will be immaterial in Fiscal 1999
because its federal and California tax net operating loss carryovers of
approximately $14,900,000 and $5,300,000, respectively, are expected to offset
taxable income.
FISCAL 1997 COMPARED TO FISCAL 1996
Net revenues for Fiscal 1997 were $8,718,000, of which $8,333,000
represented licensing revenues in comparison to net sales of $13,899,000 for
Fiscal 1996, which included $1,421,000 in licensing revenues with the
remaining sales from the liquidations of apparel and footwear inventories. As
a percentage of total revenues for Fiscal 1997 and Fiscal 1996, licensing
revenues represented 95.6% and 10.2%, respectively, and the terminated
businesses represented 4.4% and 89.8%, respectively.
The Company's gross profit margin for Fiscal 1997 was $8,534,000 or 98% of
net revenues compared to $3,454,000 or 25% of net sales for Fiscal 1996. 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 Fiscal 1997 were $3,406,000
or 39% of net revenues compared to $4,460,000 or 32% of net sales for Fiscal
1996. During Fiscal 1997, certain other accruals totaling $750,000 were deemed
no longer required and were reversed. In Fiscal 1996, the Company recorded a
non-cash charge to expense of $4,567,000 for Wilstar performance options,
which was the difference between the market price of the Common Stock at
exercise date and exercise price of the options. (See Notes to the Financial
Statements Note 11: Employment and Management Agreements). During Fiscal 1997,
selling, general and administrative expenses declined from historical levels
primarily as a result of the termination of the manufacturing and importing of
apparel and footwear and the sale of its Uniform Division. These actions
enabled the Company to significantly reduce its work force, space requirements
and other operating expenses.
20
For Fiscal 1997, the Company gains on sale of assets was attributable to the
sale of a trademark asset and the Company's Wentworth Street facility, its
former headquarters from August 1988 to October 1995. For Fiscal 1996, the
Company's gain on sale of assets was attributable to the sale of the Uniform
Division and the "Rockers" trademark. On July 28, 1995, the Company sold the
assets of the Uniform Division to Strategic Partners. The assets sold included
accounts receivable, inventory, furniture and fixtures, equipment and the
exclusive right to use the Cherokee trademark with respect to the manufacture
and sale of uniforms. The sales price was $11,700,000, which was $4,000,000
greater than the book value of the assets that were sold. Of the purchase
price, $9,575,000 was paid in cash and $2,125,000 was paid by a 10%
subordinated promissory note (the "Note"). The Note required quarterly
payments of interest and annual principal payments of $300,000 on July 27,
1997, 1998, 1999 and 2000 with the remaining principal amount due on July 27,
2001. The Company recorded the note at its estimated fair value of $1,588,000,
which represented a discount of $537,000. In addition, Strategic Partners
agreed to pay the Company royalties with respect to its sales of Cherokee
brand uniform footwear, and beginning in June 2001, agreed to pay Cherokee,
subject to certain conditions, a royalty equal to 2% of annual sales of
Cherokee brand uniform in excess of $30,000,000. On December 1, 1995, the
Company sold its patents and trademarks related to the "Rockers" brand
footwear to Strategic Partners for $250,000. Strategic Partners also agreed to
pay the Company a royalty if the "Rockers" trademark was used in connection
with the sale of Cherokee footwear to the uniform trade.
On April 3, 1997, Strategic Partners and the Company negotiated a 10%
discount to pay off the $2,125,000 Note due 2001 and in addition, Strategic
Partners agreed to pay $100,000 in royalty income to buy back all future
royalty obligations for the Cherokee branded uniform apparel and uniform
shoes. Strategic Partners delivered a payment of $1,912,500 and $100,000 on
May 14, 1997 in full satisfaction of the Note and royalty income buy back.
The Company's interest expense for the Eight Month Fiscal Period ended
January 31, 1998, Fiscal 1997 and Fiscal 1996 was $330,000, $3,000 and
$355,000, respectively. The Company's investment and interest income for the
Eight Month Fiscal Period ended January 31, 1998, Fiscal 1997 and Fiscal 1996
was $525,000, $460,000 and $543,000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
On January 31, 1998, the Company had $10,275,000 in cash and cash
equivalents. 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 the Eight Month Fiscal Period, cash provided by operations was
$4,488,000. During the Eight Month Fiscal Period, cash used in investing
activities was $3,423,000 due to the initial payment made in the Sideout
Agreement and the costs associated with the leveraged recapitalization. During
the Eight Month Fiscal Period, cash used in financing activities was $181,000
which represented the net from the proceeds received from the exercise of
warrants and stock options, the net proceeds from the issuance of long-term
debt and the cash dividend distributions made during the Eight Month Fiscal
Period.
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
The Year 2000 issue is a result of computer programs being written using two
digits, e.g. "98", to define a year. Date-sensitive software may recognize the
year "00" as the year 1900 rather than the year 2000. This would result in
errors and miscalculations or even system failure causing disruptions in
everyday business activities and transactions. Software is termed "Year 2000
compliant" when it is capable of performing transactions correctly in the year
2000.
21
Based on a recent assessment of the Company's computer systems software, it
has been determined that more than 95% of the Company's hardware and software
systems are either currently Year 2000 compliant or have an existing upgrade
available from the software vendor that is Year 2000 compliant. All systems
that are not currently Year 2000 compliant will either be upgraded to be Year
2000 compliant or replaced with alternative systems that are Year 2000
compliant over the next eighteen months.
The Company does not expect the achieving of Year 2000 compliance to have a
material impact on its financial condition or results of operations.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting standards ("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 generalpurpose 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 eight months ended January 31, 1998 and
the three years ended May 31, 1997, June 1, 1996 and June 3, 1995, the Company
had no other comprehensive income components as defined in SFAS No. 130. SFAS
No. 130 does not apply to an enterprise that has no items of other
comprehensive income in any of the periods presented.
In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information," which changes current practice and
established a new framework, referred to as the "management" approach, on
which to base segment reporting. The management approach requires that
management identify the "operating segments" based on the way that management
disaggregates the entity for internal operating decisions. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997 and is not
required for interim statements in the first year of adoption. Management
believes that the adoption of this new standard will not have any material
impact on the Company's financial position or results of operations.
In February 1998, The FASB issued SFAS No. 132 "Employers' Disclosures About
Pensions and Other Post-retirement Benefits" which revises employers'
disclosures about pension and post-retirement benefit plans. This statement is
effective for fiscal years beginning after December 15, 1997. This statement
is not anticipated to have any effect on the Company.
SUBSEQUENT EVENTS
On March 3, 1998, the Company announced the resignation of Patricia Warren
as President of the Company. She will continue to work with the Company
through 1998 in selected special projects. Mr. Margolis will assume Ms.
Warren's responsibilities until a new president is appointed.
On April 6, 1998, the Company announced that its Board of Directors had
declared a cash dividend of $0.50 per share to be distributed on May 1, 1998
to the Company's shareholders of record on the close of business on April 17,
1998. Assuming the Company's cash position continues to be favorable, the
Company intends to maintain a quarterly cash dividend of $0.25 per share for
the balance of the fiscal year ending January 30, 1999; however, the
declaration of such dividends remains subject to the discretion of the
Company's Board.
ITEM 7A. QUALITATIVE AND QUANTITATIVE RISK
Not applicable
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Transition 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
22
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, "Certain Business Considerations and Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operation," and "Business." 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 "Certain Business Considerations and 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.
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 31, 1998, May 31, 1997 and June 1,1996........................ F-2
Consolidated Statements of Operations
For the Eight Months Ended January 31, 1998 and February 1, 1997
(unaudited) (Successor Company), and for the Years Ended May 31, 1997 and
June 1, 1996 (Successor Company), and for the Three Months Ended June 3,
1995 (Successor Company), and for the Nine Months Ended February 25, 1995
(Predecessor Company).................................................... F-3
Consolidated Statements of Stockholders' Equity (Deficit)
for the Eight Months Ended January 31, 1998 and February 1, 1997
(unaudited) (Successor Company), and for the Years Ended May 31, 1997 and
June 1, 1996 (Successor Company), and for the Three Months Ended June 3,
1995 (Successor Company), and for the Nine Months Ended February 25, 1995
(Predecessor Company).................................................... F-4
Consolidated Statements of Cash Flows
For the Eight Months Ended January 31, 1998 and February 1, 1997
(unaudited) (Successor Company), and for the Years Ended May 31, 1997 and
June 1, 1996 (Successor Company), and for the Three Months Ended June 3,
1995 (Successor Company), and for the Nine Months Ended February 25, 1995
(Predecessor Company).................................................... F-5
Notes to Financial Statements............................................. F-7
SCHEDULES
II Valuations and Qualifying Accounts and Reserves....................... F-27
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.
23
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders
Cherokee Inc.
We have audited the accompanying consolidated balance sheets of Cherokee
Inc. (the "Company") as of January 31, 1998, May 31, 1997 and June 1, 1996,
and the related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for the eight months ended January 31, 1998, the
years ended May 31, 1997 and June 1, 1996, the three months ended June 3, 1995
and the nine months ended February 25, 1995. Our audits also included the
financial statement schedule listed in the accompanying index. These financial
statements and schedule are the responsibility of management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As discussed in Note 1 to the financial statements, the Company's
reorganization plan became effective on February 25, 1995 for financial
reporting purposes. In accordance with the American Institute of Certified
Public Accountants Statement of Position No. 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code," the Company was
required to account for the reorganization using "Fresh-Start Reporting."
Accordingly, all financial statements prior to February 25, 1995, are not
comparable to the financial statements for periods after the implementation of
fresh-start reporting.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Cherokee
Inc. at January 31, 1998, May 31, 1997 and June 1, 1996, and the results of
its operations and its cash flows for the eight months ended January 31, 1998,
for the years ended May 31, 1997 and June 1, 1996, the three months ended June
3, 1995 and the nine months ended February 25, 1995, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
Coopers & Lybrand L.L.P.
Los Angeles, California
April 6, 1998
F-1
CHEROKEE INC.
CONSOLIDATED BALANCE SHEETS
[Download Table]
JANUARY 31, MAY 31, JUNE 1,
1998 1997 1996
------------ ----------- -----------
ASSETS
Current assets:
Cash and cash equivalents............. $ 10,275,000 $ 9,391,000 $ 1,207,000
Restricted cash....................... -- -- 310,000
Receivables, net...................... 2,347,000 1,024,000 694,000
Inventories........................... 45,000 80,000 256,000
Other current assets.................. 220,000 30,000 10,000
------------ ----------- -----------
Total current assets................ 12,887,000 10,525,000 2,477,000
Assets held for sale.................... -- -- 3,576,000
Notes receivable........................ -- -- 1,961,000
Securitization fees..................... 1,218,000 -- --
Deferred tax asset...................... 7,576,000 2,408,000 --
Other assets............................ 2,790,000 668,000 306,000
------------ ----------- -----------
Total assets........................ $ 24,471,000 $13,601,000 $ 8,320,000
============ =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................... $ 645,000 $ 210,000 $ 112,000
Other accrued liabilities............. 522,000 417,000 638,000
Current portion of long term Notes
payable.............................. 6,525,000 -- --
------------ ----------- -----------
Total current liabilities........... 7,692,000 627,000 750,000
Other liabilities....................... 750,000 750,000 1,500,000
Notes payable less current portion...... 41,675,000 -- --
------------ ----------- -----------
Total liabilities................... 50,117,000 1,377,000 2,250,000
------------ ----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' (DEFICIT) EQUITY
Common stock, $.02 par value, 20,000,000
shares authorized, 8,612,657, 7,726,986
and 7,650,813 shares issued and
outstanding at January 31, 1998, May
31, 1997 and June 1, 1996,
respectively........................... 173,000 155,000 153,000
Additional paid-in capital.............. (23,806,000) 11,334,000 11,977,000
Retained earnings....................... -- 735,000 (5,916,000)
Note receivable from stockholder........ (2,013,000) -- (144,000)
------------ ----------- -----------
Total stockholders' (deficit)
equity............................. (25,646,000) 12,224,000 6,070,000
------------ ----------- -----------
Total liabilities and stockholders'
equity............................. $ 24,471,000 $13,601,000 $ 8,320,000
============ =========== ===========
The accompanying notes are an integral part of these financial statements.
F-2
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
[Enlarge/Download Table]
PREDECESSOR
SUCCESSOR COMPANY COMPANY
--------------------------------------------------------------- ------------
EIGHT MONTHS EIGHT MONTHS NINE MONTHS
ENDED ENDED YEAR ENDED YEAR ENDED THREE MONTHS ENDED
JANUARY 31, FEBRUARY 1, MAY 31, JUNE 1, ENDED FEBRUARY 25,
1988 1997 1997 1996 JUNE 3, 1995 1995
------------ ------------ ---------- ----------- ------------ ------------
(UNAUDITED)
REVENUES:
Product sales, net...... $ -- $ 366,000 $ 385,000 $12,478,000 $19,939,000 $ 64,138,000
Licensing revenues...... 8,553,000 4,723,000 8,333,000 1,421,000 325,000 1,485,000
---------- ---------- ---------- ----------- ----------- ------------
Total net sales....... 8,553,000 5,089,000 8,718,000 13,899,000 20,264,000 65,623,000
Cost of goods sold...... -- 183,000 184,000 10,445,000 16,310,000 54,994,000
---------- ---------- ---------- ----------- ----------- ------------
Gross profit............ 8,553,000 4,906,000 8,534,000 3,454,000 3,954,000 10,629,000
Selling, general and
administrative
expenses............... 4,192,000 1,778,000 3,406,000 4,460,000 5,153,000 19,097,000
Performance option
expense................ -- -- -- 4,567,000 -- --
Amortization of
trademarks and
goodwill............... 43,000 -- -- -- -- 819,000
Operational
restructuring charge... -- -- -- -- 3,165,000 --
---------- ---------- ---------- ----------- ----------- ------------
Operating income (loss). 4,318,000 3,128,000 5,128,000 (5,573,000) (4,364,000) (9,287,000)
OTHER INCOME (EXPENSES):
Interest expense........ (330,000) (2,000) (3,000) (355,000) (587,000) (5,467,000)
Investment and interest
income................. 525,000 293,000 460,000 543,000 24,000 107,000
Gain on sale of Uniform
Division and other
assets................. -- -- 220,000 3,840,000 -- --
Other income............ 422,000 -- 75,000 96,000 116,000 167,000
---------- ---------- ---------- ----------- ----------- ------------
Total other income
(expenses), net...... 617,000 291,000 752,000 4,124,000 (447,000) (5,193,000)
REORGANIZATION ITEMS:
Professional fees and
expenses............... -- -- -- -- -- (3,429,000)
Fresh start adjustments. -- -- -- -- -- (50,664,000)
---------- ---------- ---------- ----------- ----------- ------------
Total reorganization
items................ -- -- -- -- -- (54,093,000)
Income (loss) before
income taxes and
extraordinary item..... 4,935,000 3,419,000 5,880,000 (1,449,000) (4,811,000) (68,573,000)
Income tax benefit...... (782,000) -- (771,000) -- (400,000) (5,230,000)
---------- ---------- ---------- ----------- ----------- ------------
Income (loss) before
extraordinary item..... 5,717,000 3,419,000 6,651,000 (1,449,000) (4,411,000) (63,343,000)
EXTRAORDINARY ITEM:
Gain on extinguishment
of debt................ -- -- -- -- -- 88,291,000
---------- ---------- ---------- ----------- ----------- ------------
Net income (loss)....... $5,717,000 $3,419,000 $6,651,000 $(1,449,000) $(4,411,000) $ 24,948,000
========== ========== ========== =========== =========== ============
Basic earnings (loss)
per share.............. $ 0.73 $ 0.45 $ 0.87 $ (0.22) $ (0.72) *
========== ========== ========== =========== ===========
Diluted earnings (loss)
per share.............. $ 0.68 $ 0.42 $ 0.82 $ (0.21) $ (0.72)
========== ========== ========== =========== ===========
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic................. 7,866,862 7,660,813 7,688,521 6,480,443 6,096,000
Diluted............... 8,412,768 8,080,100 8,154,311 6,945,360 6,131,590
--------
* Per share results are not presented for periods prior to June 3, 1995, due
to the general lack of comparability as a result of the revised capital
structure of the Company.
The accompanying notes are an integral part of these financial statements.
F-3
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
[Enlarge/Download Table]
COMMON STOCK ACCUMULATED NOTES
-------------------- ADDITIONAL (DEFICIT)/ RECEIVABLE
PAR PAID-IN RETAINED FROM
SHARES VALUE CAPITAL EARNINGS STOCKHOLDERS TOTAL
---------- -------- ----------- ----------- ------------ -----------
Predecessor Company
balance at May 28,
1994................... 5,016,298 50,000 13,150,000 (24,830,000) -- (11,630,000)
========== ======== =========== =========== ========== ===========
Net loss for the nine
months ended prior to
fresh start
adjustments............ -- -- -- (12,679,000) -- (12,679,000)
Recapitalization and
fresh start adjustments
(Notes 1 and 2)
Cancellation of old
common stock.......... (5,016,298) (50,000) (13,150,000) -- -- (13,200,000)
Issuance of new common
stock................. 6,096,000 122,000 11,703,000 -- -- 11,825,000
Issuance of note
receivable to
stockholder........... -- -- -- -- (192,000) (192,000)
Fresh start
adjustments........... -- -- -- 37,509,000 -- 37,509,000
---------- -------- ----------- ----------- ---------- -----------
Successor Company
balance at
February 25, 1995...... 6,096,000 122,000 11,703,000 -- (192,000) 11,633,000
Net loss for three
months ended June 3,
1995................... -- -- -- (4,411,000) -- (4,411,000)
---------- -------- ----------- ----------- ---------- -----------
BALANCE AT JUNE 3, 1995. 6,096,000 122,000 11,703,000 (4,411,000) (192,000) 7,222,000
========== ======== =========== =========== ========== ===========
Issuance of new common
stock.................. 366,667 7,000 (7,000) -- -- --
Exercise of director
warrants, employee
stock options and
performance options.... 1,694,739 35,000 4,620,000 -- -- 4,655,000
Purchase and retirement
of treasury shares..... (31,593) (1,000) (60,000) (56,000) -- (117,000)
Cancellation of shares
held and returned by
disbursing agent....... (475,000) (10,000) 10,000 -- -- --
Distribution of capital. -- -- (4,289,000) -- -- (4,289,000)
Repayment on note
receivable............. -- -- -- -- 48,000 48,000
Net loss for the year
ended June 1, 1996..... -- -- -- (1,449,000) -- (1,449,000)
---------- -------- ----------- ----------- ---------- -----------
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, employee
stock options and...... 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.......... -- -- (42,467,000) (6,452,000) -- (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)
========== ======== =========== =========== ========== ===========
COMPARATIVE TRANSITION PERIOD
(UNAUDITED)
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, employee
stock options and...... 80,000 2,000 336,000 -- -- 338,000
Cancellation of shares
held and returned by
disbursing agent....... (18,827) -- -- -- -- --
Interest on note
receivable from
stockholder............ -- -- -- -- (6,000) (6,000)
Dividend distribution
adjustment............. -- -- (7,000) -- -- (7,000)
Cash dividend
distributions.......... -- -- -- -- -- --
Net income for the eight
months ended
February 1, 1997....... -- -- -- 3,419,000 -- 3,419,000
---------- -------- ----------- ----------- ---------- -----------
BALANCE AT FEBRUARY 1,
1997................... 7,711,986 155,000 12,306,000 (2,497,000) (150,000) 9,814,000
========== ======== =========== =========== ========== ===========
The accompanying notes are an integral part of these financial statements.
F-4
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
[Enlarge/Download Table]
PREDECESSOR
SUCCESSOR COMPANY COMPANY
-------------------------------------------------------------- ------------
EIGHT EIGHT THREE NINE
MONTHS MONTHS YEAR YEAR MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED ENDED
JANUARY 31, FEBRUARY 1, MAY 31, JUNE 1, JUNE 3, FEBRUARY 25,
1988 1997 1997 1996 1995 1995
----------- ----------- ---------- ----------- ----------- ------------
UNAUDITED
OPERATING ACTIVITIES
Net (loss) income....... $ 5,717,000 $3,419,000 $6,651,000 $(1,449,000) $(4,411,000) $24,948,000
Adjustments to reconcile
net (loss) income to
net cash provided by
(used in) operating
activities:
Depreciation and
amortization.......... 23,000 6,000 19,000 18,000 26,000 690,000
Amortization of
goodwill and
trademarks............ 43,000 -- -- -- -- 819,000
Provision for bad
debts................. -- -- (112,000) 112,000 72,000 696,000
Operational
restructuring charge.. -- -- -- -- 2,551,000 --
Gain on Sale of Uniform
Division.............. -- -- -- (1,588,000) -- --
Change in other
liabilities........... -- (750,000) (750,000) -- -- --
Interest income on note
receivable from
stockholder........... (13,000) (6,000) -- -- -- --
Deferred taxes......... (3,058,000) -- (926,000) -- (500,000) (5,230,000)
Stock option tax
benefit............... 2,367,000 -- -- -- -- --
Amortization of
deferred financing
costs
and debt discount..... 347,000 -- -- -- -- 85,000
Gain on extinguishment
of debt............... -- -- -- -- -- (88,291,000)
Fresh start
adjustments........... -- -- -- -- -- 50,664,000
Amortization of
discount on note
receivable............ -- (83,000) -- 108,000 -- --
Performance option
exercise expense...... -- -- -- 4,567,000 -- --
Changes in current
assets and
liabilities:
Receivables........... (1,323,000) (1,014,000) (218,000) 10,747,000 5,010,000 (2,441,000)
Inventories........... 35,000 179,000 176,000 11,274,000 5,724,000 (1,880,000)
Other current assets.. (190,000) (89,000) (20,000) 496,000 (141,000) (88,000)
Accounts payable...... 540,000 (181,000) (122,000) (1,348,000) (1,794,000) 7,787,000
Accrued payroll and
related expenses..... -- -- -- (1,559,000) 1,152,000 (227,000)
Other liabilities..... -- -- -- (1,668,000) (521,000) 364,000
----------- ---------- ---------- ----------- ----------- -----------
Net cash provided by
(used in) operating
activities............. 4,488,000 1,481,000 4,698,000 19,710,000 7,168,000 (12,104,000)
INVESTING ACTIVITIES
Purchases of trademark.. $(2,000,000) $ -- $ -- $ -- $ -- $ --
Proceeds from sales of
assets held for sale... -- -- 3,576,000 89,000 -- 435,000
Purchase of treasury
shares................. -- -- -- (117,000) -- --
Restricted cash......... -- 310,000 310,000 (310,000) -- --
Repayment on note
receivable from
stockholder............ -- -- 144,000 48,000 -- --
Change in other assets.. (1,673,000) (197,000) (382,000) (84,000) 95,000 87,000
Collection of notes
receivable............. 250,000 -- 1,961,000 -- -- --
----------- ---------- ---------- ----------- ----------- -----------
Net cash (used in)
provided by investing
activities............. (3,423,000) 113,000 5,609,000 (374,000) 95,000 522,000
FINANCING ACTIVITIES
Payment of long-term
debt, including
revolving credit which
was classified as
current at June 3,
1995................... -- -- -- -- (7,065,000) (2,383,000)
Net proceeds from the
issuance of long-term
debt................... 47,870,000 -- -- -- -- 14,719,000
Net (payments on)
proceeds from revolving
credit and other....... -- -- -- (14,213,000) 64,000 (1,232,000)
Note receivable from
stockholder............ (2,000,000) -- -- -- -- --
Proceeds from exercise
of stock options....... 2,786,000 281,000 336,000 64,000 -- --
Proceeds from exercise
of warrants............ 82,000 57,000 70,000 24,000 -- --
Cash Distributions...... (48,919,000) -- (2,529,000) (4,289,000) -- --
----------- ---------- ---------- ----------- ----------- -----------
Net cash (used in)
provided by financing
activities............. (181,000) 338,000 (2,123,000) (18,414,000) (7,001,000) 11,104,000
----------- ---------- ---------- ----------- ----------- -----------
Increase (decrease) in
cash and cash
equivalents............ 884,000 1,932,000 8,184,000 922,000 262,000 (478,000)
Cash and cash
equivalents at
beginning of period.... 9,391,000 1,207,000 1,207,000 285,000 23,000 501,000
----------- ---------- ---------- ----------- ----------- -----------
Cash and cash
equivalents at end of
period................. $10,275,000 $3,139,000 $9,391,000 $1,207,000 $285,000 $23,000
=========== ========== ========== =========== =========== ===========
TOTAL PAID DURING
PERIOD:
Income taxes........... $ 64,000 $ 4,600 $ 4,600 $ -- $ 92,000 $ 17,000
Interest............... $ -- $ 2,000 $ 3,000 $ 355,000 $ 587,000 $ 1,644,000
NON-CASH TRANSACTIONS:
Declaration of cash
dividend.............. $ -- $1,159,000 $ -- $ -- $ -- $ --
Utilization of pre-
bankruptcy NOL
carryforwards......... $ 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. REORGANIZATION
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"), hold several trademarks including Cherokee(TM), Sideout(TM),
Sideout Sport(TM), King of the Beach(TM), 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 31, 1998 the Company had twenty-five continuing
license agreements, covering both domestic and international markets.
On April 24, 1995, a group including Robert Margolis, who founded the
Company's Apparel Division in 1981, and who had been the Company's Chairman
and Chief Executive Officer from May 1989 to October 1993, purchased 1,358,000
shares, or approximately 22.3% of the Company's then outstanding Common Stock
("Common Stock"). On May 5, 1995, Mr. Margolis was appointed Chairman and
Chief Executive Officer of the Company. After a period of assessment, Mr.
Margolis set in motion a strategy which resulted in the Company's principal
business being a marketer and licensor of the Cherokee brand and other brands
it owns or may acquire in the future. The Company stopped manufacturing and
importing apparel and footwear, sold its inventories of apparel and footwear
and on July 28, 1995 sold the assets of its Uniform Division. The proceeds
from these sales were used to pay off all of the Company's indebtedness. As a
result of discontinuing the apparel and footwear business and selling the
Uniform Division, the number of employees was reduced from approximately 345
on May 28, 1994 to 15 by November 1, 1995.
The Company filed a prepackaged plan of reorganization (the "1994 Plan")
pursuant to Chapter 11 of the United States Bankruptcy Code ("Chapter 11")
with the United States Bankruptcy Court for the District of Delaware (the
"Bankruptcy Court") on November 7, 1994. An order confirming the 1994 Plan was
entered by the Court on December 14, 1994 and the Plan became effective on
December 23, 1994 (the "Effective Date"). The confirmed 1994 Plan provided for
the following:
Common Stock: On the Effective Date Cherokee issued 5,000,000 shares of
Common Stock, par value of $.02 per share, ("Common Stock") to holders of 11%
Senior Subordinated Notes due 1999 ("Old Notes") and common stock par value
$.01 per share ("Old Common Stock"). The Company also issued 1,000,000 shares
of Common Stock to a disbursing agent, which shares were to be issued to
Holders of Allowed General Unsecured Claims following allowance and settlement
of such Claims. To implement distribution of Common Stock to general unsecured
creditors, 1,000,000 shares of Common Stock were issued to Cherokee's
disbursing agent (the "Disbursing Agent"). The Disbursing Agent distributed
517,795 shares of Common Stock to general unsecured creditors and returned
482,205 shares to the Company since they were determined not to be
distributable to creditors, and subsequently, were canceled at the Company's
request. Having settled all claims, the Company sent in a Final Decree to the
Bankruptcy Court, which was signed and approved by the Bankruptcy Judge on
August 15, 1996.
In accordance with the 1994 Plan, the Company's Certificate of Incorporation
was amended to authorize 20,000,000 shares of Common Stock par value $.02 per
share, and 1,000,000 shares of Preferred Stock par value $.02 per share. The
terms and conditions of the Preferred Stock shall be determined from time to
time by the Company's Board of Directors.
F-6
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Old Notes: For each $1,000 principal amount of Old Notes (an aggregate of
$76,565,000), Holders received 63.9978 shares of Common Stock (or an aggregate
of 4,900,000 shares of Common Stock). Accrued and unpaid interest through the
petition date was taken into account in determining the exchange ratio. Having
settled all claims, the remaining 10,954 shares were returned and canceled by
the Disbursing Agent on February 24, 1997.
Allowed General Unsecured Claims: Holders of Allowed General Unsecured
Claims have received 60.5504 shares of Common Stock for each $1,000 amount of
Allowed General Unsecured Claims.
Allowed General Unsecured Claims of Less than $1,000: Holders of Allowed
General Unsecured Claims of Less than $1,000 received full payment in cash.
Old Common Stock: Holders of Old Common Stock received.019935 shares of
Common Stock for each share of Old Common Stock (or an aggregate of 100,000
shares of Common Stock). Having settled all claims, the remaining 668 shares
were returned and canceled by the Disbursing Agent on February 24, 1997.
Old Warrants: Series A, Series B and Series C Warrants were cancelled and
holders received no consideration under the Plan.
2. BASIS OF PRESENTATION
Bankruptcy Reorganization
For financial reporting purposes, the effective date of the 1994
reorganization was assumed to be February 25, 1995, the last day of the third
quarter of the Company's fiscal year.
The Company has implemented the recommended accounting principles for
entities emerging from Chapter 11 set forth in the American Institute of
Certified Public Accountants Statement of Position 90-7 on Financial Reporting
by Entities in Reorganization under the Bankruptcy Code ("SOP 90-7"). This
results in the use of "fresh start" reporting, since the reorganization value,
as defined, was less than the total of all post-petition liabilities and pre-
petition claims, and holders of voting shares immediately before confirmation
of the 1994 Plan received less than fifty percent of the voting shares of the
emerging entity. Under this concept, all assets and liabilities are restated
to reflect the reorganization value of the reorganized entity, which
approximates its fair value at the date of reorganization. In addition, the
accumulated deficit of the Company was eliminated and its capital structure
was recast in conformity with the 1994 Plan.
F-7
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
BALANCE SHEETS
FEBRUARY 25, 1998
($000 OMITTED)
[Enlarge/Download Table]
PRE-FRESH START FRESH START FRESH START
BALANCE SHEET CANCELLATION DEBT FAIR VALUE BALANCE SHEET
FEB. 25, 1995 OF STOCK DISCHARGE ADJUSTMENT FEB. 25, 1995
--------------- ------------ --------- ----------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash
equivalents............ $ 23 $-- $ -- $ -- $ 23
Receivables, net........ 16,857 -- -- (622)(3) 16,235
INVENTORIES:
Raw materials........... 5,643 -- -- (1,831)(3) 3,812
Work in process......... 1,802 -- -- (41)(3) 1,761
Finished goods.......... 16,616 -- -- (2,833)(3) 13,783
------- ---- ------- -------- -------
24,061 -- -- (4,705)(3) 19,356
Deferred income taxes... 2,511 -- -- (2,511)(4) --
Other current assets.... 415 -- -- (1)(3) 414
Total current assets.. 43,867 -- -- (7,839) 36,028
Property & Equipment.... 12,578 -- -- (8,863)(1) 3,715
Less accumulated
depreciation and
amortization........... (1,455) -- -- 1,455(3) --
------- ---- ------- -------- -------
11,123 -- -- (7,408)(3) 3,715
------- ---- ------- -------- -------
Trademarks, net of
amortization........... 36,290 -- -- (36,290)(5) --
Other assets............ 3,156 192(2) -- (1,564)(3) 1,784
------- ---- ------- -------- -------
Total assets.......... $94,436 $192(2) $ -- $(53,101) $41,527
======= ==== ======= ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Short-term revolving
credit and other....... $ 439 $-- $ -- $ -- $ 439
Current maturities of
long-term debt......... 1,780 -- -- -- 1,780
Accounts payable and
accrued expenses....... 13,754 -- (7,365)(2) 29(3) 6,418
Accrued interest
payable................ 4,361 -- (4,361)(2) -- --
Income tax payable...... 70 -- -- -- 70
Senior subordinated
notes due 1999......... 76,565 -- (76,565)(2) -- --
------- ---- ------- -------- -------
Total current
liabilities.......... 96,969 -- (88,291) 29 8,707
Long-term debt, net of
current maturities..... 18,995 -- -- -- 18,995
Deferred incomes taxes.. 2,781 -- -- (781)(4) 2,000
------- ---- ------- -------- -------
Total liabilities..... 118,745 -- (88,291) (752) 29,702
STOCKHOLDERS' EQUITY
(DEFICIT):
Common stock, $.01 par
value, 20,000,000
authorized, 5,016,298
shares issued and
outstanding............ 50 (50)(1) -- -- --
Common stock, $.02 par
value, 20,000,000
authorized, 6,096,000
shares issued and
outstanding............ -- 4(1) 118(2) -- 122
Additional paid-in
capital................ 13,150 238(1) (1,685)(2) 11,703
Deficit................. (37,509) -- 88,173(2) (50,664)(3) --
------- ---- ------- -------- -------
Stockholders' Equity
(Deficit)............ (24,309) 192 88,291 (52,349) 11,825
------- ---- ------- -------- -------
Total liabilities and
Stockholders' Equity
(Deficit)............ $94,436 $192 $ -- $(53,101) $41,527
======= ==== ======= ======== =======
F-8
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
--------
(1) Exchange Common Stock for Old Common Stock.
(2) Exchange of Old Notes and accounts payable for Common Stock and related
gain on debt extinguishment.
(3) Record assets and liabilities at their fair value pursuant to the
reorganization value of the Company and eliminate any retained earnings or
deficit.
(4) Record income tax effect of fresh start adjustments.
(5) Based on the Company's continued poor operating performance and its second
bankruptcy reorganization since fiscal year 1993, no value was attributed
to trademarks in connection with the fresh start accounting for the 1994
Plan.
3. 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 determined to change 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 Company had restricted cash of $310,000 at June 1, 1996, held as
collateral for a stand by letter of credit ("LC"). The LC secured a custom's
bond in the Company's name. The LC was returned and the cash was released to
the Company on August 23, 1996.
INVENTORIES
Inventories are valued at the lower of cost or market, determined by the use
of the first-in, first-out method.
REVENUE RECOGNITION
Product sales are recognized on the date of shipment. Royalty revenues are
recognized when earned based upon contractual agreement.
F-9
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DEPRECIATION AND AMORTIZATION
In accordance with fresh start reporting related to the 1994 Plan, the pre-
effective date accumulated depreciation and amortization of $1,455,000 at
February 25, 1995 was eliminated and a new depreciation and amortization base
was established equal to the estimated fair market value of the existing fixed
assets at that date.
Depreciation of furniture and fixtures, stated at cost, is provided on a
straight-line method over the estimated useful lives of the assets ranging
from three to eight years.
OTHER ASSETS AND ASSETS HELD FOR SALE
Other assets is comprised of property, plant and equipment and intangible
assets. Property and equipment are stated at cost, less accumulated
depreciation and amortization. Other assets includes the Sideout trademarks
acquired on November 7, 1997 for $2,000,000.
Based on the Company's continued poor operating performance and its second
bankruptcy reorganization since fiscal year 1993, no value was attributed to
trademarks in connection with the fresh start accounting for the 1994 Plan.
Subsequent to 1994, the Company capitalizes all fees incurred in filing
trademark registrations and renewals. Trademark registrations, renewal fees
and acquired trademarks are amortized over the life of the registrations
ranging from five to ten years.
Assets held for sale at June 1, 1996 included the Company facility in
Sunland, California, which was sold on April 22, 1997.
Securitization fees are the costs associated with the leveraged
recapitalization which have been capitalized and are being amortized over the
term of the Note Agreement.
LONG-TERM ASSETS
The carrying value of long-term 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.
Under fresh-start reporting and SFAS No. 109, the tax benefits realized from
net operating loss carryforwards that survive the reorganization will be a
direct credit to additional paid-in-capital.
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
F-10
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
cash by maintaining cash balances with quality financial institutions. At
January 31, 1998, May 31, 1997 and June 1, 1996, 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. As of January 31, 1998, the Company had twenty-
five continuing license agreements; five of which were with retailers, seven
of which were with domestic licensees and thirteen of which were with
international licensees.
One customer accounted for approximately 96% and 83%, respectively, of the
Company's trade receivables at January 31, 1998 and May 31, 1997 and
approximately 75% and 68%, respectively, of the Company's revenues during the
fiscal year ended January 31, 1998 and May 31, 1997. No customer accounted for
more than 10% of trade receivables at June 1, 1996 or of sales during the
period ended June 1, 1996.
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). SFAS 123 established a fair value-based method of
accounting for compensation cost related to stock options and other forms of
stock-based compensation plans. However, SFAS 123 allows an entity to continue
to measure compensation costs using the principles of APB 25 if certain pro
forma disclosures are made.
The Company has elected to account for its stock compensation arrangements
under the provisions of APB 25, "Accounting for Stock Issued to Employees."
The Company adopted the provisions for pro forma disclosure requirements of
SFAS 123 in Fiscal 1997. (See Note 13.)
ADVERTISEMENT
The Company's retail direct licensees fund their own advertisement programs.
The Company's advertising and promotional costs are immaterial and are
expensed as incurred.
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128").
SFAS 128 supersedes and simplifies the previous computational guidelines under
Accounting Principles Board Opinion No. 15, "Earnings Per Share". Among other
changes, SFAS 128 eliminates the presentation of primary EPS and replaces it
with basic EPS for which common stock equivalents are not considered in the
computation. It also revises the computation of diluted EPS.
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 common share is 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. Earnings per share and weighted average shares outstanding for
all prior periods have been restated in accordance with SFAS 128.
For the eight months ended January 31, 1998, the Company, in consolidation,
recorded as a charge against income, $474,000 in financial advisory services,
resulting in a reduction in basic and diluted earnings per share of $0.06 and
$0.05, respectively. For the year ended June 1, 1996, the Company recorded a
non-cash charge to
F-11
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
recognize performance option expense of $4,567,000, resulting in a reduction
in basic and diluted earnings per share of $0.70 and $0.66, respectively.
RECLASSIFICATIONS
Certain prior year amounts have been reclassed to conform with current
period presentation.
4. RECEIVABLES
Receivables consist of the following:
[Download Table]
JANUARY 31, MAY 31, JUNE 1,
1998 1997 1996
----------- ---------- ----------
Trade........................................ $2,289,000 $ 657,000 $ 621,000
Due from Factor.............................. -- -- 43,000
Note Receivable, Current..................... -- 250,000 --
Other........................................ 58,000 117,000 621,000
---------- ---------- ----------
2,347,000 1,024,000 1,285,000
Less allowance for doubtful accounts......... -- -- (591,000)
---------- ---------- ----------
$2,347,000 $1,024,000 $ 694,000
========== ========== ==========
5. LONG-TERM DEBT
In September 1997, the Company's Board authorized Libra Investments, Inc.
("Libra") to explore ways to maximize shareholder value, including a
recapitalization or sale of the Company. 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 Dayton Hudson 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 secured by the Amended Target
Agreement and the domestic Cherokee brand name and trademarks. The Secured
Notes indenture (the "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 per year for each of the two
fiscal years ending January 29, 1999 and 2000 and $10.5 million per year for
each of the four fiscal years ending January 31, 2001 through 2004, therefore,
the aggregate scheduled amortization under the Secured Notes ($60.0 million)
equals the aggregate minimum guaranteed royalty payable under the Amended
Target Agreement ($60.0 million).
F-12
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
MATURITY SCHEDULE OF SECURED NOTES
[Download Table]
FACE VALUE
-----------
1999......................................................... $ 6,750,000
2000......................................................... 9,000,000
2001......................................................... 10,125,000
2002......................................................... 10,500,000
2003......................................................... 10,500,000
Thereafter................................................... 13,125,000
-----------
Total.................................................... $60,000,000
Less unamortized Note Discount............................... 11,800,000
-----------
42,800,000
Less current portion of long term debt....................... 6,525,000
-----------
Long term obligation......................................... $41,625,000
6. INCOME TAXES
The income tax benefit as shown in the statements of operations includes the
following:
[Enlarge/Download Table]
SUCCESSOR PREDECESSOR
SUCCESSOR COMPANY COMPANY COMPANY
------------------------------------ ------------ ------------
EIGHT MONTHS NINE MONTHS
ENDED YEAR ENDED YEAR ENDED THREE MONTHS ENDED
JANUARY 31, MAY 31, JUNE 1, ENDED FEBRUARY 25,
1998 1997 1996 JUNE 3, 1995 1995
------------ ---------- ---------- ------------ ------------
Current:
Federal............... $ 1,892,000 $ 96,000 $-- $ -- $ --
State................. 353,000 32,000 -- 100,000 --
Foreign............... 31,000 27,000 -- -- --
----------- --------- ---- --------- -----------
2,276,000 155,000 -- 100,000 --
Deferred:
Federal............... (3,058,000) (785,000) -- (250,000) (3,355,000)
State................. -- (141,000) -- (250,000) (1,875,000)
Foreign............... -- -- -- -- --
----------- --------- ---- --------- -----------
(3,058,000) (926,000) -- (500,000) (5,230,000)
----------- --------- ---- --------- -----------
$ (782,000) $(771,000) $-- $(400,000) $(5,230,000)
F-13
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Deferred income taxes are comprised of the following:
[Download Table]
JANUARY 31, 1998 MAY 31, 1997
------------------- -------------------
CURRENT NON-CURRENT CURRENT NON-CURRENT
------- ----------- ------- -----------
Deferred tax assets:
Fixed assets.......................... -- -- -- --
Inventory reserve..................... -- -- -- --
Uniform capitalization................ -- -- -- --
Bad debt reserve...................... -- -- -- --
Accrued liabilities................... -- -- -- --
Tax effect of NOL carryovers.......... -- 9,110,000 -- 8,648,000
Other................................. -- 324,000 -- 218,000
Valuation allowance................... -- (1,858,000) -- (6,458,000)
---- ----------- ---- -----------
Total deferred tax assets......... $-- $ 7,576,000 $-- $ 2,408,000
==== =========== ==== ===========
[Download Table]
JUNE 1, 1996 JUNE 3, 1995
-------------------- -------------------------
CURRENT NON-CURRENT CURRENT NON-CURRENT
------- ------------ ----------- ------------
Deferred tax assets:
Fixed assets................ -- -- -- 442,000
Inventory reserve........... -- -- 2,583,000 --
Uniform capitalization...... -- -- 418,000 --
Bad debt reserve............ -- -- 436,000 --
Accrued liabilities......... -- -- 967,000 --
Tax effect of NOL
carryovers................. -- 10,624,000 -- 14,823,000
Other....................... -- 90,000 -- 232,000
Valuation allowance......... -- (10,714,000) (4,404,000) (15,497,000)
---- ------------ ----------- ------------
Total deferred tax
assets................. $-- $ -- $ -- $ --
==== ============ =========== ============
The Company's deferred tax asset is primarily related to net operating loss
carryforwards. The Company believes that it is more likely than not that the
majority of the deferred tax asset will be realized based upon the expected
future income from the Amended Target Agreement. Accordingly, with the
exception of the amount attributable to IRC Section 382 net operating losses
(as described below) which cannot be utilized until after the Target Agreement
expires, the valuation allowance has been reduced during the short period
ended January 31, 1998. The reduction in the valuation allowance relating to
pre-reorganization carryovers has been credited to additional paid-in-capital.
F-14
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A reconciliation of the actual income tax rates to the federal statutory
rate follows:
[Enlarge/Download Table]
PREDECESSOR
SUCCESSOR COMPANY COMPANY
----------------------------------------------- ------------
EIGHT MONTHS NINE MONTHS
ENDED YEAR ENDED YEAR ENDED THREE MONTHS ENDED
JANUARY 31, MAY 31, JUNE 1, ENDED FEBRUARY 25,
1998 1997 1996 JUNE 3, 1995 1995
------------ ---------- ---------- ------------ ------------
Tax (benefit) expense at
U.S. statutory rate.... 34.0% 34.0% (34.0)% (34.0)% 34.0%
Additional paid-in-
capital................ 35.2 25.2 -- -- --
Net gain from
extraordinary gain from
extinguishment of debt
not taxable............ -- -- -- -- (51.2)
Net operating loss for
which no tax benefit
was recognized......... -- -- 34.0 33.9 12.5
Writedown of net
deferred taxes......... -- -- -- (5.2) (21.0)
Utilization of net
operating loss
carryforward........... -- (33.6) -- -- --
Valuation Allowance..... (93.8) (41.0) -- -- --
Foreign taxes........... .6 .5 -- -- --
Nondeductible
reorganization costs... -- -- -- -- 4.7
State income tax benefit
net of federal income
tax.................... 4.8 .4 -- (3.1) --
Minority interest and
others................. 3.2 1.4 -- .4 --
----- ----- ----- ----- -----
Tax benefit............. (16.0)% (13.1)% -- (8.0)% (21.0)%
===== ===== ===== ===== =====
At January 31, 1998 the Company has federal and California tax net operating
loss carryovers ("NOL's"), generated subsequent to the Company's 1994
reorganization, of approximately $14,900,000 and $5,300,000, respectively,
which will begin to expire in 2010 and 2000, respectively. The Company
believes utilization of these losses is not subject to Internal Revenue Code
("IRC") Section 382 limitations.
As a result of the 1994 Plan discussed in Note 1, an ownership change
occurred and the annual utilization 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 against the valuation allowance.
7. OPERATIONAL RESTRUCTURING CHARGE
The operational restructuring charge of $3,165,000 which was taken in the
three months ended June 3, 1995, covers the costs and charges of exiting from
apparel and footwear manufacturing, importing and wholesaling businesses in
order to implement the Company's new licensing strategy. Historically, the
Company operated a wholesale licensing program; it licensed the Cherokee
trademark to unaffiliated manufacturers for the production and marketing of
apparel, footwear and accessories that the Company did not manufacture, import
or market. The Company's current operating strategy includes retail direct
licensing whereby the Company grants retailers the license to use the Cherokee
trademark on certain categories of merchandise, including those products that
the Company previously manufactured. Under its licensing operating strategy,
the Company was transformed into a significantly smaller, more focused
organization.
F-15
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company completed the transition out of the apparel and footwear
manufacturing and importing businesses in November 1995. The $3,165,000
restructuring charge includes $614,000 in severance payments, $2,027,000 in
writedowns of inventory to estimated realizable values, and $524,000 for
cancellation of inventory orders, prepaid expenses, deposits and others. The
Company's work force was reduced from approximately 165 on June 3, 1995 to
approximately 15 by November 1, 1995. As of June 3, 1995, approximately
$1,504,000 of the $3,165,000 was included in liability accounts and has since
been paid.
Revenues and gross profit for the Company's terminated businesses were
$84,077,000 and $12,772,000 in Fiscal 1995.
8. COMMITMENT AND CONTINGENCIES
LEASES
The Company leases real property in Dallas Texas under a lease agreement
expiring on February 28, 1998. The Company has no plans to renew the lease for
these premises. Monthly rent is $1,496 plus operating expenses. The Company
entered into a sublease agreement on August 30, 1995 with an unaffiliated
third party. The term of this sublease is from September 1, 1995 to February
28, 1998. Sublessee is to pay rent of $1,280 per month for the property.
From May 26, 1995 to October 31, 1997, the Company has rented approximately
1,500 square feet of office space from The Newstar Group d/b/a The Wilstar
Group ("Wilstar") and paid Wilstar $.75 per square foot or $1,125 per month.
In addition, the Company reimbursed Wilstar for one-half of certain costs
relating to this office space. Beginning November 1, 1997, the Company
increased its rental space to 3,685 square feet and currently pays Wilstar
$2,762 in rent per month. The Company believes that its rental of such space
from Wilstar is on terms no less favorable than could be obtained from an
unaffiliated third party. The rent and costs are prorated based upon square
footage used by Cherokee and Wilstar does not profit from this reimbursement.
Since May 4, 1996, the Company has rented 4,000 feet of Wilstar's warehouse
space at $.50 per square foot as storage space for its financial records. Both
rental agreements are on a month to month basis.
Total rent expense was $48,000, $60,000 and $198,000 for the eight months
ended January 31, 1998 and the years ended May 31, 1997 and June 1, 1996,
respectively.
9. NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting standards ("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 eight months ended January 31, 1998 and
the three years ended May 31, 1997, June 1, 1996 and June 3, 1995, the Company
had no other comprehensive income components as defined in SFAS No. 130.
In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information," which changes current practice and
established a new framework, referred to as the "management" approach, on
which to base segment reporting. The management approach requires that
management identify the "operating segments" based on the way that management
disaggregates the entity for internal operating decisions. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997 and
F-16
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
is not required for interim statements in the first year of adoption.
Management believes that the adoption of this new standard will not have any
material impact on the Company's financial position or results of operations.
Prior to implementing its strategy to change its business to that of a
licensor, the Company was primarily engaged in the manufacturing, importing
and the distribution of apparel and shoes; therefore, its business is within
one industry segment.
In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures About
Pensions and Other Post-retirement Benefits" which revises employers'
disclosures about pension and post-retirement benefit plans. This statement is
effective for fiscal years beginning after December 15, 1997. This statement
is not anticipated to have any effect on the Company.
10. EMPLOYMENT AND MANAGEMENT AGREEMENTS
On April 24, 1995, a group which included Mr. Margolis (a former Chairman
and Chief Executive Officer of the Company) acquired approximately 22.3% of
the Company's then outstanding Common Stock (the "Group"). The Group sought to
have Mr. Margolis installed as Chief Executive Officer of the Company and to
have Mr. Margolis appointed a director of the Company. On May 4, 1995, the
Company and Wilstar entered into a Management Agreement (the "Agreement")
pursuant to which Wilstar agreed to provide executive management services to
the Company by providing the services of Robert Margolis as Chief Executive
Officer. The Agreement originally provided it would terminate on May 31, 1998;
however, the Agreement provided an automatic extension for additional one-year
terms as long as the Company's pre-tax earnings are equal to at least 80% of
the pre-tax earnings contained in the budget submitted to and approved by the
Board of Directors for such fiscal year. During Fiscal 1996, Wilstar met the
80% pre-tax earning requirement; hence, the contract was extended for an
additional one year term. In addition, Wilstar received an option to purchase
7 1/2% of the Common Stock on a fully diluted basis (675,700 shares) at a
purchase price of $3.00 per share (the "Wilstar Options"). The Wilstar options
were exercised on December 29, 1997. Subsequent to the exercise date and
pursuant to a redemption agreement entered into by all its principals, Wilstar
transferred to each principal individually his pro-rata share of the Common
Stock as consideration for redeeming his Wilstar shares.
On April 24, 1996, the Board of Directors revised the Agreement to
accelerate the vesting of Wilstar's performance options so that Wilstar was
immediately vested in its right to purchase up to 20% of the Company's fully
diluted Common Stock. Wilstar agreed to relinquish its rights to purchase up
to an additional 2.5% of the Company's fully diluted stock pursuant to the
performance options. Wilstar exercised the performance options in full on
April 25, 1996 and purchased 1,674,739 shares. The Company accounted for this
transaction as a non cash charge to earnings of $4,567,000. During Fiscal
1997, Wilstar transferred to its principals an aggregate of 874,739 shares of
the Common Stock in satisfaction of principal and interest due on
indebtedness, bonuses and Subchapter S distributions owed to its principals
and shareholders. During Fiscal 1998, Wilstar transferred 17,500 shares of the
Common Stock to certain employees and 384,386 shares of the Common Stock to
its principals, whereby, pursuant to a redemption agreement, each principal
received his pro-rata share individually as consideration for redeeming his
Wilstar shares.
The Agreement further provides that Wilstar and the Group each have the
right to elect two members of the Company's Board of Directors.
Effective for services rendered on or after June 1, 1997, the Compensation
Committee and the Board of Directors amended the Agreement by the adoption of
two amendments, designated, respectively, the Second Amendment and the Third
Amendment. The changes to the Agreement made by the Second Amendment include
(i) extension of the specified term of the Agreement to May 31, 2000; (ii)
modification of the existing provision of the Agreement for automatic
extension of its term for an additional year for each year after fiscal year
1997 in
F-17
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
which the Company achieves specified levels of pre-tax earnings; (iii)
increase in the annual base compensation of Wilstar from $400,000 to $550,000;
(iv) provision for an annual cost-of-living increase in base compensation
after fiscal year 1998; and (v) increase in the annual performance bonus
percentage payable to Wilstar based on the Company's earnings before interest,
taxes, depreciation and amortization above specified levels from 10% to 15% of
such earnings in excess of $10,000,000. At January 31, 1998 and May 31, 1997,
the Company had accrued the bonus payable under Other Accrued Liabilities.
The Third Amendment, approved by a majority of shareholders on September 15,
1997 at the 1997 Annual Meeting, further provided changes to the Agreement
including, (i) provision for payment of an "acquisition bonus" to Wilstar in
the event of an acquisition of the Company for a price per share of not less
than $12 pursuant to an acquisition agreement entered into by the end of
fiscal year 2000 (the amount of such acquisition bonus ranges from $1,000,000
to $2,500,000 in the event of an acquisition of the Company for a price per
share ranging from $12 to $15 or more and automatically decreases by one-third
per year if the acquisition agreement is not entered into by the end of May
31, 1998, 1999, or 2000); and (ii) provision for payment of $3,000,000 to
Wilstar in consideration for an agreement not to compete with the Company for
a specified period of time by Wilstar and Mr. Margolis in the event of an
acquisition of the Company pursuant to an acquisition agreement entered into
by the end of May 31, 2000 (the amount of such payment automatically decreases
by one-third per year if the acquisition agreement is not entered into by the
end of May 31, 1998, 1999, or 2000); and (iii) provision for reduction of
payments under the Agreement that are contingent on a change in control if it
is determined that such payments would result in the nondeductibility of some
or all of such payments under the provisions of Section 280G of the Internal
Revenue Code.
During the eight months ended January 31, 1998 and the year ended May
31,1997, the Company made compensation payments in lieu of cash dividends to
Wilstar totalling $135,134 and $375,100, respectively.
Mr. Margolis was employed pursuant to an employment agreement which would
have expired on May 31, 1994. Under such agreement, Mr. Margolis would have
received an annual salary of $780,550 during Fiscal 1994; Mr. Margolis was
actually paid $345,140 in salary prior to his resignation. Mr. Margolis
resigned all of his positions with the Company on October 31, 1993 and entered
into a consulting agreement with the Company pursuant to which he agreed to
make himself available as a consultant to the Company for a period of one year
for a fee of $1,130,000 of which $880,000 was paid during Fiscal 1994.
The $250,000 which was owed to Mr. Margolis became an unsecured creditor's
claim in the Company's 1994 Plan; Mr. Margolis received the same treatment as
all other unsecured creditors and received 15,259 shares of the Company's
Common Stock in full satisfaction of such claim.
Mr. Seyhun, the former Chief Operating Officer and the former Chief
Financial Officer of the Company, was employed pursuant to a 28 month
agreement expiring May 31, 1997. In connection with the agreement on February
1, 1995, Mr. Seyhun purchased 96,000 shares of Common Stock from the Company
at a price of $2.00 per share. Mr. Seyhun paid for these shares with a
$192,000, 7% Promissory Note for which $48,000 was paid in May 1996. Proceeds
from the sale of such stock must be applied first to accrued and unpaid
interest and then to unpaid principal. The note was recorded as a reduction to
stockholders equity. Mr. Seyhun repaid the note in full on February 19, 1997.
Mr. Seyhun also received an option to purchase 96,000 shares for a price of
$2.00 per share which was cancelled upon termination of his employment
agreement. Mr. Seyhun terminated his employment on January 5, 1996. Mr. Seyhun
paid the remaining principal and interest on the Promissory Note on February
19, 1997.
Ms. Warren, the former President of the Company, who resigned March 3, 1998,
was employed pursuant to a three-year agreement expiring on May 30, 1998 which
provided for a salary at an annual rate of $100,000 from June 21, 1995 to May
31, 1996 and $325,000 from June 1, 1996 to May 31, 1998. Ms. Warren will
continue
F-18
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
to work with the Company on selected special projects through November 1998
and will be paid through December 4, 1998. Ms. Warren could earn bonuses
ranging from 10% of her salary up to $175,000 based upon the Company's
earnings before interest and taxes.
11. RELATED PARTY TRANSACTIONS
On December 23, 1997 the Company loaned $2.0 million to Robert Margolis, who
is a Director, the Chairman of the Board of Directors and the Chief Executive
Officer of the Company. The loan was approved by a majority of the
disinterested members of the Company's Board of Directors on December 19,
1997. Mr. Margolis executed a note, dated December 23, 1997, in favor of the
Company for $2.0 million which yields 6.0% interest per annum, which has been
recorded as a reduction to stockholders' equity on the January 31, 1998
Balance Sheet. The principal amount of the note and all accrued interest
thereon is due and payable on December 23, 2002. The note may be repaid in
whole or in part at any time without penalty.
In connection with the Securitization and issuance of the Secured Notes, the
Company paid to Libra Investments, Inc. ("Libra") fees totaling $1,432,000.
Mr. Jess Ravich, the Chairman of Libra, is a member of the Board of Directors
of the Company.
In fiscal years ended May 31, 1997 and June 1, 1996, Wilstar purchased
apparel and trim from the Company totalling $87,000 and $154,000,
respectively.
12. WARRANTS AND OPTIONS
On February 1, 1995, the Company granted warrants to purchase 5,000 shares
of Common Stock at an exercise price of $2.43 to each of the Company's five
outside directors of the Board. On July 25, 1995, the Company granted warrants
to purchase 5,000 shares of Common Stock at an exercise price of $3.00 to any
new outside directors of the Board. The warrants expire on January 31, 2000
and June 30, 2000, respectively. On April 25, 1996 two Board members exercised
their warrants in full and each purchased 5,000 shares. On various dates
during Fiscal 1997, five Board members exercised their warrants in full and
each purchased 5,000 shares. During Fiscal 1998, two Board members exercised
their warrants in full and each purchased 5,000 shares.
On October 14, 1996, the Company granted options to purchase 10,000 shares
of Common Stock at an exercise price of $5.50 to each of the Company's seven
directors of the Board.
On various dates during Fiscal 1997, five Board members exercised their
options in full and each purchased 10,000 shares. During Fiscal 1998, two
Board members exercised their options in full and each purchased 10,000
shares.
On September 15, 1997, the Company granted options to purchase 5,000 shares
of Common stock at an exercise price of $11.25 to each of the Company's six
directors of the Board. The Company granted options to purchase 20,000 shares
of Common Stock at an exercise price of $11.25 to one retiring director. The
option plan provided an adjustment to the exercise price, in the event the
Company distributed to all shareholders an extraordinary dividend. The option
grants were adjusted from 5,000 and 20,000 shares to 8,277 and 33,109 shares,
respectively, and the exercise price was adjusted from $11.25 to $6.80 per
share in accordance with Internal Revenue Code Section 425. The adjustment did
not result in a compensation charge to earnings. None of the directors
exercised any of these options during Fiscal 1998.
F-19
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. 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.
Any employee is eligible to receive an Option under the Plan; provided,
however that no person who owns stock possessing more than 10% of the total
combined voting power of all classes of stock of the Company shall be eligible
to receive an Incentive Stock Option unless at the time such Option is granted
the Option price is at least 110% of the fair market value of the shares
subject to the Option.
The aggregate number of shares which may be issued upon the exercise of
Options granted under the Plan shall not exceed 600,000 shares of Common
Stock. The Options are vested in equal installments over a three year period,
starting from the date of grant and have a term of ten years.
On November 10, 1997, the Compensation Committee determined to grant Options
to certain of its employees pursuant to the Company's Plan. The Board of
Directors adopted an amendment to the Plan, pursuant to which any Option
granted shall provide that upon the Company's payment of an extraordinary cash
dividend to the Company's shareholders, the exercise price of each of the
Options shall be adjusted in accordance with Section 7.13 of the Plan.
Pursuant to the Company's declaration of the $5.50 dividend, on December 29,
1997 and January 2, 1998, certain directors, officers, employees and related
parties exercised options and purchased 819,004 shares of Cherokee common
stock.
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under SFAS
123, "Accounting for Stock-Based Compensation," requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, when the exercise price of the Company's employee stock
options equals the market price of the underlying stock on the date of grant,
no compensation expense is recognized.
During the fiscal year ended May 31, 1997, the Board of Directors adopted a
plan for compensation of officers of the Company, employees of the Company,
and Wilstar in lieu of cash dividends. If and when cash dividends are paid on
outstanding shares of common stock of the Company, compensation will be paid
to each plan participant in an amount equal to the cash dividends which would
have been paid on the vested option shares covered by stock options of the
Company held by such participant as if such shares had been purchased by such
participant prior to, and were outstanding and owned by such participant on,
the record date and the payment date for such cash dividend. The plan began on
January 15, 1997 and will terminate on December 31, 1998 or such earlier or
later date as may be determined by the Board of Directors. During the eight
months ended January 31, 1998 and the year ended May 31, 1997, an aggregate of
$150,801 and $391,850, respectively, was paid to participants in the plan.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of SFAS 123. The
fair value for these options was estimated at the date of grant using a Black-
Scholes option pricing model with the following weighted-average assumptions
for 1996 and 1997: weighted-average risk-free interest
F-20
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
rate range between 5.27% and 6.57%; dividend yields of 12.80%; weighted-
average volatility factors of the expected market price of the Company's
common stock of 99.24%; and a weighted average expected life of the option of
three years. For 1998, the weighted average assumptions were as follows:
weighted-average risk-free interest rate range between 5.80% and 6.35%;
dividend yields of 7.50%; weighted-average volatility factors of the expected
market price of the Company's common stock of 68.97%; and a weighted-average
expected life of the option of three years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimates, in the
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:
[Download Table]
1998 1997 1996
---------- ---------- -----------
Pro Forma net income (loss)................. $5,179,000 $6,546,000 $(1,502,000)
Pro Forma basic earnings (loss) per share... $ 0.66 $ 0.85 $ (0.23)
Pro Forma diluted earnings (loss) per share. $ 0.62 $ 0.80 $ (0.22)
A summary of the Company's stock option activity, and related information
for the eight months ended January 31, 1998 and the years ended May 31, 1997
and June 1, 1996 follows:
[Enlarge/Download Table]
1998 1997 1996
------------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
------- -------------- ------- -------------- ------- --------------
Outstanding at beginning
of year................ 180,000 $3.91 180,000 $3.29 -- $.00
Granted............... 480,083(1) 9.46(1)(2) 35,000 6.25(1) 210,000 3.27(1)
Exercised............. 180,000 3.91 (20,000) 3.03 (10,000) 3.00
Forfeited............. -- -- (15,000) 3.13 (20,000) 3.00
------- ----- ------- ----- ------- ----
Outstanding at end of
year................... 480,083 9.46 180,000 3.91 180,000 3.29
======= ===== ======= ===== ======= ====
Exerciseable at end of
year................... 78,635 9.46 45,003 3.35 -- --
--------
(1) Weighted average grant date fair value of options granted during the year
(2) The Options have exercise prices and become exercisable in four
installments upon the following dates, subject to the optionee's continued
employment by the Company on each vesting date installments: (i) 25% of
the number of shares vest immediately with an adjusted exercise price of
$8.15, (ii) 25% of the number of shares vest November 10, 1998 with an
adjusted exercise price of $8.97, (iii) 25% of the number of shares vest
November 10, 1999 with an adjusted exercise price of $9.86 and (iv) 25% of
the number of shares vest November 10, 2000 with an adjusted exercise
price of $10.85. As a result of the Company's payment of an extraordinary
cash dividend to the Company's shareholders, the exercise price of each of
the Options has been adjusted in accordance with Section 7.13 of the Plan.
F-21
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
14. SALE OF UNIFORM DIVISION
On July 28, 1995, the Company sold the Uniform Division to Strategic
Partners, Inc. ("Strategic Partners"), a corporation which was formed by
Michael Singer and investors unaffiliated with Cherokee. Mr. Singer was the
President of Cherokee's Uniform Division until the sale of the Uniform
Division and is the President and Chief Executive Officer of Strategic
Partners. The assets sold included accounts receivable, inventory, furniture
and fixtures, equipment, and the exclusive right to use the Cherokee trademark
with respect to the manufacture and sale of uniforms. The sales price was
approximately $11,700,000, which was $4,000,000 greater than the book value of
the assets that were sold. Of the purchase price, approximately $9,575,000 was
paid in cash and $2,125,000 was paid by a 10% subordinated promissory note
("Note").
The Company has recorded the Note at its estimated fair value of $1,588,000,
which represents a discount of $537,000, resulting in an effective interest
rate of 16%. The Note requires quarterly payments of interest and principal
payments of $300,000 on July 27, 1997, 1998, 1999 and 2000 with the remaining
principal amount due on July 27, 2001. On April 3, 1997, Strategic Partners
and the Company negotiated a 10% discount to pay off the $2,125,000 note due
2001. Strategic Partners delivered a payment of $1,912,500 on May 14, 1997 in
full satisfaction of the note.
15. SUBSEQUENT EVENT
On March 3, 1998, the Company announced the resignation of Patricia Warren
as President of the Company. She will continue to work with the Company
through 1998 in selected special projects. Mr. Margolis will assume Ms.
Warren's responsibilities until a new president is chosen.
On April 6, 1998, the Company announced that its Board of Directors had
declared a cash dividend of $0.50 per share to be distributed on May 1, 1998
to the Company's shareholders of record on the close of business on April 17,
1998. Assuming the Company's cash position continues to be favorable, the
Company intends to maintain a quarterly cash dividend of $0.25 per share for
the balance of the fiscal year ending January 30, 1999; however, the
declaration of such dividends remains subject to the discretion of the
Company's Board.
F-22
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CHEROKEE INC.
SCHEDULE II VALUATIONS AND QUALIFYING ACCOUNTS AND RESERVES
[Enlarge/Download Table]
CHARGED/
BALANCE AT (CREDITED) TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
----------- ----------- ------------- ----------- ---------- -----------
DEDUCTED FROM ASSETS TO
WHICH THEY APPLY:
ALLOWANCE FOR DOUBTFUL
ACCOUNTS
Year ended Jan 31,
1998................. $ -- $ -- $ -- $ -- $ --
Year ended May 31,
1997................. $ 591,000 $ (112,000) $ -- $ 479,000(1) $ --
Year ended June 1,
1996................. $ 1,006,000 $ 112,000 $ -- $ 527,000(1) $ 591,000
Year ended June 3,
1995................. $ 2,885,000 $1,602,000 $ -- $3,481,000(1) $ 1,006,000
INVENTORY RESERVE
Year ended Jan 31,
1998................. $ -- $ -- $ -- $ -- $ --
Year ended May 31,
1997................. $ -- $ -- $ -- $ -- $ --
Year ended June 1,
1996................. $ 6,011,000 $ -- $ -- $6,011,000 $ --
Year ended June 3,
1995................. $ 2,146,000 $3,865,000 $ -- $ -- $ 6,011,000
TAX VALUATION ALLOWANCE
Year ended Jan 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
Year ended June 1,
1996................. $19,901,000 $ -- $ 5,702,000 $3,485,000 $10,714,000
Year ended June 3,
1995................. $ -- $ -- $19,901,000 $ -- $19,901,000
--------
(1) Uncollectible accounts receivable written off against the allowance.
F-23
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. 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 Annual Meeting of Stockholders scheduled to be held on June 8, 1998,
which will be filed with the SEC no later than 120 days after the close of the
Eight Months Fiscal Period ended January 31, 1998. The following table sets
forth information with respect to each of the Company's executive officers.
[Enlarge/Download Table]
NAME, AGE AND PRINCIPAL OCCUPATION FOR PAST FIVE YEARS;
PRESENT POSITION WITH THE COMPANY BUSINESS EXPERIENCE
--------------------------------- -----------------------------------------
Robert Margolis, 50 Mr. Margolis was appointed Chairman of the Board
Director, Chairman of the Board of and Chief Executive Officer of the Company on
Directors and Chief Executive Officer 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. Since 1994 Mr.
Margolis has been Chief Executive Officer and a
Director of a privately owned company operates
various textiles and apparel related
enterprises, including a private label
manufacturing operation. Wilstar's private label
manufacturing operations were sold to an
unrelated party in April 1997. Wilstar provides
Mr. Margolis' services as Chief Executive
Officer of the Company pursuant to the terms of
a management agreement between the Company and
Wilstar (the "Wilstar Management Agreement").
Patricia Warren, 51 Ms. Warren has been employed by Cherokee since
President May 1995 and became its President on June 21,
1995. Ms. Warren resigned as President on March
3, 1998, but will continue to work with the
Company on selected projects through the end of
1998. From October 1989 to May 1993 she was
Senior Vice President and General Merchandise
Manager of The Bon Marche, a division of
Federated Department Stores. From May 1993 to
May 1994, she was Executive Vice President,
Merchandising for The Broadway Department
Stores. From September 1994 until May 1995, she
was an independent consultant to wholesalers and
retailers.
24
[Enlarge/Download Table]
NAME, AGE AND PRINCIPAL OCCUPATION FOR PAST FIVE YEARS;
PRESENT POSITION WITH THE COMPANY BUSINESS EXPERIENCE
--------------------------------- -----------------------------------------
Carol Gratzke, 49 Ms. Gratzke returned to Cherokee in November
Chief Financial Officer 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.
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
Annual Meeting of Stockholders scheduled to be held on June 8, 1998, which
will be filed with the SEC no later than 120 days after the close of the Eight
Month Fiscal Period ended January 31, 1998.
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
Annual Meeting of Stockholders scheduled to be held on June 8, 1998, which
will be filed with the SEC no later than 120 days after the close of the Eight
Month Fiscal Period ended January 31, 1998.
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
Annual Meeting of Stockholders scheduled to be held on June 8, 1998, which
will be filed with the SEC no later than 120 days after the close of the Eight
Month Fiscal Period ended January 31, 1998.
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.
25
[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 Financing Agreement dated as of December 23, 1994, between Cherokee
Inc. and The CIT Group/Business Credit, Inc. (incorporated by
reference from Exhibit 4.1 of Cherokee Inc.'s Form 10 dated April 24,
1995).
4.2 Amendment to Financing Agreement dated June 2, 1995 between Cherokee
Inc. and The CIT Group/Business Credit Inc. (incorporated by reference
from Exhibit 4.1 of Cherokee Inc.'s Form 10 dated April 24, 1995).
4.3 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.
4.4 Security Agreement dated December 23, 1997, between SPELL C. LLC and
Wilmington Trust Company.
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 Management Agreement dated as of May 4, 1995 between Cherokee Inc. and
The Newstar Group Inc., d/b/a The Wilstar Group ("Wilstar")
(incorporated by reference from Exhibit 10.5 of Cherokee Inc.'s Form
10-K dated June 3, 1995).
10.3 Option Agreement dated as of May 4, 1995 between Cherokee Inc. and
Wilstar (incorporated by reference from Exhibit 10.5 of Cherokee
Inc.'s Form 10-K dated June 3, 1995).
10.4 Registration Rights Agreement dated as of May 4, 1995 between Cherokee
Inc. and Wilstar (incorporated by reference from Exhibit 10.6 of
Cherokee Inc.'s Form 10-K dated June 3, 1995).
10.5 Amendment No. 1 to the Non-Qualified Stock Option Agreement dated
October 30, 1995. (incorporated herein by reference from Exhibit 10.7
of Cherokee Inc.'s Form 10-K dated June 1, 1996).
10.6 Amendment No. 2 to the Non-Qualified Stock Option Agreement dated
March 23, 1996. (incorporated herein by reference from Exhibit 10.7 of
Cherokee Inc.'s Form 10-K dated June 1, 1996).
10.7 Amendment No. 1 to the Revised and Restated Wilstar Management
Agreement dated April 26, 1996. (incorporated herein by reference from
Exhibit 10.7 of Cherokee Inc.'s Form 10-K dated June 1, 1996).
10.8 Asset Purchase Agreement dated July 17, 1995 between Cherokee Inc. and
Strategic Partners, Inc. (incorporated herein by reference from
Exhibit 2.1 to Cherokee Inc.'s Current Report on Form 8-K dated August
10, 1995).
10.9 Stock Purchase Agreement dated July 28, 1995 between Cherokee Inc. and
Axicom Capital Group (incorporated by reference from Exhibit 10.8 of
Cherokee Inc.'s Form 10-K dated June 3, 1995).
10.10 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).
26
[Download Table]
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
10.11 Amendment No. 2 to the Revised and Restated Wilstar Management
Agreement dated July 21, 1997 (incorporated by reference from Exhibit
10.11 of Cherokee Inc.'s Form 10-K dated May 31, 1997).
10.12 Amendment No. 3 to the Revised and Restated Wilstar Management
Agreement dated July 21, 1997 (incorporated by reference from Exhibit
10.12 of Cherokee Inc.'s Form 10-K dated May 31, 1997).
10.13 Plan for Compensation in Lieu of Cash Dividends, dated January 15,
1997 (incorporated by reference from Exhibit 10.13 of Cherokee Inc.'s
Form 10-K dated May 31, 1997).
10.14 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).
10.15 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).
10.16 Note Purchase Agreement dated December 23, 1997, between SPELL C. LLC
and the purchasers listed on the signature pages thereto.
10.17 Trademark Purchase and License Assignment Agreement dated December 23,
1997 between SPELL C. LLC and Cherokee Inc.
10.18 Administrative Services Agreement dated December 23, 1997, between
SPELL C. LLC and Cherokee Inc.
10.19 Limited Liability Company Agreement of SPELL C. LLC dated as of
December 23, 1997, between SPELL C. LLC and Cherokee Inc.
16.1 Letter of Ernst & Young L.L.P. regarding change in accountants
(incorporated herein by reference from Exhibit 16.1 to Cherokee Inc.'s
Current Report on Form 8-K dated June 5, 1995).
21.1 Subsidiaries of Cherokee Inc.
23.1 Consent of Independent Auditors dated April 20, 1998.
27.1 Article 5 of Regulation S-X--Financial Data Schedule
(b) Reports on Form 8-K.
On December 23, 1997, the Company filed a report on Form 8-K regarding (1)
the Board of Director's declaration of the January 15, 1998 cash dividend
of $5.50, (2) the completion of a leveraged recapitalization and (3) the
change in the Company's fiscal year end.
27
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.
/s/ Robert Margolis
By-----------------------------------
Robert Margolis
Chairman and Chief Executive
Officer
Date: April 20, 1998
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]
/s/ Robert Margolis Chairman and Chief Executive April 20, 1998
----------------------------- Officer and Director
Robert Margolis
/s/ Carol Gratzke Chief Financial Officer/Chief April 20, 1998
----------------------------- Accounting Officer
Carol Gratzke
/s/ Timothy Ewing Director April 20, 1998
-----------------------------
Timothy Ewing
/s/ Keith Hull Director April 20, 1998
-----------------------------
Keith Hull
/s/ Douglas Weitman Director April 20, 1998
-----------------------------
Douglas Weitman
/s/ Jess Ravich Director April 20, 1998
-----------------------------
Jess Ravich
/s/ Avi Dan Director April 20, 1998
-----------------------------
Avi Dan
28
Dates Referenced Herein and Documents Incorporated by Reference
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