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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x |
|
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended November 2, 2002.
¨ |
|
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the Transition Period From
to
.
Commission file number 0-18640
CHEROKEE INC.
(Exact name of registrant as specified in its charter)
| Delaware |
|
95-4182437 |
| (State or other jurisdiction of Incorporation or organization) |
|
(IRS employer identification number) |
| |
| 6835 Valjean Avenue, Van Nuys, CA |
|
91406 |
| (Address of principal executive offices) |
|
Zip Code |
(818) 908-9868
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
| Class
|
|
Outstanding at November 2, 2002
|
| Common Stock, $.02 par value per share |
|
8,282,264 |
INDEX
| |
|
|
| |
| ITEM 1. |
|
|
|
|
| |
| |
|
|
|
2 |
| |
| |
|
|
|
3 |
| |
| |
|
|
|
4 |
| |
| |
|
|
|
5 |
| |
| ITEM 2. |
|
|
|
9 |
| |
| ITEM 3. |
|
|
|
17 |
| |
| ITEM 4. |
|
|
|
18 |
| |
| |
|
|
| |
| ITEM 1. |
|
|
|
18 |
| |
| ITEM 2. |
|
|
|
19 |
| |
| ITEM 3. |
|
|
|
19 |
| |
| ITEM 4. |
|
|
|
20 |
| |
| ITEM 5. |
|
|
|
20 |
| |
| ITEM 6. |
|
|
|
20 |
1
Part 1. Financial Information
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CHEROKEE INC.
CONSOLIDATED BALANCE SHEETS
| |
|
November 2, 2002
|
|
February 2, 2002
|
|
| |
|
(unaudited) |
|
|
|
| Assets |
|
|
|
|
|
|
|
| Current assets: |
|
|
|
|
|
|
|
| Cash and cash equivalents |
|
$ |
7,243,000 |
|
$ |
4,394,000 |
|
| Restricted cash |
|
|
2,651,000 |
|
|
2,645,000 |
|
| Receivables |
|
|
7,517,000 |
|
|
6,232,000 |
|
| Prepaid expenses and other current assets |
|
|
94,000 |
|
|
62,000 |
|
| Deferred tax asset |
|
|
887,000 |
|
|
886,000 |
|
| |
|
|
|
|
|
|
|
| Total current assets |
|
|
18,392,000 |
|
|
14,219,000 |
|
| Deferred tax asset |
|
|
2,100,000 |
|
|
2,100,000 |
|
| Securitization fees, net of accumulated amortization of $994,000 and $840,000, respectively |
|
|
246,000 |
|
|
401,000 |
|
| Property and equipment, net of accumulated depreciation of $304,000 and $265,000, respectively |
|
|
125,000 |
|
|
156,000 |
|
| Trademarks, net of accumulated amortization of $1,930,000 and $1,433,000, respectively |
|
|
7,436,000 |
|
|
7,365,000 |
|
| Other assets |
|
|
15,000 |
|
|
15,000 |
|
| |
|
|
|
|
|
|
|
| Total assets |
|
$ |
28,314,000 |
|
$ |
24,256,000 |
|
| |
|
|
|
|
|
|
|
| |
| Liabilities and Stockholders’ Equity (Deficit) |
|
|
|
|
|
|
|
| Current liabilities: |
|
|
|
|
|
|
|
| Accounts payable |
|
$ |
308,000 |
|
$ |
400,000 |
|
| Income taxes payable |
|
|
32,000 |
|
|
22,000 |
|
| Other accrued liabilities |
|
|
3,016,000 |
|
|
3,584,000 |
|
| Notes payable |
|
|
10,500,000 |
|
|
10,500,000 |
|
| |
|
|
|
|
|
|
|
| Total current liabilities |
|
|
13,856,000 |
|
|
14,506,000 |
|
| Notes payable—long term |
|
|
4,521,000 |
|
|
11,510,000 |
|
| |
|
|
|
|
|
|
|
| Total liabilities |
|
|
18,377,000 |
|
|
26,016,000 |
|
| |
|
|
|
|
|
|
|
| |
| Commitments and Contingencies (note 4) |
|
|
|
|
|
|
|
| |
| Stockholders’ Equity (Deficit): |
|
|
|
|
|
|
|
| Common stock, $.02 par value, 20,000,000 shares authorized, 8,282,264 and 8,163,405 shares issued and outstanding at
November 2, 2002 and at February 2, 2002, respectively |
|
|
165,000 |
|
|
164,000 |
|
| Additional paid-in capital |
|
|
2,491,000 |
|
|
1,252,000 |
|
| Retained earnings/(deficit) |
|
|
7,281,000 |
|
|
(3,176,000 |
) |
| |
|
|
|
|
|
|
|
| Stockholders’ equity (deficit) |
|
|
9,937,000 |
|
|
(1,760,000 |
) |
| |
|
|
|
|
|
|
|
| Total liabilities and stockholders’ equity (deficit) |
|
$ |
28,314,000 |
|
$ |
24,256,000 |
|
| |
|
|
|
|
|
|
|
See the accompanying notes which are an integral part of these consolidated
financial statements.
2
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS Unaudited
| |
|
Three months ended
|
|
|
Nine months ended
|
|
| |
|
November 2, 2002
|
|
|
November 3, 2001
|
|
|
November 2, 2002
|
|
|
November 3, 2001
|
|
| Royalty revenues |
|
$ |
6,060,000 |
|
|
$ |
5,533,000 |
|
|
$ |
26,080,000 |
|
|
$ |
24,384,000 |
|
| Selling, general and administrative expenses |
|
|
2,388,000 |
|
|
|
2,087,000 |
|
|
|
7,882,000 |
|
|
|
7,049,000 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Operating income |
|
|
3,672,000 |
|
|
|
3,446,000 |
|
|
|
18,198,000 |
|
|
|
17,335,000 |
|
| Other income (expense) : |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Interest expense |
|
|
(231,000 |
) |
|
|
(416,000 |
) |
|
|
(886,000 |
) |
|
|
(1,378,000 |
) |
| Investment and interest income |
|
|
37,000 |
|
|
|
84,000 |
|
|
|
114,000 |
|
|
|
249,000 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total other expenses, net |
|
|
(194,000 |
) |
|
|
(332,000 |
) |
|
|
(772,000 |
) |
|
|
(1,129,000 |
) |
| Income before income taxes |
|
|
3,478,000 |
|
|
|
3,114,000 |
|
|
|
17,426,000 |
|
|
|
16,206,000 |
|
| Income tax provision |
|
|
1,391,000 |
|
|
|
1,248,000 |
|
|
|
6,970,000 |
|
|
|
6,490,000 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net income |
|
$ |
2,087,000 |
|
|
$ |
1,866,000 |
|
|
$ |
10,456,000 |
|
|
$ |
9,716,000 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Comprehensive Income |
|
$ |
2,087,000 |
|
|
$ |
1,866,000 |
|
|
$ |
10,456,000 |
|
|
$ |
9,716,000 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Basic earnings per share |
|
$ |
0.25 |
|
|
$ |
0.23 |
|
|
$ |
1.27 |
|
|
$ |
1.18 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Diluted earnings per share |
|
$ |
0.25 |
|
|
$ |
0.23 |
|
|
$ |
1.24 |
|
|
$ |
1.18 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Weighted average shares outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Basic |
|
|
8,283,418 |
|
|
|
8,178,655 |
|
|
|
8,222,470 |
|
|
|
8,211,244 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Diluted |
|
|
8,497,561 |
|
|
|
8,216,385 |
|
|
|
8,444,604 |
|
|
|
8,241,365 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See the accompanying notes which are an integral part of these consolidated
financial statements.
3
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS Unaudited
| |
|
Nine months ended
|
|
| |
|
November 2, 2002
|
|
|
November 3, 2001
|
|
| Operating activities |
|
|
|
|
|
|
|
|
| Net income |
|
$ |
10,456,000 |
|
|
$ |
9,716,000 |
|
| Adjustments to reconcile net income to net cash |
|
|
|
|
|
|
|
|
| provided by operating activities: |
|
|
|
|
|
|
|
|
| Depreciation and amortization |
|
|
39,000 |
|
|
|
47,000 |
|
| Amortization of trademarks |
|
|
497,000 |
|
|
|
389,000 |
|
| Amortization of securitization fees |
|
|
154,000 |
|
|
|
154,000 |
|
| Amortization of debt discount |
|
|
886,000 |
|
|
|
1,378,000 |
|
| Stock option tax benefit |
|
|
342,000 |
|
|
|
— |
|
| Changes in current assets and liabilities: |
|
|
|
|
|
|
|
|
| (Increase) decrease in accounts receivable |
|
|
(1,285,000 |
) |
|
|
716,000 |
|
| Increase in prepaid expenses and other current assets |
|
|
(32,000 |
) |
|
|
(39,000 |
) |
| (Decrease) increase in accounts payable, income taxes payable and accrued liabilities |
|
|
(650,000 |
) |
|
|
139,000 |
|
| |
|
|
|
|
|
|
|
|
| Net cash provided by operating activities |
|
|
10,407,000 |
|
|
|
12,500,000 |
|
| |
|
|
|
|
|
|
|
|
| Investing activities |
|
|
|
|
|
|
|
|
| Purchase of property and equipment |
|
|
(8,000 |
) |
|
|
— |
|
| Purchase of trademarks |
|
|
(569,000 |
) |
|
|
(1,255,000 |
) |
| |
|
|
|
|
|
|
|
|
| Net cash used in investing activities |
|
|
(577,000 |
) |
|
|
(1,255,000 |
) |
| |
|
|
|
|
|
|
|
|
| Financing activities |
|
|
|
|
|
|
|
|
| (Increase) decrease in restricted cash |
|
|
(6,000 |
) |
|
|
63,000 |
|
| Proceeds from exercise of stock options |
|
|
1,028,000 |
|
|
|
— |
|
| Repurchase of common stock |
|
|
(128,000 |
) |
|
|
(608,000 |
) |
| Payment on notes |
|
|
(7,875,000 |
) |
|
|
(7,875,000 |
) |
| |
|
|
|
|
|
|
|
|
| Net cash used in financing activities |
|
|
(6,981,000 |
) |
|
|
(8,420,000 |
) |
| |
|
|
|
|
|
|
|
|
| Increase in cash and cash equivalents |
|
|
2,849,000 |
|
|
|
2,825,000 |
|
| Cash and cash equivalents at beginning of period |
|
|
4,394,000 |
|
|
|
2,598,000 |
|
| |
|
|
|
|
|
|
|
|
| Cash and cash equivalents at end of period |
|
$ |
7,243,000 |
|
|
$ |
5,423,000 |
|
| |
|
|
|
|
|
|
|
|
See the accompanying notes which are an integral
part of these consolidated financial statements.
4
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) |
|
Basis of Presentation |
The accompanying consolidated financial statements as of November 2, 2002 and for the three and nine month periods ended November 2, 2002 and November 3, 2001 have been prepared in accordance with U.S. generally accepted accounting
principles (“GAAP”). These consolidated financial statements have not been audited by independent accountants but include all adjustments, consisting of normal recurring accruals, which in the opinion of management of Cherokee Inc. (which
may be referred to as Cherokee, we, us, or our) are necessary for a fair statement of the financial position and the results of operations for the periods presented. Certain previously reported amounts have been reclassified to conform to current
year presentation. The accompanying consolidated balance sheet as of February 2, 2002 has been derived from audited consolidated financial statements, but does not include all disclosures required by GAAP. The results of operations for the three and
nine month periods ended November 2, 2002 are not necessarily indicative of the results to be expected for the fiscal year ended February 1, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included
in Cherokee’s annual report on Form 10-K for the fiscal year ended February 2, 2002.
The preparation of
financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates.
(2) |
|
Summary of Significant Accounting Policies |
Principles of Consolidation
The consolidated financial
statements include the accounts of Cherokee and its wholly owned subsidiary, SPELL C. LLC, a Delaware limited liability corporation (“Spell C”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Revenue Recognition
Revenues from royalty and finders agreements are recognized when earned by applying contractual royalty rates to quarterly point of sale data received from our licensees.
Revenues are not recognized unless collectibility is reasonably assured.
Earnings Per Share Computation
The following table provides a reconciliation of the numerator and denominator of the basic and diluted
per-share computations for the three and nine month periods ended November 2, 2002 and November 3, 2001:
5
| |
|
2002
|
|
2001
|
| |
|
3 Months
|
|
9 Months
|
|
3 Months
|
|
9 Months
|
| Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
| Net income-numerator for net income per common share and net income per common share assuming dilution
|
|
$ |
2,086,000 |
|
$ |
10,456,000 |
|
$ |
1,866,000 |
|
$ |
9,716,000 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
| Denominator for net income Per common share-weighted average shares |
|
|
8,283,418 |
|
|
8,222,470 |
|
|
8,178,655 |
|
|
8,211,244 |
| |
| Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
| Stock options |
|
|
214,143 |
|
|
222,134 |
|
|
37,730 |
|
|
30,121 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Denominator for net income per common share, assuming dilution: Adjusted weighted average shares and assumed
exercises |
|
|
8,497,561 |
|
|
8,444,604 |
|
|
8,216,385 |
|
|
8,241,365 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
Common shares issuable upon exercise of stock options that are
anti-dilutive amounted to 30,464 and 341,735, respectively, for the nine month periods ended November 2, 2002 and November 3, 2001.
Significant Contracts
In 1997, we entered into an agreement with Target Stores that grants
Target Stores the exclusive right in the United States to use the Cherokee trademarks in certain categories of merchandise. Under the Target Stores agreement, Target Stores will pay a royalty each fiscal year, up to and including the fiscal year
ending January 31, 2004, based on percentages, specified in the agreement, of Target Stores’ net sales of Cherokee branded merchandise during each fiscal year, which percentages vary based on the volume of sales of merchandise. In any event,
Target Stores has agreed to pay a minimum guaranteed royalty of $9.0 million for each of the two fiscal years ended January 31, 1999 and 2000 and $10.5 million for each of the four fiscal years ending January 31, 2001 through 2004. The agreement
will automatically renew for successive one-year periods, providing Target Stores is current in its minimum guaranteed payments, unless Target Stores provides one-year notice to terminate the agreement
In 2001, Mervyn’s renewed its licensing agreement for certain merchandise categories of the Sideout brand for an additional three
years on the same terms and conditions as the existing license agreement. The renewal term commenced on February 1, 2002 and continues through January 31, 2005. Under the Mervyn’s agreement, Mervyn’s will pay a royalty each fiscal year
based on a percentage of Mervyn’s net sales of Sideout branded merchandise during each fiscal year, subject to a guaranteed minimum royalty.
6
On August 22, 1997, we entered into an international retail direct licensing
agreement with Zellers Inc., a Canadian corporation, which is a division of Hudson’s Bay Company. Zellers was granted the exclusive right in Canada to use the Cherokee brand and related trademarks in certain categories of merchandise. The term
of the agreement is for five years, with automatic renewal options, provided that specified minimums are met each contract year. Under the agreement, Zellers agreed to pay us a minimum guaranteed royalty of $10.0 million over the five-year initial
term of the agreement. During Fiscal 2002, Zellers exercised its right to renew its licensing agreement for the Cherokee brand for an additional term of five years on the same terms and conditions. Under the terms of the renewal agreement, Zeller
agreed to pay us a minimum guaranteed royalty of $15.6 million over the five-year term on the same conditions. The renewal term will commence on February 1, 2003 and continue through January 31, 2008.
Trademarks
During the three months ended November 2, 2002 (the “Third Quarter”), the nine months ended November 2, 2002 (the “Nine Months”) and the three and nine months ended November 3, 2001, Cherokee did not purchase
trademarks, other than the contingent purchase payments made to Sideout Inc., under the terms of the Sideout Agreement. We capitalized $79,000 and $287,000, respectively, in Sideout contingent payments for the Third Quarter and Nine Months in
comparison to $375,000 and $1.0 million, respectively, for the three and nine months ended November 3, 2001. Trademark registration and renewal fees capitalized for the Third Quarter and Nine Months totaled $111,000 and $282,000, respectively, in
comparison to $117,000 and $225,000, respectively, for the three and nine months ended November 3, 2001.
Long term debt is comprised of Zero-Coupon Secured Notes (“Secured Notes”) yielding 7% interest per annum and maturing on February 20, 2004. The Secured Notes amortize quarterly from May 20, 1998 through February 20, 2004.
The following table summarizes the maturity of the long-term debt:
| For the year ending:
|
|
Face Value
|
| November 2, 2003 |
|
$ |
10,500,000 |
| November 2, 2004 |
|
|
5,250,000 |
| Total |
|
|
15,750,000 |
| Less unamortized note discount |
|
|
729,000 |
| |
|
|
|
| |
|
|
15,021,000 |
| Less current portion of long term debt |
|
|
10,500,000 |
| |
|
|
|
| Long term obligation |
|
$ |
4,521,000 |
| |
|
|
|
7
(4) |
|
Commitments and Contingencies |
Legal Proceedings
Effective March 27, 2000, Cherokee entered into a Finder’s
Agreement with Mossimo, Inc. (“Mossimo”) to reflect sums due Cherokee for introducing Mossimo and Target Corporation (“Target”). As a direct result of Cherokee’s actions, Mossimo entered into a licensing agreement with
Target, which has generated significant revenues for Mossimo.
Since 2000, Mossimo has paid Cherokee 15% of all
the revenues paid by Target to Mossimo under its licensing agreement with Target. However, on May 2, 2002, Mossimo asserted a claim for arbitration against Cherokee contending that “Mossimo, Inc. is entitled to a refund of the finder’s
fees which have already been paid to Cherokee, to the extent they are attributable to design services or the personal services and commitments of Mossimo Giannulli, rather than to the trademark license.” This assertion was made by Mossimo even
though the design or personal services are required to be performed under its license agreement with Target. Mossimo also sought “a declaration as to the portion of any subsequent or future payments by Target which will be subject to the 15%
finder’s fee.”
Upon being informed by a representative of Mossimo that first quarter fees earned by
Cherokee under the Finder’s Agreement would not be paid pending the outcome of an arbitration case, Cherokee demanded arbitration against Mossimo for breach of the Finder’s Agreement on the grounds of Mossimo’s refusal to pay sums
clearly due and owing under the Finder’s Agreement.
Mossimo amended its license agreement with Target to
reflect that 45% of the revenues received by Mossimo from Target are in connection with design services. It was Cherokee’s position that this amendment had no bearing on the 15% owed to Cherokee because the Finder’s Agreement provides that
“Mossimo shall not enter into any agreement with Target pursuant to which Mossimo will receive any consideration that is not included within Net Revenues.” We believed Mossimo’s position was meritless, and vigorously defended the
claim.
An arbitration was heard between the parties in mid-October. An arbitration panel ruled in favor of
Cherokee on November 11, 2002, issuing an interim arbitration award directing Mossimo to pay all monies owed Cherokee plus interest on any of the monies withheld, along with legal fees. The arbitrators also reaffirmed the Finder’s Agreement.
Cherokee is moving to confirm the arbitration ruling, however we do not know whether or not Mossimo plans to further contest this award, and they have publicly stated that they are evaluating their options. Cherokee understands that Mossimo has set
aside the finder’s fees due to Cherokee in a separate cash account pending a final judgment.
For the Third
Quarter and Nine Months, we recognized revenues from Mossimo of $431,000 and $2.4 million, respectively, in comparison to $420,000 and $1.8 million, respectively, for the three and nine months ended November 3, 2001. We have made no provision for
reserves against the revenues accrued for Mossimo for the Third Quarter and Nine Months. We have made no provision for receivables from Mossimo.
8
| ITEM 2. |
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
Cherokee Inc. (which may be referred to as Cherokee, we, us, or our) is in the business of marketing and licensing the Cherokee and
Sideout brands and related trademarks and other brands it owns or represents. We are one of the leading licensors of brand names and trademarks for apparel, footwear and accessories in the United States. We and our wholly-owned subsidiary, SPELL C.
LLC (“Spell C”), hold several trademarks including Cherokee™, Sideout™, Sideout Sport™, King of the Beach™ and others. The
Cherokee brand 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 an active lifestyle, were acquired by us in
November 1997.
Our operating strategy emphasizes domestic and international, retail direct and wholesale
licensing whereby we grant retailers and wholesalers the license to use the trademarks held by us on certain categories of merchandise, and the licensees are responsible for designing and manufacturing the merchandise. We provide design direction
and collaborate with our retailers on pre-approved packaging, graphics and quality control standards. The retailer is responsible for manufacturing the merchandise. Our retail, wholesale and international license agreements generally provide us with
final approval of pre-agreed upon quality standards, packaging and marketing of licensed products and also grant us the right to conduct periodic quality control inspections to ensure that the image and quality of licensed products remain
consistent. As of November 2, 2002, we had 10 continuing license agreements for our various trademarks, covering both domestic and international markets. Recently, agreements which were to terminate by year end were terminated early with Dong Kwang
for Cherokee in Korea and Matienzo for Sideout in Mexico. We incurred no costs in connection with these terminations. Chori for Sideout in Japan expired and was not renewed. We will continue to solicit new licensees and may, from time to time,
retain the services of outside consultants to assist us in this regard.
In November 1997, we reaffirmed our
relationship with Target Stores, a division of Target Corporation, by entering into an amended licensing agreement (the “Amended Target Agreement”) which grants Target Stores the exclusive right in the United States to use the Cherokee
trademarks on certain specified categories of merchandise. Under the Amended Target Agreement, Target Stores 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 Nine-year initial term of the agreement.
During the three months ended November 2, 2002
(the “Third Quarter”) and nine months ended November 2, 2002 (the “Nine Months”), sales of Cherokee branded products by Target Stores approached $443 million and $1.4 billion, respectively, compared to $430 million and $1.3
billion, respectively, for the three and nine months ended November 3, 2001. Target Stores pays royalty revenues to us based on a percentage of its sales of Cherokee branded products. As explained below, the Amended Target Agreement, like several of
our license agreements, is structured to provide royalty rate reductions for Target Stores after it has achieved certain levels of retail sales of Cherokee branded products during each fiscal year. The increase in sales of
9
Cherokee branded merchandise caused Target Stores to reach the maximum royalty rate reduction earlier in this fiscal quarter, but the lower
royalty rate was offset by increased sales of Cherokee branded merchandise.
The initial term of the Amended
Target Agreement commenced on February 1, 1998 and ends January 31, 2004. If Target Stores 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 Stores has paid a minimum guaranteed royalty equal to or greater than $9.0 million for the preceding fiscal year. Target Stores may terminate the Amended
Target Agreement effective January 31, 2004, if it gives us written notice of its intent to do so during February 2003, and may terminate at the end of any fiscal year thereafter, if it gives us written notice of its intent to do so during February
of the calendar year prior to termination. If Target Stores elects not to extend or renew the Amended Target Agreement beyond the expiration of its initial term on January 31, 2004, it would have a material adverse effect on our business, financial
condition, results of operations and liquidity. There can be no guarantee that we would be able to replace lost royalty payments from Target Stores from other sources. See “Item 1. Risk Factors” in our Form 10-K for the fiscal year ended
February 2, 2002.
During the Third Quarter, sales of merchandise bearing the Cherokee brand continued to increase
with total retail sales approaching $525 million compared to $472 million in total retail sales for the three months ended November 3, 2001. Sales at Tesco, which launched its Cherokee program in August 2002, reached $43 million for the quarter,
while sales at Carrefour, which launched earlier this year in Spain, Portugal and Greece, were $11.5 million. Zellers Inc.’s sales of merchandise bearing the Cherokee brand were $34.5 million during the Third Quarter compared to $38.9 million
for the three months ended November 3, 2001.
During the Third Quarter and Nine Months, sales of Mervyn’s
young men’s, junior’s and children’s apparel and accessories bearing the Sideout brand were approximately $29.9 million and $86.5 million, respectively, in comparison to $28.7 million and $73.8 million, respectively, for the three and
nine months ended November 3, 2001. The increase in sales is due mainly to the expansion of product categories bearing the Sideout brand.
As an incentive for our licensees to achieve higher retail sales of Cherokee or Sideout branded products, many of our existing license agreements, including the Amended Target Agreement, are structured to provide royalty
rate reductions for the licensees after they achieve certain levels of retail sales of Cherokee or Sideout branded products during each fiscal year. As a result, our royalty revenues as a percentage of certain licensees’ retail sales of branded
products are highest at the beginning of each fiscal year and decrease throughout each fiscal year as licensees reach certain retail sales thresholds contained in their respective license agreements. Therefore, the amount of royalty revenue received
by us in any quarter is dependent not only on retail sales of branded products in such quarter, but also on the level of retail sales, and the resulting attainment of royalty rate reductions in any preceding quarters in the same fiscal year. The
size of the royalty rate reductions and the level of retail sales at which they are achieved varies in each licensing agreement. During the Third Quarter, increased retail sales by Target Stores resulted in another royalty rate reduction earlier in
this fiscal quarter than in the third quarter of the previous year.
We are frequently approached by parties, or
we approach parties, seeking to sell their brands and related trademarks. Should an established and marketable brand become available on
10
favorable terms, we would be interested in pursuing such an acquisition. In addition to acquiring and
licensing our own brands, we assist other companies in identifying licensees for their brands. Generally, as an exclusive consultant, we will perform a range of services including marketing of brands, solicitation of licensees, contract negotiations
and administration and maintenance of license or distribution agreements. In return for our services we will normally receive a certain percentage of net royalties generated by the brands we represent and/or manage.
During the fiscal year ended February 3, 2001, we assisted Mossimo Inc. in locating Target Stores as a licensee of the Mossimo brand and
entered into a finder’s agreement with Mossimo, which provides that we will receive 15% of the royalties paid to Mossimo by Target Stores. Under Mossimo’s agreement with Target Stores, Target Stores is obligated to pay Mossimo a royalty
based on a percentage of net sales of Mossimo branded products, with a minimum guaranteed royalty, beginning in 2001, of approximately $27.8 million over the initial three year term of the agreement. Mossimo’s agreement with Target Stores is
subject to early termination under certain circumstances. Products bearing the Mossimo brand began selling at Target Stores in late December 2000. During the Third Quarter and Nine Months, we recognized revenues from Mossimo of approximately
$431,000 and $2.4 million, respectively, in comparison to $420,000 and $1.8 million, respectively, for the three and nine months ended November 3, 2001. However, Mossimo has refused to pay an aggregate of $2.4 million in finder’s fees during
the Nine Months. An arbitration was heard between the parties in mid-October. An arbitration panel ruled in favor of Cherokee on November 11, 2002, issuing an interim arbitration award directing Mossimo to pay all monies owed Cherokee plus interest
on any of the monies withheld, along with legal fees. The arbitrators also reaffirmed the Finder’s Agreement. Cherokee is moving to confirm the arbitration ruling, however we do not know whether or not Mossimo plans to further contest this
award, and they have publicly stated that they are evaluating their options. Cherokee understands that Mossimo has set aside the finder’s fees due to Cherokee in a separate cash account pending a final judgment. See “Part II. Item 1, Legal
Proceedings.” We have made no provision for reserves against the revenues accrued for Mossimo for the Third Quarter and Nine Months.
Additionally, we have four active exclusive consulting agreements, one to represent Hot Kiss in Europe, Asia and South America, one to represent DIC Entertainment’s Liberty Kids for certain categories in the
United States, one to represent the Mrs. Fields brand in the United States and throughout the world and one to represent House Beautiful worldwide excluding the U.K. We will not receive any revenues from such agreements unless we succeed in finding
licensees for the brands owned by the companies for whom we consult. On August 15, 2002, we announced that we had introduced and assisted DIC Entertainment in consummating an agreement with Toys “R” Us to create a retail partnership in the
licensing and children’s entertainment business for Liberty Kids branded merchandise. The products are planned to be launched in Spring of 2003. In exchange for our involvement, we will receive from DIC 33% of the royalties they receive
from Toys “R” Us.
Our Board of Directors has authorized and approved the extension of the expiration
date of our stock repurchase program to July 31, 2003. During the Third Quarter, we did not repurchased any shares of our common stock. From July 1999 through the Third Quarter, we have repurchased and retired 557,800 shares of our common stock. We
are currently authorized to repurchase up to an additional 442,200 shares of our common stock. Continued repurchases of our stock, if any, will be made from time to time in the open market at prevailing market prices or in privately negotiated
transactions.
11
In December 1997, we completed a series of transactions whereby we sold our
rights to the Cherokee brand and related trademarks in the United States to Spell C, our wholly-owned subsidiary, and also assigned to Spell C our rights in the Amended Target Agreement. In return we 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, amortize quarterly from May 20, 1998 through 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 is $60.0 million, which equals the aggregate minimum guaranteed royalty payable under the Amended Target
Agreement, of $60.0 million. As of the end of the Third Quarter, approximately $15.75 million remains outstanding under the Secured Notes.
Results of Operations
Net revenues were $6.1 million and $26.1 million,
respectively, during the Third Quarter and Nine Months as compared to $5.5 million and $24.4 million, respectively, during the three and nine month periods ended November 3, 2001, which represents an increase of 10% and 7%. Revenues for the Cherokee
brand were $4.8 million and $20.9 million, respectively, for the Third Quarter and Nine Months compared to $4.1 million and $20.0 million, respectively, for the three and nine months ended November 3, 2001. During the Third Quarter and Nine Months,
royalty revenues of $3.1 million and $17.3 million, respectively, were recognized from Target Stores, which accounted for 51% and 67% of total revenues, respectively, in comparison to $3.1 million and $16.5 million, or 57% and 68% of total revenues,
respectively, for the three and nine months ended November 3, 2001. The increase in our Cherokee brand net revenues is principally due to the successful fall launch of Cherokee products at Tesco in the United Kingdom. For the Third Quarter and Nine
Months, Sideout brand revenues were $789,000 and $2.7 million, respectively, compared to $939,000 and $2.5 million, respectively, for the three and nine months ended November 3, 2001. For the Third Quarter and Nine Months, our net revenues include
$431,000 and $2.4 million, respectively, from Mossimo Inc. compared to $420,000 and $1.8 million, respectively, in the comparative periods ended November 3, 2001. However, Mossimo has refused to pay the $2.4 million in finder’s fees during the
Nine Months. An arbitration was heard between the parties in mid-October. An arbitration panel ruled in favor of Cherokee on November 11, 2002, issuing an interim arbitration award directing Mossimo to pay all monies owed Cherokee plus interest on
any of the monies withheld, along with legal fees. The arbitrators also reaffirmed the Finder’s Agreement. Cherokee is moving to confirm the arbitration ruling, however we do not know whether or not Mossimo plans to further contest this award,
and they have publicly stated that they are evaluating their options. Cherokee understands that Mossimo has set aside the finder’s fees due to Cherokee in a separate cash account pending a final judgment. See “Part II. Item 1, Legal
Proceedings.” We have made no provision for reserves against the revenues accrued for Mossimo for the Third Quarter and Nine Months.
Our royalty recognition policy provides for recognition of royalties in the quarter earned, although a large portion of such royalty payments are actually received during the two months following the end of a quarter. Our
receivable balance included the accrual of Mossimo’s Nine Months payments required under our Finder’s Agreement and Target, Zeller and Mervyn’s royalty revenues earned during the Third Quarter.
Selling, general, and administrative expenses for the Third Quarter and Nine Months were $2.4 million and $7.9 million or 39% and 30%,
respectively, of net revenues in comparison to
12
selling, general and administrative expenses of $2.1 million and $7.0 million or 38% and 29%, respectively, of net revenues during the three and nine months ended November 3, 2001. The increase
in expenses is attributable to an increase in trademark amortization, start up costs spent positioning Cherokee for growth in Europe, attorney fees related to the arbitration with Mossimo Inc. and accrued management bonus. Cherokee will not
recognize any potential reimbursement of attorney fees until the amounts have been agreed upon and received.
During the Third Quarter and Nine Months, our interest expense was $232,000 and $886,000, respectively, compared to $416,000 and $1.4 million, respectively, for the three and nine months ended November 3, 2001. The interest expense
is attributable to the Secured Notes. The decrease in interest expense is due to the reduction in the outstanding principal amount of the Secured Notes. For the Third Quarter and Nine Months, our investment and interest income was $37,000 and
$114,000, respectively, in comparison to $84,000 and $249,000, respectively, for the three and nine months ended November 3, 2001. The decrease in interest income is due to lower interest rates available for investment in the Third Quarter and Nine
Months.
During the Third Quarter and Nine Months, net income was $2.1 million and $10.5 million, respectively, or
$0.25 and $1.24 per diluted share whereas for the three and nine months ended November 3, 2001, net income was $1.9 million and $9.7 million, respectively, or $0.23 and $1.18 per diluted share. For the Third Quarter and Nine Months, we incurred a
charge for income taxes of $1.4 million and $7.0 million, respectively, in comparison to $1.2 million and $6.5 million, respectively, for the three and nine months ended November 3, 2001. For fiscal year ending February 1, 2003, we expect to utilize
approximately $780,000 of our limited net operating loss carryforwards for federal income tax purposes.
Liquidity and Capital Resources
Cash Flows. On November 2, 2002 we had cash
and cash equivalents of $9.9 million, which amount included restricted cash of $2.7 million held in a collection account by the trustee under the indenture for the Secured Notes. On February 2, 2002 we had cash and cash equivalents of $7.0 million,
which amount included restricted cash of $2.7 million. The $2.8 million increase in cash and cash equivalents is primarily attributable to improved operating results and cash received from the exercise of employee stock options.
During the Nine Months, cash provided by operations was $10.4 million, compared to $12.5 million for the nine months ended
November 3, 2001. Cash provided from operations has been negatively affected by the increase in receivables as a result of Mossimo withholding payments of royalties due under the Finder’s Agreement. Mossimo has refused to pay the $2.4 million
in finder’s fees during the Nine Months. Cherokee and Mossimo engaged in an arbitration in regards to Mossimo’s refusal to pay. An arbitration was heard between the parties in mid-October. An arbitration panel ruled in favor of Cherokee on
November 11, 2002, issuing an interim arbitration award directing Mossimo to pay all monies owed Cherokee plus interest on any of the monies withheld, along with legal fees. The arbitrators also reaffirmed the Finder’s Agreement. Cherokee is
moving to confirm the arbitration ruling, however we do not know whether or not Mossimo plans to further contest this award, and they have publicly stated that they are evaluating their options. Cherokee understands that Mossimo has set aside the
finder’s fees due to Cherokee in a separate cash account pending a final judgment. See “Part II. Item 1, Legal Proceedings.” We have made no provision for reserves against the revenues accrued for Mossimo for the Third Quarter and
Nine Months. Cash used in investing activities during the Nine Months was $577,000 comprised of $287,000 in contingent payments made to Sideout
13
Sport, Inc. and the remainder in trademark registration fees for the Cherokee and Sideout brands. In comparison, during the nine months ended
November 3, 2001, cash used in investing activities was $1.3 million comprised of $1.0 million in contingent payments to Sideout Sport, Inc. with the remainder in trademark registration fees. Cash used in financing activities was $7.0 million for
the Nine Months, compared to $8.4 million for the nine months ended November 3, 2001 and principally pertained to the three quarterly payments on the Secured Notes offset by the proceeds received from stock option exercises during the Nine Months.
Contractual obligations. Our cash requirements through the end of Fiscal 2003 are primarily to fund
operations, repay the Secured Notes, repurchase shares of our common stock and, to a lesser extent for capital expenditures. We are frequently approached by parties seeking to sell their brands and related trademarks. Should an established
marketable brand or equity become available on favorable terms, we would be interested in pursuing such an acquisition and may elect to fund such acquisition, in whole or in part, using our then-available cash.
The following table provides information related to our contractual cash obligations under various financial and commercial agreements:
| |
|
Payments Due by Period (a)
|
|
| Contractual Obligations
|
|
Less than 1 year
|
|
|
1-3 years
|
|
|
4-5 years
|
|
After 5 years
|
|
Total
|
|
| |
|
(in thousands) |
|
| Long-Term Debt(b) |
|
$ |
10,500 |
|
|
$ |
5,250 |
|
|
— |
|
— |
|
$ |
15,750 |
|
| Capital Lease Obligations |
|
|
— |
|
|
|
— |
|
|
— |
|
— |
|
|
— |
|
| Operating Leases(c) |
|
|
108 |
|
|
$ |
81 |
|
|
— |
|
— |
|
$ |
189 |
|
| Unconditional Purchase Obligations |
|
|
— |
|
|
|
— |
|
|
— |
|
— |
|
|
— |
|
| Other Long-Term Obligations |
|
|
|
(d)(e) |
|
|
|
(d)(e) |
|
— |
|
— |
|
|
|
(d)(e) |
| Total Contractual Cash Obligations |
|
$ |
10,608 |
(f) |
|
$ |
5,331 |
(f) |
|
— |
|
— |
|
$ |
15,939 |
(f) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
For purposes of the above table, yearly periods were calculated to coincide with our fiscal quarters, meaning, for example, that the period covered by the
column captions “Less than 1 year” starts November 3, 2002 and ends November 2, 2003. |
(b) |
|
Represents payments to the holders of the Secured Notes. |
(c) |
|
Represents future minimum non-cancelable lease payments with respect to the lease of our office facility in Van Nuys, California. The lease currently expires on
July 31, 2004; however, we have an option to extend the term of the lease for one additional three-year period for monthly rental payments of $9,010. |
(d) |
|
Under the terms of the Sideout Agreement, we agreed to pay Sideout Sport Inc., on a quarterly basis, 40% of the first $10.0 million, 10% of the next $5.0
million and 5% of the next $20.0 million of royalties received by us through licensing of the Sideout trademarks. Upon the earlier of such time as we have paid Sideout total contingent payments of $5.5 million or October 22, 2004, we will have no
further obligations to pay Sideout Sport Inc. Since January 1999, we have paid, in total, $4.27 million in contingent payment under the Sideout Agreement. Because payments to Sideout Sport Inc. are based on royalties received, we cannot predict the
exact amount of payments we will be obligated to make to Sideout Sport up to October 22, 2004. Steven Ascher, an Executive Vice President of Cherokee, beneficially owns 37.2% of Sideout Sport Inc. and Mr. Ascher’s Father and Father-in-law
beneficially own 8.9% and 5.0%, respectively, of Sideout Sport Inc. |
(e) |
|
Under the terms of the management agreement with Mr. Margolis, our Chief Executive Officer, Mr. Margolis will be paid $647,564 per fiscal year, subject to
annual cost of |
14
living increases. The management agreement also provides that, for each fiscal year after Fiscal 2000, if our EBITDA for
such fiscal year is no less than $5.0 million, then Mr. Margolis will receive a performance bonus equal to (x) 10% of our EBITDA for such fiscal year in excess of $2.5 million up to $10.0 million, plus (y)15% of our EBITDA for such fiscal year in
excess of $10.0 million. As a result, for the Nine Months we accrued a bonus of $2.0 million for Mr. Margolis and if our EBITDA continues to increase, the bonus payable to Mr. Margolis under the management agreement will also increase. Because
payments to Mr. Margolis are based on a percentage of our EBITDA, we cannot predict the exact amount of payments we will be obligated to make to Mr. Margolis over the next five years. Additionally, if we terminate the management agreement without
cause or Mr. Margolis terminates the management agreement after we materially breach any of the terms and conditions thereof or fail to perform any material obligations thereunder, we would be obligated to pay Mr. Margolis, within ninety days after
the date of the termination, a lump sum in cash in excess of $9.0 million. See “Item 1. Risk Factors” and “Item 7. Management’s Discussion of Analysis of Financial Condition and Results of Operations” in our Form 10-K for
the fiscal year ended February 2, 2002.
(f) |
|
Stated amount does not include any payments pursuant to either the Sideout Agreement or the management agreement with Mr. Margolis.
|
On December 23, 1997, Spell C issued the Secured Notes, which yield 7.0% interest per annum and mature on
February 20, 2004. See “Item 1. Recapitalization; Sale of Cherokee Trademarks to Spell C; Issuance of Secured Notes” and “Item 1. Risk Factors” in our Form 10-K for the fiscal year ended February 2, 2002. 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 ninth years. The Secured Notes are secured by the Amended Target Agreement and
the United States Cherokee trademarks and brand names. The aggregate scheduled amortization under the Secured Notes is $60.0 million and equals the aggregate minimum guaranteed royalty payable under the Amended Target Agreement, which is also $60.0
million. Spell C is dependant on revenues from the Amended Target Agreement for most, if not all, of its revenues. Although the Amended Target Agreement provides for a minimum annual royalty payment, if for any reason Target Stores does not pay the
minimum royalties, Spell C will be unable to meet, and will default on, its payment obligations under the indenture for the Secured Notes. We are not guarantors of the Secured Notes; however, the United States Cherokee trademarks have been pledged
as security for the Secured Notes and the permanent loss of such trademarks as a result of a default would have a material adverse effect on our business, financial condition and results of operations. The Secured Notes indenture does not contain
any financial covenants that require the maintenance of any financial ratios, cash flows, stock price, value of any assets, credit rating, level of earnings or earnings per share. The Secured Notes indenture does contain covenants prohibiting Spell
C from, among other things, transferring any right, title or interest in the Amended Target Agreement or the United States Cherokee trademarks, incurring any encumbrances on such agreement or trademarks, or taking any action to impair the liens on
such agreement or trademarks in favor of the holders of the Secured Notes. As of November 2, 2002, Spell C was in compliance with the covenants in the indenture for the Secured Notes.
As of November 2, 2002, we did not have any amounts outstanding under any credit facilities or lines of credit and we are not the guarantor of the Senior Notes or any other
material third-party obligations. As of November 2, 2002, we do not have any standby letters of credit nor any standby repurchase obligations.
15
Sources of Liquidity. Our primary source of liquidity is expected to be
cash flow generated from operations, and cash and cash equivalents currently on hand. We believe our cash flow from operations together with our cash and cash equivalents currently on hand will be sufficient to meet our working capital, capital
expenditure and other commitments for the next twelve months; provided that, if the management agreement was terminated as discussed above, we would not have sufficient cash to make the lump sum payment to Mr. Margolis. See “Item 1. Risk
Factors” in our Form 10-K for the fiscal year end February 2, 2002. We cannot predict our revenues and cash flow generated from operations. Some of the factors that could cause our revenues and cash flows to be materially lower are described
under the caption titled “Risk Factors” in Item 1 of our Form 10-K for the fiscal year end February 2, 2002 and under the caption titled “Special Note Regarding Forward-Looking Statements” below.
If our revenues and cash flows during Fiscal 2003 are only slightly lower than Fiscal 2002, we may not have cash available to continue to
repurchase shares of our common stock or to explore or consummate the acquisition of other brands. If our revenues and cash flows during Fiscal 2003 are materially lower than Fiscal 2002, we may need to take steps to reduce expenditures by scaling
back operations and reducing staff related to these activities. However, any reduction of revenues would be partially offset by reductions in the amounts we would be required to pay under the management agreement, employee bonuses and possibly the
Sideout Agreement. Further, the aggregate scheduled amortization under the Secured Notes does not exceed the aggregate minimum guaranteed royalty payments under the Amended Target Agreement. Until the outstanding amount under the Secured Notes is
fully paid, our ability to obtain funds from conventional sources of long-term external financing, such as debt, convertible debt or equity financings is somewhat limited. We do believe that, if necessary, even prior to the full repayment of the
Secured Notes, we would have access to short-term external financing, but we cannot provide any assurance that financing would be available to us on acceptable terms or at all.
Inflation and Changing Prices
Inflation did not have a significant effect on our operations during the Third Quarter or the prior year period.
Special Note Regarding Forward-Looking Statements
This quarterly report on Form
10-Q and other filings, which we make with the Securities and Exchange Commission, as well as press releases and other written or oral statements we may make may contain “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. When used, the words “anticipates”, “believes,” “estimates,” “objectives”, “goals”, “aims”, “hopes”, “may”, “likely”,
“should” and similar expressions are intended to identify such forward-looking statements. In particular, the forward-looking statements in this Form 10-Q include, among others, statements regarding our goals or expectations regarding our
future revenues and earnings, the likelihood of increased retail sales by certain of our current and future licensees, such as Target Stores, the likelihood in the achievement of certain royalty rate reductions, our prospects for obtaining new
licensees and our prospects for obtaining new brands to acquire or represent. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results, performance or
16
achievements to be materially different from any future results, performance or achievements expressed or implied by any forward-looking
statements. Such risks and uncertainties, include, but are not limited to, the effect of national and regional economic conditions, the financial condition of the apparel industry and the retail industry, the overall level of consumer spending, the
effect of intense competition in the industry in which we operate, adverse changes in licensee or consumer acceptance of products bearing the Cherokee or Sideout brands as a result of fashion trends or otherwise, the ability and/or commitment of our
licensees to design, manufacture and market Cherokee and Sideout branded products, our dependence on a single licensee for most of our revenues, our dependence on our key management personnel and the effect of a breach or termination by us of the
management agreement with our Chief Executive Officer. Several of these risks and uncertainties are discussed in more detail under “Item 1. Business-Risk Factors” in our Form 10-K for the fiscal year ended February 2, 2002. You should,
however, understand that it is not possible to predict or identify all risks and uncertainties and you should not consider the risks and uncertainties identified by us to be a complete set of all potential risks or uncertainties that could
materially effect us. You should not place undue reliance on the forward-looking statements we make herein because some or all of them may turn out to be wrong. We undertake no obligation to update any of the forward-looking statements contained
herein to reflect future events and developments.
| ITEM 3. |
|
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK |
Market risk generally represents the risk that losses may occur in
the values of financial instruments as a result of movements in interest rates, foreign currency exchange rates and commodity prices. We do not enter into derivatives or other financial instruments for trading or speculative purposes.
Interest
From time to time we invest our excess cash in interest-bearing temporary investments of high-quality issuers. Due to the short time the investments are outstanding and their general liquidity, these
instruments are classified as cash equivalents in our consolidated balance sheet and do not represent a material interest rate risk to us. Our only long-term debt obligations are the Secured Notes, which are zero-coupon secured notes yielding
interest of 7.0% per annum. This long-term debt obligation does not represent a material interest rate risk to us.
Foreign Currency
We conduct business in various parts of the world. We are exposed
to fluctuations in exchange rates to the extent that the foreign currency exchange rate fluctuates in countries where our licensees do business. For the Third Quarter and Nine months, a hypothetical 10% strengthening of the US dollar relative to the
foreign currencies of countries where we operate was not material.
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| ITEM 4. |
|
DISCLOSURE CONTROLS AND PROCEDURES |
(a) Evaluation of disclosure controls and
procedures. Cherokee maintains “disclosure controls and procedures”, as such term is defined under Exchange Act Rule 13a-14 (c). Disclosure controls and procedures are designed to ensure that information required
to be disclosed in Cherokee’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Such information is accumulated and communicated to Cherokee’s
management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, Cherokee’s management
recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and Cherokee’s management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures. Cherokee has carried out an evaluation, within the 90 days prior to the date of filing of this report, under the supervision and with the participation of Cherokee
management, including Cherokee’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon their evaluation and subject to the
foregoing, the Chief Executive Officer and Chief Financial Officer concluded that Cherokee’s disclosure controls and procedures were effective in ensuring that material information relating to Cherokee is made known to the Chief Executive
Officer and Chief Financial Officer by others within Cherokee during the period in which this report was being prepared.
(b) Changes in internal controls. There have been no significant changes in Cherokee’s internal controls or in other factors that could significantly affect these controls subsequent to
the date Cherokee completed its evaluation.
PART II—OTHER INFORMATION
Effective March 27, 2000, Cherokee entered into a Finder’s
Agreement with Mossimo, Inc. (“Mossimo”) to reflect sums due Cherokee for introducing Mossimo and Target Corporation (“Target”). As a direct result of Cherokee’s actions, Mossimo entered into a licensing agreement with
Target, which has generated significant revenues for Mossimo.
Since 2000, Mossimo has paid Cherokee 15% of all
the revenues paid by Target to Mossimo under its licensing agreement with Target. However, on May 2, 2002, Mossimo asserted a claim for arbitration against Cherokee contending that “Mossimo, Inc. is entitled to a refund of the finder’s
fees which have already been paid to [Cherokee], to the extent they are attributable to design services or the personal services and commitments of Mossimo Giannulli, rather than to the trademark license.” This assertion was made by Mossimo
even though the design or personal services are required to be performed under its license agreement with Target. Mossimo also
18
sought “a declaration as to the portion of any subsequent or future payments by Target which will be subject to the 15% finder’s fee.”
Upon being informed by a representative of Mossimo that first quarter fees earned by Cherokee under the Finder’s Agreement would not
be paid pending the outcome of an arbitration case, Cherokee demanded arbitration against Mossimo for breach of the Finder’s Agreement on the grounds of Mossimo’s refusal to pay sums clearly due and owing under the Finder’s Agreement.
Mossimo amended its license agreement with Target to reflect that 45% of the revenues received by Mossimo from
Target are in connection with design services. It was Cherokee’s position that this amendment had no bearing on the 15% owed to Cherokee because the Finder’s Agreement provides that “Mossimo shall not enter into any agreement with
[Target] pursuant to which Mossimo will receive any consideration that is not included within Net Revenues.” We believed Mossimo’s position was meritless, and vigorously defended the claim.
Cherokee and Mossimo engaged in an arbitration in regards to Mossimo’s refusal to pay. An arbitration was heard between the parties
in mid-October. An arbitration panel ruled in favor of Cherokee on November 11, 2002, issuing an interim arbitration award directing Mossimo to pay all monies owed Cherokee plus interest on any of the monies withheld, along with legal fees. The
arbitrators also reaffirmed the Finder’s Agreement. Cherokee is moving to confirm the arbitration ruling, however we do not know whether or not Mossimo plans to further contest this award, and they have publicly stated that they are evaluating
their options. Cherokee understands that Mossimo has set aside the finder’s fees due to Cherokee in a separate cash account pending a final judgment.
For the Third Quarter and Nine Months, we recognized revenues from Mossimo of $431,000 and $2.4 million, respectively, in comparison to $420,000 and $1.8 million, respectively, for the three and nine
months ended November 3, 2001. We have made no provision for reserves against the revenues accrued for Mossimo for the Third Quarter and Nine Months. We have made no provision for receivables from Mossimo either.
In the ordinary course of business, we from time to time become involved in legal claims and litigation. In the opinion of management,
based on consultations with legal counsel, the disposition of litigation currently pending against us is unlikely to have, individually or in the aggregate, a materially adverse effect on our business, financial position or results of operations.
None.
| ITEM 3. |
|
DEFAULTS UPON SENIOR SECURITIES |
Not applicable.
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| ITEM 4. |
|
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
None.
None.
| ITEM 6. |
|
EXHIBITS AND REPORTS ON FORM 8-K |
(a) Exhibits
None.
(b) Reports on Form 8-K
We filed no reports on Form 8-K during the
Third Quarter. A report on Form 8-K was filed on November 12, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
Dated: December 5, 2002
| CHEROKEE INC. |
| |
| By: |
|
/s/ ROBERT MARGOLIS
|
| |
|
Robert Margolis Chief
Executive Officer |
| |
| By: |
|
/s/ KYLE B. WESCOAT
|
| |
|
Kyle B. Wescoat Chief
Financial Officer |
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CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
I, Robert Margolis, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cherokee Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Cherokee
Inc. and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to Cherokee Inc. including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the Cherokee Inc.’s disclosure controls and procedures as of a date
within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. Cherokee Inc.’s other certifying officers and I have disclosed, based on our most recent evaluation, to
Cherokee Inc.’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect Cherokee Inc.’s ability to
record, process, summarize and report financial data and have identified for Cherokee Inc.’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in Cherokee Inc.’s internal
controls; and
6. Cherokee Inc.’s other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.
Dated: December 5, 2002
| By: |
|
/s/ ROBERT
MARGOLIS
|
| |
|
Robert Margolis Chief
Executive Officer (Principal Executive Officer) |
21
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
I, Kyle B. Wescoat, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cherokee Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Cherokee
Inc. and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to Cherokee Inc. including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the Cherokee Inc.’s disclosure controls and procedures as of a date
within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. Cherokee Inc.’s other certifying officers and I have disclosed, based on our most recent evaluation, to
Cherokee Inc.’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect Cherokee Inc.’s ability to
record, process, summarize and report financial data and have identified for Cherokee Inc.’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in Cherokee Inc.’s internal
controls; and
6. Cherokee Inc.’s other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.
Dated: December 5, 2002
| By: |
|
/s/ KYLE B.
WESCOAT
|
| |
|
Kyle B. Wescoat Chief
Financial Officer (Principal Financial Officer) |
22