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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MAY 31, 1997 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _______
COMMISSION FILE NO. 0-18640
_______________
CHEROKEE INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
DELAWARE 95-4182437
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
6835 VALJEAN AVENUE
VAN NUYS, CA 91406
(ADDRESS OF PRINCIPAL (818) 908-9868 (ZIP CODE)
EXECUTIVE OFFICE) (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.
YES NO X
----- -----
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
YES X NO
----- ------
As of July 21, 1997, the registrant had 7,741,986 shares of its Common Stock,
par value $.02 per share, issued and outstanding.
As of July 21, 1997, the aggregate market value of the voting stock held by non-
affiliates of the registrant was approximately $58,928,000 (computed on the
basis of the last trade of the Common Stock on the NASDAQ Small Cap Issue Market
on July 21, 1997).
Certain portions of the following document are incorporated by reference into
Part III of this Form 10-K:
The registrant's proxy statement for the Annual Meeting of Stockholders to be
held on September 15, 1997.
1
CHEROKEE INC.
INDEX
PART I PAGE
Item 1. Business........................................... 3
Item 2. Properties......................................... 9
Item 3. Legal Proceedings.................................. 9
Item 4. Submission of Matters to a Vote of Security Holders 9
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters...................... 10
Item 6. Selected Financial Data.......................... 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation............... 13
Item 8. Financial Statements and Supplementary Data....... 18
PART III
Item 10. Executive Officers of the Registrant.............. 19
Item 11. Executive Compensation............................ 20
Item 12. Security Ownership of Certain Beneficial Owners
and Management................................... 20
Item 13. Certain Relationships and Related Transactions.... 20
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K.............................. 21
2
PART I
ITEM 1. BUSINESS
On April 24, 1995, a group including Robert Margolis, who founded Cherokee
Inc.'s (the "Company") 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 has
terminated manufacturing and importing apparel and footwear, has sold its
inventories of apparel and footwear and on July 28, 1995 sold the assets of its
Uniform Division. The proceeds from these sales have been 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 at May 28, 1994 to 15 by November 1, 1995. (See
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation.)
Prior to this major strategic change, the Company (as defined above) 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 (collectively, the
"Divisions"). 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.
RESTRUCTURINGS
- --------------
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 debtholders 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
3
debtholders 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 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 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. 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"), of which the Company estimated that between 268,000 and 393,000 shares
would be returned for cancellation. As of May 31, 1997 the Disbursing Agent had
distributed 517,795 shares of Common Stock to general unsecured creditors, and
canceled 482,205 shares at the Company's request since they were determined not
to be distributable to creditors.
CHANGES IN MANAGEMENT
- ---------------------
In accordance with and on the Effective Date, a new Board of Directors was
appointed. The seven directors were Peter Brown, Herschel Elias, Peter Handal,
Jeffrey Schultz, B. Chris Schwartz, David Sarns, and Michael Seyhun. At such
time the Board of Directors undertook a search for a new Chief Executive Officer
of the Company. In the interim, Michael Seyhun, Chief Operating Officer of the
Company, was the highest ranking officer. Concurrent with the appointment of
Mr. Margolis as Chairman of the Board of Directors and Chief Executive Officer
on May 5, 1995, Messrs. Brown, Handal, and Schwartz resigned as Directors and
Mr. Margolis, Jess Ravich, and Douglas Weitman were appointed directors of the
Company by the remaining directors. On June 21, 1995, Patricia Warren was
elected President of the Company, and Michael Seyhun was elected Chief Financial
Officer. On July 5, 1995, the number of authorized directors was increased
from seven to nine and Keith Hull and Avi Dan were appointed directors. On July
25, 1995, David Sarns resigned as a director and on January 5, 1996, Michael
Seyhun resigned as a director and Chief Financial Officer and left the Company.
The Company presently has a seven member Board of Directors.
CHEROKEE'S LICENSING BUSINESS
- -----------------------------
As of May 31, 1997 ("Fiscal 1997"), the Company had nineteen continuing
license agreements; seven of which were with retailers, six of which were with
domestic wholesale licensees and six of which were with international wholesale
and/or retail licensees. The Company's license agreements are with wholesalers
and retailers and are either international masters or category specific
exclusives or non-exclusives. Wholesale licensees manufacture and import various
categories of apparel, footwear and accessories, under the Cherokee trademarks,
and sell the licensed products to retailers. The Company's primary emphasis for
the past 2 years has been directed toward retail direct licensing. In retail
direct licensing, the Company grants retailers the license to use the Cherokee
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
Company's license agreements, wholesale and retail, 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.
4
RETAIL DIRECT LICENSING
- -----------------------
During May, June and July of 1995, Company management met with key
retailers, conducted consumer research and developed its retail direct licensing
marketing strategy. The Company launched its retail direct licensing marketing
program on August 1, 1995.
On August 15, 1995, the Company entered into a major strategic alliance
with Target Stores, a division of Dayton Hudson Corporation ("Target"). Target
was granted the exclusive right 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 (the "Exclusive Products"). 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 "Non-
exclusive Products"). During the terms of these agreements, which expire on
January 31, 2001, Target has guaranteed minimum sales in excess of $575,000,000
with respect to the Exclusive and Non-exclusive Products. The royalty rate
starts at 3% and varies, thereafter, based upon annual sales of the Exclusive
and Non-exclusive Products. If Target's sales of the Exclusive Products exceed
$200,000,000 in the last year of the agreement and in each year thereafter, the
agreement will automatically renew for additional one year terms, subject to
Target's right to terminate the agreement every third year. Target has the
option beginning on January 31, 2002, to acquire in perpetuity the exclusive
rights to manufacture, import and sell the Exclusive Products for a purchase
price equal to (a) 10 times the royalty it paid Cherokee with respect to the
Exclusive Products in the year prior to exercise of its option but not less than
$40,100,000 less (b) the lesser of (i) one-half of the royalties it has paid
during the term of the agreement with respect to Exclusive Products or (ii) one-
half of (a) above; provided that the maximum price shall be $60,000,000. The
agreement prohibits the Company from granting other exclusive Cherokee retail
licenses and from granting any licenses to certain other major discount
retailers in the territory. Target commenced the initial sales of Exclusive and
Non-Exclusive Products in July 1996 and accounted for approximately 68% of the
Company's revenues during the fiscal year ended May 31, 1997.
During the fiscal year ended June 1, 1996, the Company entered into eight
retail direct non-exclusive license agreements. As of May 31, 1997, the Company
had entered into a non-exclusive license agreement with Brylane L.P., had
executed nine amendments to retail direct non-exclusive agreements whereby the
product categories were expanded and is negotiating with several other retailers
for additional non-exclusive retail direct agreements. The categories of product
available for non-exclusive license agreements include Missy, Large Size,
Petite, and Junior Sportswear and Activewear (historically Cherokee's largest
selling apparel lines), cosmetics, accessories, home, and outdoor products.
Major categories of menswear and boyswear not the subject of existing wholesale
license agreements are also available. Royalties on non-exclusive 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.
WHOLESALE LICENSING
- -------------------
The Company will continue to grant and administer exclusive and co-exclusive
wholesale licenses to unaffiliated manufacturers for the production and
marketing under the Cherokee trademark of apparel, uniform footwear,
accessories, and a variety of other products for men, women and children that
are not already the subject of exclusive licenses. Wholesale licensed products
presently include women's intimate apparel, socks, sunglasses, watches, men's
activewear and home textile products. 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.
5
INTERNATIONAL LICENSING
- -----------------------
The Company's new strategy includes the expansion of its international
licensing business in other territories. Suzuya Co. Ltd. ("Suzuya"), the
Company's Far East licensee for the past ten years, operated 21 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. For the year ended June 1, 1996 licensing agreements were signed with
Mondragon, a Philippines based company, and Blackduck Enterprises, subsidiary of
Kannaouros & Sons Ltd., a Greek corporation. In April 1997, the Suzuya licensing
agreement was terminated and a new master licensing agreement was signed with
Vantex, Inc. and three sub-licensing agreements for the further development of
the Japanese territory. Also during fiscal year ended May 31,1997, the Company
signed a new master licensing agreement for South Korea with Kum Kyung Co.,
Ltd, a South Korean based company and a new wholesale licensing agreement with
Joosung Enterprises Co., Ltd., a South Korean based company which manufacturers
handbags and handbag related items.
TRADEMARKS
- ----------
The Company owns the Cherokee trademark in connection with certain apparel
and other goods, and the Cherokee trademark is registered with the United States
Patent and Trademark Office and in certain other countries. The Company also
owns numerous trademark applications for Cherokee in numerous countries. The
Company intends to renew these registrations as appropriate prior to expiration.
The Company protects its trademark domestically and internationally by seeking
to monitor on an ongoing basis unauthorized uses of its trademark.
MARKETING
- ---------
Historically, the Company had spent between 3% and 4% of its sales on
advertising. Advertising, product, labeling and presentation are integrated to
deliver one clear and consistent message. The advertising is intended to
project a positive image to the consumer and the retailer. The Company and its
licensees intend to promote a positive image in marketing the Cherokee brand
through advertising, public relations programs, and editorial coverage. During
fiscal years ended May 31, 1997 and June 1, 1996, the Company's advertising
costs were minimal. As the Company's licensing revenues increase, the Company,
in coordination with its licensees, will increase its advertising costs.
COMPETITION
- -----------
Cherokee brand footwear, apparel, and accessories, manufactured by
wholesale licensees and sold to retailers and retail licensees, are subject to
the same competitive pressures that the Company's products were subject.
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,
the Company's business plan principally focuses on creating strategic alliances
with major retailers for their sale of Cherokee products through the licensing
of the Cherokee trademark directly to retailers. Other companies owning
established trademarks could also enter into similar arrangements with
retailers.
EMPLOYEES
- ---------
As of May 31, 1997, 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.
6
FISCAL 1997 AND FISCAL 1996 SALES BY DIVISION
- ---------------------------------------------
The following chart sets forth the approximate net sales of each of the
Divisions during fiscal year ended May 31, 1997 ("Fiscal 1997") and Fiscal 1996
and the percentage such sales represents of the Company's Fiscal 1997 and 1996
sales.
1997 FISCAL YEAR 1996 FISCAL YEAR
SALES % SALES %
------------------------- -------------------------
Apparel Division $ 0 .0 $ 7,846,000 56.4
Uniform Division 0 .0 2,301,000 16.6
Footwear Division 0 .0 2,331,000 16.8
Other 385,000 4.4 - -
Licensing Division 8,333,000 95.6 1,421,000 10.2
------------------------- -------------------------
$8,718,000 100.0 $13,899,000 100.0
========================= =========================
As a result of the Company's decision to exit the apparel and footwear
manufacturing and wholesaling businesses and to sell the Uniform Division, all
of which were substantially completed during Fiscal 1996, the Company derived
product sales only from selling its remaining inventory of sweatshirts in Fiscal
1997.
THE COMPANY'S FORMER BUSINESSES
- -------------------------------
APPAREL DIVISION
The Apparel Division manufactured and distributed a product line of
moderately priced women's apparel and youthwear. Women's apparel accounted for
approximately 91% of the Apparel Division's sales and youthwear approximately 9%
during Fiscal 1995. Bottoms and tops retailed in the range of $20 to $35 for
women's and $15 to $25 for youthwear. The Apparel Division's products were sold
nationwide in a variety of department and discount stores, including Federated
Stores, May Co., J.C. Penney, Kohl's, Mervyn's, and Sears.
By the end of Fiscal 1995, the Company began implementing its new strategy
and all activity relating to new orders and new production in the Apparel
Division ceased and the Company commenced the liquidation of its apparel
inventories. Since its founding in 1981, the Apparel Division was primarily a
niche marketer of novelty fabrication and styles, primarily for the female
consumer. During fiscal year 1994 ("Fiscal 1994") the Apparel Division closed
its men's division and its private label division. In addition, by the end of
Fiscal 1994 the Uniform Division was separated from the Apparel Division and was
established as a separate operating division of the Company. After Mr.
Margolis' resignation in October 1993, the new management of the Apparel
Division began to implement a new operating strategy which was first reflected
in its back to school product line for Fall 1994. The new Apparel Division
strategy was core styling and fabrications primarily in casual bottoms for all
female age groups. The new operating strategy failed dramatically. Sales for
the first six months of Fiscal 1995 were substantially less than planned and
inventories were substantially greater than planned. As a result, the Apparel
Division returned to its historic product line during the second half of Fiscal
1995 focusing on products for the Missy and Special Sizes customer.
FOOTWEAR DIVISION
By the end of Fiscal 1995, the Company began implementing its new strategy
and all activity relating to new orders and new production in the Footwear
Division ceased and all inventory was liquidated by the end of Fiscal 1996. The
Footwear Division designed, arranged for the manufacture of, imported and
marketed Cherokee brand footwear for women and children to shoe store chains,
specialty stores and department stores, and a line of private label footwear for
major retailers primarily on a commission basis.
The Cherokee brand footwear line consisted of a full range of shoes,
including Cherokee comfort casuals (such as sandals, moccasins and closed
shoes), Cherokee athletics (such as sports shoes), and sports leisure shoes
7
(such as walking shoes and hiking shoes). All Cherokee brand footwear products
were imported, primarily from Latin America, the Far East and Italy, and
generally retailed in the $12 to $70 range. For twenty-five years Cherokee
brand footwear has been sold in a variety of department stores, such as
Nordstrom's, The Broadway Stores, Younkers, J. Byrons, Herberger's and Sears;
store chains, such as Famous Footwear and Kinney; and specialty stores such as
Big 5, Bob's and Sports Authority.
UNIFORM DIVISION
The Uniform Division designed, sourced, marketed and distributed Cherokee
brand uniforms primarily for the medical industry. The Division's products
consisted of tops, bottoms and lab coats in white and medical scrub colors,
which generally retailed in the $23 to $40 range. In Fiscal 1995, the Uniform
Division began a school uniform program, which accounted for approximately 3.5%
of its sales. The Uniform Division sold its products in more than 1,500
locations through retail stores and specialty catalogs, including Life Uniforms
and J.C. Penney.
On July 28, 1995, the Company sold the assets of 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 the 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 (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. In addition, Strategic Partners would pay Cherokee royalties with
respect to its sales of Cherokee brand uniform footwear, and beginning in June
2001, would pay Cherokee, subject to certain conditions, a royalty equal to 2%
of annual sales of Cherokee brand uniforms in excess of $30,000,000.
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 would 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.
8
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 which the
Company shares with 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. The Company
believes this facility is currently adequate for its expected requirements for
the next few years. The Company leases an 1,158 square foot showroom facility in
Dallas, Texas, which it no longer occupies. The Company has subleased this
facility. The lease expires on February 28,1998. The Company also shares a 4,000
square foot warehouse storage facility with Wilstar 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 fourth quarter of Fiscal 1997.
9
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.
FISCAL 1996 HIGH LOW
- ----------- ------ ------
Quarter ended September 2, 1995 $5 1/2 $2 1/2
Quarter ended December 2, 1995 4 7/8 3 1/2
Quarter ended March 2, 1996 4 3/4 2 7/8
Quarter ended June 1, 1996 7 3/8 3 7/8
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
On July 21, 1997, the latest bid price for the Common Stock reported on the
NASDAQ Small Cap Issues Market was $11.50 per share.
As of July 21, 1997, the number of stockholders of record of the Common
Stock was 147. This figure does not include beneficial holders whose shares may
be held of record by brokerage firms and clearing agencies.
Previously, the Company's Board had not established a policy regarding the
ongoing payment of dividends. However, on January 28, 1997, the Company's Board
declared a quarterly dividend 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. On
May 8, 1997, the Company's Board approved a $0.20 per share dividend to all
shareholders of record as of May 14, 1997, which was paid on May 30, 1997. It
is the intention of the Company's Board to continue its dividend policy and will
base future payments upon the availability of cash and its evaluation at such
time of the Company's ongoing cash requirements and the most desirable
utilization of such cash.
On May 30, 1996, the Company made a distribution of capital to all
shareholders of record as of May 15, 1996. The distribution was $.60 per share
on Common Stock and was made in accordance with Section 316 of the Internal
Revenue Code of 1986.
10
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information, except as noted
herein, has been taken or derived from the audited consolidated financial
statements of the Company and its Predecessor and should be read in conjunction
with the consolidated financial statements included elsewhere herein. See
"Financial Statements and Supplementary Data."
Successor Company Predecessor Company
------------------------------------- ---------------------------------------
Year Year 3 Months 9 Months Year Year
Ended Ended Ended Ended Ended Ended
STATEMENT OF OPERATIONS DATA: May 31, June 1, June 3, Feb. 25, May 28, May 29,
($ IN THOUSANDS EXCEPT PER SHARE DATA) 1997 1996 1995 1995 1994 1993
------------------------------------- ---------------------------------------
Royalty revenues / Net sales................ $ 8,718 $13,899 $20,264 $ 65,623 $114,087 $157,299
Cost of goods sold.......................... 184 10,445 16,310 54,994 83,225 115,630
------------------------------------- ---------------------------------------
Gross profit................................ 8,534 3,454 3,954 10,629 30,862 41,669
Selling, general and administrative
expenses................................... 3,406 4,460 5,153 19,097 30,974 39,600
Performance option expense.................. - 4,567 (5) - - - -
Amortization of trademarks and goodwill..... - - - 819 1,691 2,531
Operational restructuring................... - - 3,165 - 6,052 -
Write-off of reorganization value in
excess of amounts allocable to identifiable
assets..................................... - - - - 9,281 -
------------------------------------- ---------------------------------------
Operating income (loss)..................... 5,128 (5,573) (4,364) (9,287) (17,136) (462)
Other (income) expense...................... (75) (96) (116) (167) 141 975
Interest expense............................ 3 355 587 5,467 11,914 (1) 23,512 (1)
Investment and interest income.............. (460) (543) (24) (107) (55) (344)
Gain on sale of Uniform Div and other
assets..................................... (220) (3,840) - - - -
Reorganization items........................ - - - 54,093 (3) - 40,599 (2)
------------------------------------- ---------------------------------------
Income(loss) before income taxes............ 5,880 (1,449) (4,811) (68,573) (29,136) (65,204)
Income tax benefit.......................... (771) - (400) (5,230) (4,306) (3,146)
------------------------------------- ---------------------------------------
Income (loss) before extraordinary item.... 6,651 (1,449) (4,411) (63,343) (24,830) (62,058)
Extraordinary item (net of income taxes)... - - - 88,291 (3) - 82,379 (2)
------------------------------------- ---------------------------------------
Net income (loss)........................... 6,651 (1,449) (4,411) 24,948 (24,830) 20,321
Preferred dividend requirement.............. - - - - - 973
Net income (loss) applicable to common
stock...................................... $ 6,651 $(1,449) $(4,411) $ 24,948 $(24,830) $ 19,348
Net income (loss) per share (4)............ $ 0.82 $ (0.22) $ (0.72) - (4) - (4) - (4)
Cash distribution of capital per share...... - $ 0.60 - - - -
Cash dividends per share.................... $ 0.35 - - - - -
MAY 31, JUNE 1, JUNE 3, FEB. 25,(3) MAY 28, May 29,(2)
BALANCE SHEET DATA: 1997 1996 1995 1995 1994 1993
------------------------------------- ---------------------------------------
Working capital............................. $ 9,148 $ 227 $ 27,321 $ 26,517 $ 35,510
Total assets................................ 13,601 8,320 28,260 41,527 93,700 124,622
Long-term debt, net of current maturities... - - - 18,995 83,204 79,338
Stockholders' equity (deficit).............. 12,224 6,070 7,222 11,825 (11,630) 13,200
NOTES TO SELECTED FINANCIAL DATA
(1) Interest expense includes non-cash charges of $20,451 for the year ended
May 29, 1993, $9,420 for the year ended May 28, 1994 and $4,361 for the
nine months ended February 25, 1995. Non-cash interest for the year ended
May 29, 1993 includes the November 1, 1992 Reset Note interest payment
that the Company did not pay.
(2) On May 28, 1993, the 1993 Plan was confirmed by the Bankruptcy Court and
became effective on June 1, 1993. For financial statement purposes the
effective date of the 1993 Plan was assumed to be May 29, 1993, the last
day of the Company's fiscal 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 May 29,
1993 balance sheet is that of a successor company, however identified as a
Predecessor Company as a result of the subsequent reorganization reflected
as of February 25, 1995.
11
(3) 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 Plan was assumed to be February 25, 1995, the
last day of the third quarter of the Company's fiscal 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.
(4) 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 are 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.
(5) Represents a non-cash charge of $4,567,000 resulting from the exercise of
The Wilstar Group ("Wilstar") performance options. Wilstar is a related
party, majority owned by Robert Margolis.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
SUCCESSOR COMPANY PREDECESSOR
--------------------------------------------------- COMPANY
Year Ended Year Ended -----------------
May 31, June 1, Three Months Ended Nine Months Ended
1997 1996 June 3, 1995 February 25, 1995
--------------------------------------------------- -----------------
ROYALTY REVENUES / NET SALES
Apparel Division(1).......... $ - $ 7,846,000 $10,510,000 $37,216,000
Footwear Division............ - 2,331,000 4,427,000 14,555,000
Licensing Division........... 8,333,000 1,421,000 325,000 1,485,000
Other(5)/Uniforms(2)......... 385,000 2,301,000 5,002,000 12,367,000
---------- ----------- ----------- -----------
Total Company.............. $8,718,000 $13,899,000 $20,264,000 $65,623,000
========== =========== =========== ===========
GROSS PROFIT
Apparel Division(1).......... $ - $ 1,217,000 $ 620,000 $ 760,000
Footwear Division............ - 56,000 1,242,000 4,189,000
Licensing Division........... 8,333,000 1,421,000 325,000 1,485,000
Other/Uniforms(2)............ 201,000 760,000 1,767,000 4,195,000
---------- ----------- ----------- -----------
Total Company.............. $8,534,000 $ 3,454,000 $ 3,954,000 $10,629,000
========== =========== =========== ===========
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES..... $3,406,000 $ 4,460,000 $ 5,153,000 $19,097,000
PERFORMANCE OPTION EXPENSE... - $ 4,567,000 (3) - -
OPERATING INCOME (LOSS)...... $5,128,000 $(5,573,000) $(4,364,000)(4) $(9,287,000)(4)
- -------------------
(1) By the end of Fiscal 1994, the Uniform Division was separated from the
Apparel Division and was established as a separate Division of the Company.
(2) Other consists of the elimination of intercompany transactions and the
Uniform Division's results for periods ended February 25, 1995 and June 3,
1995.
(3) A non-cash charge of $4,567,000 resulting from the exercise of performance
options for the year ended June 1, 1996.
(4) Operating loss includes an operational restructuring charge for the three
months ended June 3, 1995.
(5) Other sales includes the liquidation of the remaining sweatshirt inventory
during fiscal year ended May 31, 1997.
FISCAL 1997
Historically, 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 May 1995, the Company set in motion a
new 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 terminated manufacturing and importing apparel and
footwear, sold most of its inventories and on July 28, 1995 sold the assets of
its Uniform Division.
In previous years, the Company's Licensing Division operated primarily 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 emphasizes wholesale and retail direct
licensing whereby the Company grants wholesales and retailers the license to use
the Cherokee trademark on certain categories of merchandise, including those
products that the Company previously manufactured. The Company's license
agreements are either international masters or category specific exclusives or
non-exclusives and provide the Company with final approval of pre-agreed upon
quality standards,
13
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 a result of this newly adopted strategy, the Company today is no longer
comparable to the former Cherokee.
RESULTS OF OPERATIONS
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 is
the difference between the market price of the common stock at exercise date and
exercise price of the options. (See Note 10: Employment and Management
Agreements). During the year, selling, general and administrative expenses have
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.
For Fiscal 1997, the Company's gain 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 would pay Cherokee royalties with
respect to its sales of Cherokee brand uniform footwear, and beginning in June
2001, would 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. A royalty was to be paid to
Cherokee if the "Rockers" trademark is 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 would 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.
14
The Company's interest expense for Fiscal 1997 was $3,000 compared to $355,000
in Fiscal 1996, a decrease of $352,000. The Company's investment and interest
income for Fiscal 1997 and Fiscal 1996 were $460,000 and $543,000, respectively.
The Company has no debt and anticipates having interest income from investing
its excess cash.
Based on the Company's anticipated results for Fiscal 1998, management believes
that the Company's tax liabilities will be immaterial in Fiscal 1998 as it has
available sufficient net operating loss carry forwards to offset taxable income.
FISCAL 1995
Net Sales for the three months ended June 3, 1995 were $20,264,000, which
accounted for approximately 24% of Fiscal 1995 sales. As a percentage of total
fourth quarter sales, the Apparel Division represented 52%, the Footwear
Division represented 22%, the Uniform Division represented 24%, and the
Licensing Division represented 2%. Sales continued to decrease during the
fourth quarter of Fiscal 1995 as compared to previous periods as a result of a
lack of retailer confidence stemming from the 1994 Plan and the Company's May
1995 announcement that it would be exiting apparel and footwear manufacturing
and wholesaling businesses.
The Company's gross profit margin for the three months ended June 3, 1995 was
$3,954,000 or 20% of net sales. The gross profit percentage declined from
previous levels of 27% in Fiscal 1994 primarily as a result of deteriorating
margins for the Company's Apparel Division, which has experienced continued
pricing pressures and lack of retailer confidence. The overall performance of
the Apparel Division was a key contributing factor to the 1994 Plan and 1995
operational restructuring.
Selling, general and administrative expenses for the three months ended June 3,
1995 were $5,153,000, which accounted for approximately 21% of Fiscal 1995
selling, general and administrative expenses. Selling, general and
administrative expenses declined in the fourth quarter of Fiscal 1995 as a
result of the 1994 Plan which enabled the Company to reduce operating expenses
through the rejections of leases and other executory contracts and personnel
reduction.
The Company's net interest expense was $587,000 for the three months ended June
3, 1995, as compared to $5,467,000 for the nine months ended February 25, 1995.
The decrease in net interest expense is attributable to the 1994 Plan which
eliminated $76,565,000 in Subordinated Notes.
NINE MONTHS ENDED FEBRUARY 25, 1995 COMPARED TO NINE MONTHS ENDING FEBRUARY 26,
1994
Net sales for the nine months ended February 25, 1995 (the "1995 Nine Months")
were $65,623,000, a decrease of $19,170,000, or 22.6%, from $84,793,000 for the
nine months ended February 26, 1994 (the "1994 Nine Months"). Net sales in the
1994 Nine Months include sales of $10,201,000 of Priority Finishing Corporation
("Priority"),an enterprise in which the Company had a minority interest, which
was sold in May 1994. After adjusting for Priority's sales, sales for the 1995
Nine Months declined by $8,969,000, or 12.0%, from the 1994 Nine Months.
The Apparel Division accounted for approximately 57% of the Company's net sales
during the 1995 Nine Months. Net Sales in the Apparel Division for the 1995
Nine Months were $37,217,000, a decrease of $12,612,000, or 25.3%, from
$49,829,000 for the 1994 Nine Months. The Company's decision to de-emphasize
the junior and youthwear business in order to focus on the women's apparel
business, and to limit its sales efforts to the moderate department store level
distribution, contributed to the sales decline.
The Footwear Division accounted for approximately 22% of the Company's Net Sales
during the 1995 Nine Months. Net sales for the Shoe Division for the 1995 Nine
Months were $14,554,000, an increase of $989,000, or 7.3%, from the 1994 Nine
Months sales of $13,565,000. The increase in sales in the 1995 period was
primarily due
15
to the successful introduction of the Division's new athletic shoes in February
and a significant increase in sales to one customer during the third quarter of
Fiscal 1995.
During the 1995 Nine Months, the Uniform Division accounted for approximately
19% of the Company's sales. Net sales for the 1995 Nine Months were
$12,367,000, an increase of approximately $3,130,000, or 33.9%, from the 1994
Nine Months' sales of $9,237,000. The increase in sales was primarily due to an
expansion of the Division's product line.
The Licensing Division's revenues decreased to $1,485,000 in the 1995 Nine
Months, or 24.3%, from $1,961,000 in the 1994 Nine months.
The decline in gross profit from $23,336,000 in the 1994 Nine Months to
$10,629,000 in the 1995 Nine Months and in gross profit as a percentage of sales
from 27.5% in the 1994 Nine Months to 16.2% in the 1995 Nine Months was
primarily due to the disposition of a portion of the 14 oz. denim 5-pocket jean
and corduroy bottoms inventory by the Apparel Division at less than normal
margins. The excess inventory of these products which resulted from late
deliveries and over-buying necessitated such action. The Operational
restructuring charge of $6,052,000 recorded in the 1994 Nine Months included
approximately $1,075,000 in cash payments and non-cash charges of approximately
$4,977,000. These charges covered the costs of restructuring the Apparel
Division in order to implement the division's new operating strategy which was
introduced in the 1994 Back-to-School selling season. The failure of this
strategy resulted in the excess Apparel Division's inventory.
Selling, general and administrative expenses, including amortization of
trademarks and goodwill of the Company, decreased by $8,420,000 in the 1995 Nine
Months to $19,916,000 from $28,336,000 (including the Operational restructuring
charge of $6,052,000) in the 1994 Nine Months. As a percentage of sales,
selling, general and administrative expenses decreased to 30.3% in the 1995 Nine
Months from 33.4% in the 1994 Nine Months. The decrease in selling, general and
administrative expenses in the 1995 Nine Months from the 1994 Nine Months is
primarily attributable to cost reduction in the Apparel Division related to
headcount, rent and other cost savings, and approximately $872,000 was due to
reduced amortization expense attributed to the reorganization.
The operating loss in the 1995 Nine Months was $9,287,000 compared to $5,000,000
in the 1994 Nine Months.
The Company's net interest expense decreased $3,405,000 in the 1995 Nine Months
from the 1994 Nine Months. The decrease in net interest expense in the 1995
period from the 1994 period is attributable to the fact that interest on the
Company's subordinated debt accrued for the entire 1994 Nine Months but, because
of the Company's reorganization which eliminated the Company's subordinated
debt, no interest was charged with respect to the subordinated debt during the
third quarter of fiscal year 1995.
For the 1995 Nine Months, reorganization expenses include professional fees and
expenses of $3,429,000 which consist primarily of legal, accounting, investment
banking and banking fees paid in connection with the negotiation, implementation
and completion of the Company's reorganization. Adjustments to fair market
value of $50,664,000 represent the charge to earnings necessary to reduce the
carrying value of the Company's current assets, property and equipment,
trademarks, and other assets to their values in accordance with fresh start
accounting. The extraordinary gain of $88,291,000 represents the Company's
basis in the debt securities (including accrued interest with respect to such
debt securities) and trade debt that were extinguished in the reorganization.
The tax benefit of 21% for the 1995 Nine Months is lower than the statutory rate
because of the reversal of deferred tax liabilities required as a result of an
increase in deferred tax assets arising from a taxable loss generated in the
1995 Nine Months.
16
LIQUIDITY AND CAPITAL RESOURCES
On December 23, 1994, the Company refinanced its then outstanding revolving
credit facility and term loan with The CIT Group ("CIT"). Pursuant to the
Company's operational restructuring plan, as of August 21, 1995, the term loan
was fully paid and borrowings under the revolving credit facility was
approximately $200,000. Cash to repay the debt was generated from approximately
$9,575,000 in cash proceeds from the sale of the Uniform Division and the
liquidations of inventories and receivables of the Apparel and Footwear
Divisions. At September 1995, borrowings under the revolving credit facility and
the term loan were fully paid. The Company terminated its borrowing agreements
with CIT effective September 30, 1995.
On May 31, 1997, the Company had $9,391,000 in cash and cash equivalents. Cash
flow needs over the next 12 months are expected to be met through the operating
cash flows generated from licensing revenues and the Company's cash and cash
equivalents.
During Fiscal 1997, cash provided by operations was $3,216,000 and cash provided
by investing activities was $5,609,000, which included the return of restricted
cash held as collateral on the LC bond, the proceeds from the sale of assets
held for sale and the repayment of the Strategic Partner note receivable. During
the same period cash used in financing activities was $641,000, which
represented the net from the proceeds received from the exercise of warrants and
stock options, the utilization of pre-bankruptcy net operating loss
carryforwards and the cash dividend distributions made during fiscal year end
May 31, 1997.
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.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
This Form 10-K contains forward-looking statements regarding revenue and
earnings trends, sales of assets, dividend distributions and international
expansion. Such statements are subject to risks and uncertainties. Actual
results could vary materially from these statements or current trends. The
Company is subject to certain risk factors, which include but are not limited
to, competition, dependence on a single licensee and dependence on key
management. These risk factors and 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 the context of these
factors. In addition, the Company disclaims any intent or obligation to update
these forward-looking statements.
17
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
- -----------------------------
CHEROKEE INC. PAGE
- ------------- ----
Reports of Independent Accountants.................................... F-1
Balance Sheets
at May 31, 1997 and June 1, 1996.................................... F-2
Statements of Operations
for the Year Ended May 31, 1997 (Successor Company), and
for the Year Ended 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
Statements of Stockholders' Equity (Deficit)
for the Year Ended May 31, 1997 (Successor Company), and
for the Year Ended 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
Statements of Cash Flows
for the Year Ended May 31, 1997 (Successor Company), and
for the Year Ended 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-24
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 Financial
Statements and related notes.
18
Report of Independent Accountants
The Board of Directors and Stockholders
Cherokee Inc.
We have audited the accompanying balance sheets of Cherokee Inc. (the "Company")
as of May 31, 1997 and June 1, 1996, and the related statements of operations,
stockholders' equity (deficit), and cash flows for the years ended May 31, 1997,
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 financial statements referred to above present fairly, in
all material respects, the financial position of Cherokee Inc. at May 31, 1997
and June 1, 1996 and the results of its operations and its cash flows 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 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
July 8, 1997
F-1
CHEROKEE INC.
BALANCE SHEETS
May 31, 1997 June 1, 1996
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 9,391,000 $ 1,207,000
Restricted cash - 310,000
Receivables, net 1,024,000 694,000
Inventories 80,000 256,000
Other current assets 30,000 10,000
------------ ------------
Total current assets 10,525,000 2,477,000
Assets held for sale - 3,576,000
Notes receivable - 1,961,000
Deferred tax asset 2,408,000
Other assets 668,000 306,000
------------ ------------
Total assets $ 13,601,000 $ 8,320,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 210,000 $ 112,000
Other accrued liabilities 392,000 288,000
Customer deposits 25,000 350,000
------------ ------------
Total current liabilities 627,000 750,000
Other liabilities 750,000 1,500,000
COMMITTMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.02 par value, 20,000,000 shares authorized,
7,726,986 and 7,650,813 shares issued and outstanding
at May 31, 1997 and June 1, 1996, respectively 155,000 153,000
Additional paid-in capital 11,334,000 11,977,000
Accumulated deficit 735,000 (5,916,000)
Note receivable from stockholder - (144,000)
------------ ------------
Total stockholders' equity 12,224,000 6,070,000
------------ ------------
Total liabilities and stockholders' equity $ 13,601,000 $ 8,320,000
============ ============
The accompanying notes are an integral part of these financial statements.
F-2
CHEROKEE INC.
STATEMENTS OF OPERATIONS
Predecessor
Successor Company Company
-------------------------------------------------- -----------------
Year Ended Year Ended Three Months Ended Nine Months Ended
May 31, 1997 June 1, 1996 June 3, 1995 February 25, 1995
------------ ------------ ------------------ -----------------
Revenues:
Product sales, net $ 385,000 $ 12,478,000 $ 19,939,000 $ 64,138,000
Licensing revenues 8,333,000 1,421,000 325,000 1,485,000
------------ ------------ ------------ ------------
Total net sales 8,718,000 13,899,000 20,264,000 65,623,000
Cost of goods sold 184,000 10,445,000 16,310,000 54,994,000
------------ ------------ ------------ ------------
Gross profit 8,534,000 3,454,000 3,954,000 10,629,000
Selling, general and administrative expenses 3,406,000 4,460,000 5,153,000 19,097,000
Performance option expense - 4,567,000 - -
Amortization of trademarks and goodwill - - - 819,000
Operational restructuring charge - - 3,165,000 -
Operating income (loss) 5,128,000 (5,573,000) (4,364,000) (9,287,000)
Other income (expenses):
Interest expense (3,000) (355,000) (587,000) (5,467,000)
Investment and interest income 460,000 543,000 24,000 107,000
Gain on sale of Uniform Division and other assets 220,000 3,840,000 - -
Minority interest and others 75,000 96,000 116,000 167,000
------------ ------------ ------------ ------------
Total other income (expenses), net 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 5,880,000 (1,449,000) (4,811,000) (68,573,000)
Income tax benefit (771,000) - (400,000) (5,230,000)
------------ ------------ ------------ ------------
Income (loss) before extraordinary item 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) $ 6,651,000 $ (1,449,000) $ (4,411,000) $ 24,948,000
============ ============ ============ ============
Primary earnings (loss) per share $ 0.82 $ (0.22) * *
============ ============
Fully diluted earnings (loss) per share $ 0.82 $ (0.22)
============ ============
* 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.
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
Common Stock Additional
------------------------ Paid-in
Shares Par Value Capital
------------------------------------------
Predecessor Company balance at May 28, 1994 5,016,298 50,000 13,150,000
==========================================
Net loss for the nine months ended prior to fresh start adjustments - - -
Recapitalization and fresh start adjustments (Notes 1 and 2)
Cancellation of old common stock (5,016,298) (50,000) (13,150,000)
Issuance of new common stock 6,096,000 122,000 11,703,000
Issuance of note receivable to stockholder - - -
Fresh start adjustments - - -
- ---------------------------------------------------------------------------------------------------------------------
Successor Company balance at February 25, 1995 6,096,000 122,000 11,703,000
Net loss for three months ended June 3, 1995 - - -
- ---------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 3, 1995 6,096,000 122,000 11,703,000
=====================================================================================================================
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
Purchase and retirement of treasury shares (31,593) (1,000) (60,000)
Cancellation of shares held and returned by disbursing agent (475,000) (10,000) 10,000
Distribution of capital - - (4,289,000)
Repayment on note receivable - - -
Net loss for the year ended June 1, 1996 - - -
- ---------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 1, 1996 7,650,813 $153,000 $ 11,977,000
=====================================================================================================================
Exercise of director warrants, employee stock options and 95,000 2,000 404,000
Cancellation of shares held and returned by disbursing agent (18,827) - -
Cash dividend distributions - - (2,529,000)
Utilization of pre-bankruptcy NOL carryforwards - - 1,482,000
Repayment on note receivable - - -
Net income for the year ended May 31, 1997 - - -
- ---------------------------------------------------------------------------------------------------------------------
BALANCE AT MAY 31, 1997 7,726,986 155,000 11,334,000
=====================================================================================================================
Notes
Receivable
Accumulated from
Deficit Stockholders Total
------------------------------------------
Predecessor Company balance at May 28, 1994 (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 - - (13,200,000)
Issuance of new common stock - - 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 - (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 (4,411,000) (192,000) 7,222,000
=====================================================================================================================
Issuance of new common stock - - -
Exercise of director warrants, employee stock options and
performance options - - 4,655,000
Purchase and retirement of treasury shares (56,000) - (117,000)
Cancellation of shares held and returned by disbursing agent - - -
Distribution of capital - - (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 $ (5,916,000) $(144,000) $ 6,070,000
=====================================================================================================================
Exercise of director warrants, employee stock options and - - 406,000
Cancellation of shares held and returned by disbursing agent - - -
Cash dividend distributions - - (2,529,000)
Utilization of pre-bankruptcy NOL carryforwards - - 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 735,000 - 12,224,000
=====================================================================================================================
F-4
CHEROKEE INC.
STATEMENTS OF CASH FLOWS
Successor Company Predecessor Company
----------------------------------------------- -------------------
Three Months Nine Months
Year Ended Year Ended Ended Ended
May 31, 1997 June 1, 1996 June 3, 1995 February 25, 1995
----------------------------------------------- -------------------
OPERATING ACTIVITIES
Net (loss) income $ 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 19,000 18,000 26,000 690,000
Amortization of goodwill and trademarks - - - 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)
Deferred taxes (2,408,000) - (500,000) (5,230,000)
Amortization of deferred financing costs
and debt discount - - - 85,000
Gain on extinguishment of debt - - - (88,291,000)
Fresh start adjustments - - - 50,664,000
Amortization of discount on
note receivable - 108,000 - -
Performance option exercise expense - 4,567,000 - -
Changes in current assets and liabilities:
Receivables (218,000) 10,747,000 5,010,000 (2,441,000)
Inventories 176,000 11,274,000 5,724,000 (1,880,000)
Other current assets (20,000) 496,000 (141,000) (88,000)
Accounts payable (122,000) (1,348,000) (1,794,000) 7,787,000
Accrued payroll and related expenses - (1,559,000) 1,152,000 (227,000)
Income taxes payable - - - -
Other liabilities - (1,668,000) (521,000) 364,000
----------- ------------ ------------ ------------
Net cash provided by (used in) operating
activities 3,216,000 19,710,000 7,168,000 (12,104,000)
Continued
F-5
CHEROKEE INC.
STATEMENTS OF CASH FLOWS
Successor Company Predecessor Company
----------------------------------------------- -------------------
Three Months Nine Months
Year Ended Year Ended Ended Ended
May 31, 1997 June 1, 1996 June 3, 1995 February 25, 1995
----------------------------------------------- -------------------
(Note 2)
INVESTING ACTIVITIES
Purchases of long term assets $ (24,000) $ (25,000) $ (13,000) $ (296,000)
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) - -
Repayment on note receivable from stockholder 144,000 48,000 - -
Change in other assets (358,000) (59,000) 108,000 383,000
Collection of notes receivable 1,961,000 - - -
----------- ------------ ------------ ------------
Net cash provided by (used in) investing activities 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 - - - 14,719,000
Net (payments on) proceeds from revolving
credit and other - (14,213,000) 64,000 (1,232,000)
Utilization of pre-bankruptcy
net operating loss carryforwards 1,482,000 - - -
Proceeds from exercise of stock options 336,000 64,000 - -
Proceeds from exercise of warrants 70,000 24,000 - -
Cash Distributions (2,529,000) (4,289,000) - -
----------- ------------ ------------ ------------
Net cash (used in) provided by financing activities (641,000) (18,414,000) (7,001,000) 11,104,000
----------- ------------ ------------ ------------
Increase (decrease) in cash and cash equivalents 8,184,000 922,000 262,000 (478,000)
Cash and cash equivalents at beginning of period 1,207,000 285,000 23,000 501,000
----------- ------------ ------------ ------------
Cash and cash equivalents at end of period 9,391,000 $ 1,207,000 $ 285,000 $ 23,000
=========== ============ ============ ============
TOTAL PAID DURING PERIOD:
Income taxes $ 4,600 $ - $ 92,000 $ 17,000
Interest $ 3,000 $ 355,000 $ 587,000 $ 1,644,000
The accompanying notes are an integral part of these financial statements.
F-6
NOTES TO FINANCIAL STATEMENTS
1. REORGANIZATION
Cherokee Inc. ("Cherokee" or the "Company") up until May 1995 was a designer,
manufacturer, importer and marketer of casual apparel and footwear primarily
under the Cherokee brand name and on July 28, 1995 sold its Uniform Division.
The Company's principal business since May 1995 has been that of a licensor and
marketer of the Cherokee trademark to wholesalers and retailers. See Note 7.
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"). As of May 31, 1997 the Disbursing Agent had
distributed 517,795 shares of Common Stock to general unsecured creditors and
had 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.
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.
F-7
NOTES TO FINANCIAL STATEMENTS
Old Warrants: Series A, Series B and Series C Warrants were cancelled and
holders received no consideration under the Plan.
Reorganization items included in the statement of operations for the nine months
ended February 25, 1995 consist of professional fees and expenses of $3,429,000,
which consist primarily of legal, accounting, investment banking and banking
fees.
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-8
NOTES TO FINANCIAL STATEMENTS
BALANCE SHEETS
FEBRUARY 25, 1995
($000 OMITTED)
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)(3) 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-9
NOTES TO FINANCIAL STATEMENTS
(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.
F-10
NOTES TO FINANCIAL STATEMENTS
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
COMPANY YEAR END
The Company uses a 52 or 53 week fiscal year ending on the Saturday nearest 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.
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.
F-11
NOTES TO FINANCIAL STATEMENTS
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.
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 registration and renewal fees
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.
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 cash by
maintaining cash balances with quality financial institutions. At 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 May 31,
1997, the Company had nineteen continuing license agreements; seven of which
were with retailers, six of which were with domestic licensees and six of which
were with international licensees.
F-12
NOTES TO FINANCIAL STATEMENTS
One customer accounted for approximately 83% of the Company's trade receivables
at May 31, 1997 and approximately 68% of the Company's revenues during the
fiscal year ended 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
Our 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
Primary earnings (loss) per common share amounts were computed by dividing
earnings (loss) by the average number of common and dilutive equivalent shares
outstanding. Fully diluted per-common-share amounts assume the issuance of
common stock for all other potentially dilutive equivalents outstanding. The
weighted average number of shares used in the calculation of primary and fully
diluted earnings per share were 8,091,725 and 8,156,188 shares, respectively.
For the year ended June 1, 1996, the Company recorded a non-cash charge to
recognize performance option expense of $4,567,000, resulting in a reduction in
earnings per share of $0.70.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS
128 is effective for financial statements for periods ending after December 15,
1997. The Company will adopt this statement and reflect its disclosures in the
Company's 1997 financial statements. SFAS 128 requires dual presentation of
basic and diluted earnings per share, as defined. This statement requires that
prior period earnings per share data be restated. As a result, earnings per
share as of May 31, 1997 would reflect basic and diluted earnings per share of
$0.87 and $0.82, respectively. The weighted average number of shares used in
the calculation of basic and diluted earnings per share were 7,682,377 and
8,091,725 shares, respectively.
F-13
NOTES TO FINANCIAL STATEMENTS
4. RECEIVABLES
Receivables consist of the following:
MAY 31, 1997 JUNE 1, 1996
------------ ------------
Trade $ 657,000 $ 621,000
Due from Factor - 43,000
Note Receivable, Current 250,000 -
------------ ------------
Other 117,000 621,000
------------ ------------
1,024,000 1,285,000
Less allowance for doubtful accounts - (591,000)
------------ ------------
$1,024,000 $ 694,000
============ ============
Management has made its best estimate as to the collectibility of accounts
receivable considering the fact that the Company has sold or terminated its
significant operations. In establishing its allowance for doubtful accounts,
the Company has taken into consideration termination of its customer relations
in determining the adequacy of its allowance for doubtful accounts.
5. LONG-TERM DEBT
REVOLVING CREDIT FACILITY AND TERM LOAN
On December 23, 1994, the Company entered into a revolving credit facility and
term loan with CIT (the "CIT Agreement"). The interest rates on the revolving
credit facility and the term loan were equal to the Chemical Bank base rate plus
1.5% and plus 2%, respectively. The weighted average interest rate on the
Company's short term borrowings was 10.54% for the year ended June 3, 1995. As
of September 30, 1995 both the revolving credit facility and term loan were
repaid. In consideration for CIT entering into the CIT Agreement, the Company
granted CIT a Warrant to purchase up to 10% of the shares of Common Stock to be
issued in connection with the 1994 Plan (approximately 570,000 shares). In
April 1995, an unaffiliated third party ("Investor") paid CIT $500,000 to
surrender the CIT Warrant to the Company. The fair market value of the Warrant
was considered in the reorganization value of the Company determined in
conjunction with the 1994 Plan.
In April 1995, the Company entered into agreements in principle pursuant to
which the Company would have issued to an unaffiliated investor, a warrant to
purchase 440,000 shares of Common Stock at an exercise price of $.02 per share
and the Company would have caused the investor to be appointed a director of the
Company in consideration for his (a) paying $500,000 to CIT to purchase the
warrant held by CIT entitling CIT to purchase up to 10% of the shares of Common
Stock to be issued in connection with the 1994 Plan (approximately 570,000
shares) at an exercise price of $.02 per share and surrendering such warrant to
the Company, (b) guaranteeing a $4,000,000 overadvance facility to be provided
the Company by CIT until August 31,1995 and a $2,000,000 overadvance facility
from September 1, 1995 to January 31, 1996 and (c) securing such guarantee with
standby bank letters of credit. The investor paid CIT $500,000 and the CIT
warrant was surrendered to the Company. Prior to the issuance of the new
warrant to the investor, the Company made a major change of strategy as a result
of which the Company no longer required the CIT overadvance. The Company
negotiated a new agreement with the investor pursuant to which he and the
Company agreed to surrender all of their rights under the original agreement
between them and the Company agreed to issue to him or his nominee 366,667
shares of Common Stock and to
F-14
NOTES TO FINANCIAL STATEMENTS
5. LONG-TERM DEBT (CONTINUED)
reimburse the investor for his legal fees up to $10,000. On June 21, 1995, the
investor became a director of the Company and on August 21, 1995, the Company
issued 366,667 shares of Common Stock to Axicom Capital Group, the investor's
nominee.
6. INCOME TAXES
The income tax benefit as shown in the statements of operations includes the
following:
SUCCESSOR PREDECESSOR
SUCCESSOR COMPANY COMPANY COMPANY
--------------------------- ------------ -----------------
THREE MONTHS NINE MONTHS
YEAR ENDED YEAR ENDED ENDED ENDED
MAY 31, 1997 JUNE 1, 1996 JUNE 3, 1995 FEBRUARY 25, 1995
------------ ------------ ------------ -----------------
Current:
Federal $ 96,000 $ - $ - $ -
State 32,000 - 100,000 -
Foreign 27,000 - - -
------------ ------------ ------------ -----------------
155,000 - 100,000 -
Deferred:
Federal (785,000) - (250,000) (3,355,000)
State (141,000) - (250,000) (1,875,000)
Foreign - - - -
------------ ------------ ------------ -----------------
(926,000) - (500,000) (5,230,000)
------------ ------------ ------------ -----------------
$ (771,000) $ - $ (400,000) $(5,230,000)
Deferred income taxes are comprised of the following:
MAY 31, 1997 JUNE 1, 1996
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 - 8,648,000 - 10,624,000
Other - 218,000 - 90,000
Valuation allowance - (6,458,000) - (10,714,000)
----------------------------- -----------------------------
Total deferred tax assets $ - $ 2,408,000 $ - $ -
----------------------------- -----------------------------
F-15
NOTES TO FINANCIAL STATEMENTS
6. INCOME TAXES (CONTINUED)
JUNE 3, 1995
- -------------------------------------------------------------------------------
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 - 14,823,000
Other - 232,000
Valuation allowance (4,404,000) (15,497,000)
Total deferred tax assets $ - $ -
- -------------------------------------------------------------------------------
The Company has provided a valuation reserve against the majority of the
deferred tax assets due to the uncertainty surrounding the utilization of the
net operating loss and tax credit carryforwards. A valuation allowance has not
been provided to the extent of projected future earnings for the fiscal year
ending May 31, 1998 based upon management's estimation of future income. Any
reduction in the valuation allowance relating to pre-organization carryovers
will be credited to additional paid in capital.
A reconciliation of the actual income tax rates to the federal statutory rate
follows:
SUCCESSOR PREDECESSOR
SUCCESSOR COMPANY COMPANY COMPANY
---------------------------- -------------------------------
NINE MONTHS
YEAR ENDED YEAR ENDED THREE MONTHS ENDED
MAY 31, JUNE 1, ENDED FEBRUARY 25,
1997 1996 JUNE 3, 1995 1995
---------------------------- -------------------------------
Tax (benefit) expense at U.S.
statutory rate 34.0% (34.0)% (34.0)% 34.0%
Additional paid-in-capital 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 (41.0) -- -- --
Foreign taxes .5 -- -- --
Nondeductible reorganization costs -- -- -- 4.7
State income tax benefit net of federal
income tax .4 -- (3.1) --
Minority interest and others 1.4 -- .4 --
----- ---- ---- -----
Tax benefit (13.1)% -- (8.0)% (21.0)%
=====================================================================
F-16
NOTES TO FINANCIAL STATEMENTS
6. INCOME TAXES (CONTINUED)
At June 1 1997 the Company has federal and California tax net operating loss
carryovers ("NOL's"), generated subsequent to the Company's 1994 reorganization,
of approximately $13,200,000 and $4,000,000, respectively, which will begin to
expire in 2010 and 2000, respectively. The 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.
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.
F-17
NOTES TO FINANCIAL STATEMENTS
8. COMMITMENT AND CONTINGENCIES
LEASES
The Company leases real property under a lease agreement expiring on February
28, 1998. 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.
Since May 26, 1995, the Company has subleased approximately 1,500 square feet of
office space from Wilstar. The Company pays Wilstar $.75 per square foot or
$1,125 per month. In addition, the Company reimburses Wilstar for one-half of
certain costs relating to this office space. 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 subleased 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 $60,000, $198,000, $149,000 and $730,000, 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, respectively.
9. SEGMENT INFORMATION
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.
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
The Newstar Group d/b/a The Wilstar Group ("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 will terminate on May 31,
1998; however, the Agreement will automatically extend 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. Wilstar will receive an annual management
fee of $400,000 and a bonus equal to 10% of the Company's pre-tax earnings in
excess of $2,666,000 in Fiscal 1996 and in excess of $2,500,000, thereafter. At
May 31, 1997, the Company had accrued the bonus payable under Other Accrued
Liabilities. In addition, Wilstar received options to purchase 7-% of the Common
Stock on a fully diluted basis (675,700 shares) at a purchase price of $3.00 per
share (the "Wilstar Options"). All of these options are currently exercisable.
During the fiscal year ended May 31,1997, the Company made compensation payments
in lieu of cash dividends to Wilstar
F-18
NOTES TO FINANCIAL STATEMENTS
10. EMPLOYMENT AND MANAGEMENT AGREEMENTS (CONTINUED)
totalling $375,100. Wilstar's ability to exercise the Wilstar Options
accelerates and such options become fully exercisable upon the occurrence of
certain events, including a termination of the Wilstar Agreement without cause,
termination due to the Company's breach, or under certain circumstances, the
merger of the Company, sale of substantially all of its assets, or sale of a
majority of its common stock.
In the original Agreement Wilstar had the right to purchase up to an additional
22.5% of the Common Stock at a price of $.02 per share until May 3, 2000 based
on the equity value of the Company as follows:
CUMULATIVE PERCENTAGE OF DILUTED
COMMON STOCK EXERCISABLE EQUITY VALUE OF THE COMPANY(i)
7.5% Equal to or Greater than $32,500,000
7.5% Equal to or Greater than $52,500,000
5.0% Equal to or Greater than $72,500,000
2.5% Equal to or Greater than $92,500,000
-----
22.5%
=====
(i) The "Equity Value" of the Company shall be computed as the product
of the average closing trading price of the Common Stock for any
ninety (90) day period ending on or before May 3, 2000 during the term
of the agreement, multiplied by the weighted average number of
outstanding shares of Common Stock during such period.
On April 24, 1996, the Board of Directors revised the original Agreement to
accelerate the vesting of Wilstar's performance options so that Wilstar has been
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.
The Agreement further provides that Wilstar and the Group each have the right to
elect two members of the Company's Board of Directors.
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. The note has been recorded as a reduction to
stockholders equity. Proceeds from the sale of such stock must be applied first
to accrued and unpaid interest and then to unpaid principal. 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
F-19
NOTES TO FINANCIAL STATEMENTS
10. EMPLOYMENT AND MANAGEMENT AGREEMENTS (CONTINUED)
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 President of the Company, is employed pursuant to a three-year
agreement expiring on May 30, 1998 which provides 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 could earn bonuses in Fiscal 1997 and Fiscal 1998
ranging from 10% of her salary up to $175,000 in Fiscal 1997 and Fiscal 1998
based upon the Company's earnings before interest and taxes. The agreement
gives the Company the right to terminate Ms. Warren's employment without cause
at any time. If the Company exercised such right before November 30, 1995 it
would have been obligated to pay Ms. Warren $50,000; if it exercises such right
any time thereafter, it must pay Ms. Warren $162,500.
11. CERTAIN TRANSACTIONS
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 5000 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 5000 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.
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.
13. STOCK OPTION PLAN
The Company's 1995 Incentive Stock Option Plan (the "Option Plan") was approved
at the October 30, 1995 Annual Meeting of Stockholders. The purpose of the
Option 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 may be granted under the plan - Incentive and Non-Qualified stock
options.
Any employee is eligible to receive a Stock Option under the Option 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 Stock
Option is granted the Stock Option price is at least 110% of the fair market
value of the shares subject to the Stock Option.
The aggregate number of shares which may be issued upon the exercise of Stock
Options granted under the Option Plan shall not exceed 600,000 shares of Common
Stock. The Stock Options are vested in equal installments over a three year
period, starting from the date of grant and have a term of ten years.
F-20
NOTES TO FINANCIAL STATEMENTS
13. STOCK OPTION PLAN (CONTINUED)
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 fiscal
year ended May 31, 1997, an aggregate of $391,850 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 rate range between 5.27% and
6.57%; dividend yields of 12.8%; 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.
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:
1997 1996
---- ----
Pro Forma net income (loss)................ $ 6,546,000 $ (1,502,000)
Pro forma earnings (loss) per share......... $ 0.81 $ (0.22)
F-21
NOTES TO FINANCIAL STATEMENTS
13. STOCK OPTION PLAN (CONTINUED)
A summary of the Company's stock option activity, and related information for
the years ended May 21, 1997 and June 1, 1996 follows:
1996 1997
---------------------- ------------------------
Weighted Weighted
-------- --------
Average Average
------- -------
Options Exercise Options Exercise
------- -------- ------- --------
Price Price
----- -----
Outstanding at beginning of year - $ .00 180,000 $3.29
Granted 210,000 3.27 35,000 6.25
Exercised (10,000) 3.00 (20,000) 3.03
Forfeited (20,000) 3.00 (15,000) 3.13
Outstanding at end of year 180,000 3.29 180,000 3.91
======= ===== ======= =====
Exerciseable at end of year - - 45,003 3.35
Weighted average per option fair value
of options granted during the year
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
In June 1997, the Management Agreement (the "Agreement") between the Company and
Wilstar was amended with the approval of the Board of Directors. The changes to
the Agreement 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 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 and provision for an annual cost-of-living increase in base
compensation after fiscal year 1998; (iv) 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%
F-22
NOTES TO FINANCIAL STATEMENTS
15. SUBSEQUENT EVENT (CONTINUED)
to 15% of such earnings in excess of $10,000,000; (v) 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 end of fiscal years 1998, 1999, or 2000); and (vi) 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 fiscal year 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 fiscal years 1998, 1999, or 2000). The amendments to the Agreement
providing for payment of an acquisition bonus and payment for an agreement not
to compete to Wilstar in the event of an acquisition of the Company are
contingent upon the approval of the stockholders of the Company. Those
amendments will be submitted for consideration and approval of the stockholders
of the Company at the next annual meeting of stockholders of the Company.
F-23
NOTES TO FINANCIAL STATEMENTS
CHEROKEE INC.
SCHEDULE II--VALUATIONS AND QUALIFYING ACCOUNTS AND RESERVES
CHARGED/
BALANCE AT (CREDITED) TO CHARGED TO BALANCE
BEGINNING COSTS AND OTHER AT END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- -------------------------------------------------------------------------------------------------------------------------------
DEDUCTED FROM ASSETS TO WHICH THEY
APPLY:
ALLOWANCE FOR DOUBTFUL ACCOUNTS
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 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 MAY 31, 1997
YEAR ENDED JUNE 1, 1996 $19,901,000 $ - $ - $3,485,000 $16,416,000
YEAR ENDED JUNE 3, 1995 $ - $ - $ 19,901,000 $ - $19,901,000
(1) Uncollectible accounts receivable written off against the allowance.
F-24
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 September 15,
1997, which will be filed with the SEC no later than 120 days after the close of
the fiscal year ended May 31, 1997. The following table sets forth information
with respect to each of the Company's executive officers.
NAME, AGE AND PRINCIPAL OCCUPATION FOR PAST FIVE YEARS;
PRESENT POSITION WITH THE BUSINESS EXPERIENCE
COMPANY
------------------------- -----------------------------------------
Robert Margolis, 49 Mr. Margolis was appointed Chairman of the Board
Director, Chairman of the and Chief Executive Officer of the Company on
Board of Directors and May 5, 1995. Mr. Margolis was the co-founder of
Chief Executive Officer 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. In 1994
Mr. Margolis became Chief Executive Officer and
a Director of The Newstar Group, which does
business as The Wilstar Group ("Wilstar").
Wilstar through its subsidiaries, operates
various textile and apparel related enterprises
including a private label apparel manufacturer.
Patricia Warren, 50 Ms. Warren has been employed by Cherokee since
President May 1995 and became its President on June 21,
1995. 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.
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
Rampage Clothing Company & Rampage Retailing.
19
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 September 15, 1997, which
will be filed with the SEC no later than 120 days after the close of the fiscal
year ended May 31, 1997.
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 September 15, 1997, which
will be filed with the SEC no later than 120 days after the close of the fiscal
year ended May 31, 1997.
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 September 15, 1996, which
will be filed with the SEC no later than 120 days after the close of the fiscal
year ended May 31, 1997.
20
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.
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).
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).
21
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT
- -------------- ----------------------
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 8K 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).
10.11 Amendment No. 2 to the Revised and Restated Wilstar
Management Agreement dated July 21, 1997
10.12 Amendment No. 3 to the Revised and Restated Wilstar
Management Agreement dated July 21, 1997
10.13 Plan for Compensation in Lieu of Cash Dividends, dated
January 15, 1997.
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).
23.1 Consent of Independent Auditors dated July 15, 1997
27.1 Article 5 of Regulation S-X -Financial Data Schedule
(b) Reports on Form 8-K.
The Company filed no reports on Form 8-K during the last quarter of fiscal
year 1997.
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CHEROKEE INC.
By /s/ Robert Margolis
------------------------------------
Robert Margolis
Chairman and Chief Executive Officer
Date: July 25, 1997
23
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.
Robert Margolis
/s/ Robert Margolis Chairman and Chief Executive July 25, 1997
- -------------------- Officer and Director
Robert Margolis
/s/ Carol Gratzke Chief Financial Officer/ July 25, 1997
- -------------------- Chief Accounting Officer
Carol Gratzke
/s/ Herschel Elias Director July 25, 1997
- --------------------
Herschel Elias
/s/ Jeffrey Schultz Director July 25, 1997
- --------------------
Jeffrey Schultz
/s/ Douglas Weitman Director July 25, 1997
- --------------------
Douglas Weitman
/s/ Jess Ravich Director July 25, 1997
- --------------------
Jess Ravich
/s/ Keith Hull Director July 25, 1997
- --------------------
Keith Hull
/s/ Avi Dan Director July 25, 1997
- --------------------
Avi Dan
24