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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 February 3, 2001 or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file No. 0-18640
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CHEROKEE INC.
(Exact name of registrant as specified in charter)
Delaware 95-4182437
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
6835 Valjean Avenue
Van Nuys, CA (818) 908-9868 91406
(Address of principal (Registrant's telephone (Zip Code)
executive office) number,
including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.02 par value per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
As of March 27, 2001, the registrant had 8,231,705 shares of its Common
Stock, par value $.02 per share, issued and outstanding.
As of March 27, 2001, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $31,973,000 (computed on the
basis of the last trade of the Common Stock on the NASDAQ National Market
System on March 27, 2001).
Documents Incorporated by Reference:
Certain portions of the registrant's proxy statement for the Annual Meeting
of Stockholders to be held on May 31, 2001 are incorporated by this reference
into Part III as set forth herein.
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CHEROKEE INC.
INDEX
Page
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PART I
Item 1. Business......................................................... 2
Item 2. Properties....................................................... 13
Item 3. Legal Proceedings................................................ 13
Item 4. Submission of Matters to a Vote of Security Holders.............. 13
PART II
Market for the Registrant's Common Equity and Related Stockholder
Item 5. Matters.......................................................... 14
Item 6. Selected Financial Data.......................................... 15
Management's Discussion and Analysis of Financial Condition and
Item 7. Results of Operation............................................. 16
Item 7A. Qualitative and Quantitative Disclosures of Market Risk.......... 21
Item 8. Consolidated Financial Statements and Supplementary Data......... 23
Changes in and Disagreements with Accountants on Accounting and
Item 9. Financial Disclosure............................................. 24
PART III
Item 10. Directors and Executive Officers of the Registrant............... 24
Item 11. Executive Compensation........................................... 25
Item 12. Security Ownership of Certain Beneficial Owners and Management... 25
Item 13. Certain Relationships and Related Transactions................... 25
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 26
PART I
Item 1. BUSINESS
Introduction
Cherokee Inc. (the Company, which may be referred to as WE, US, or OUR) is in
the business of marketing and licensing the Cherokee and Sideout brands and
related trademarks and other brands it owns or represents. We are one of the
leading licensors of brand names and trademarks for apparel, footwear and
accessories in the United States. Our operating strategy emphasizes domestic
and international retail direct and wholesale licensing whereby we grant
retailers and wholesalers the license to use the trademarks held by us on
certain categories of merchandise, and the licensees are responsible for
designing and manufacturing the merchandise.
We and our wholly-owned subsidiary, SPELL C. LLC ("Spell C"), own several
trademarks including Cherokee(R), Sideout(R), Sideout Sport(R), King of the
Beach(R) and others. The Cherokee brand, which began as a footwear brand in
1973, has been positioned to connote quality, comfort, fit, and a "Casual
American" lifestyle with traditional wholesome values. The Sideout brand and
related trademarks, which represent an active lifestyle, were acquired by us in
November 1997. As of February 3, 2001, we had twenty-three continuing license
agreements, covering both domestic and international markets.
Our retail direct licensing strategy is premised on the proposition that in
the United States nearly all aspects of the moderately priced apparel, footwear
and accessories business can be sourced most effectively by large retailers,
who not only command significant economies of scale, but also interact daily
with the end consumer. In addition, we believe that these retailers in general
may be able to obtain higher gross margins on sales and increase store traffic
by directly sourcing, stocking and selling licensed products bearing widely
recognized brand names, such as our brands, than through carrying strictly
private label goods or branded product from third-party vendors. Our strategy
in the United States is to capitalize on these ideas by licensing our portfolio
of brands primarily to strong and growing retailers, who, working in
conjunction with us, develop merchandise for their stores.
Beginning in 1995, we began to take a number of important steps designed to
implement our retail direct licensing strategy. On August 15, 1995, we entered
into a strategic alliance with one of the largest retailers in the United
States, Target Stores, a division of Target Corp. In November 1997, we
reaffirmed our relationship with Target Stores, by entering into an amended
licensing agreement (the "Amended Target Agreement") which grants Target Stores
the exclusive right in the United States to use the Cherokee trademarks on
certain specified categories of merchandise. Under the Amended Target
Agreement, Target Stores is obligated to pay royalties based upon a percentage
of its net sales of Cherokee branded merchandise, with a minimum guaranteed
royalty of $60.0 million over the six-year initial term of the agreement.
During the fiscal year ended February 3, 2001 ("Fiscal 2001"), a wide range of
Cherokee branded merchandise was sold at over 970 Target stores. Due to the
strong presence and sales of Cherokee branded products in Target Stores during
Fiscal 2001, royalty revenues from Target Stores totalled approximately $19.3
million, which is 183.5% of the guaranteed minimum royalty for Fiscal 2001
under the Amended Target Agreement.
In August 1997, we entered into a licensing agreement with one of Canada's
largest retailers, Zellers Inc., a division of the Hudson's Bay Company, under
which Zellers was granted the exclusive right in Canada to use the Cherokee
trademarks in connection with a broad range of categories of merchandise. Under
the Zellers licensing agreement, Zellers is obligated to pay royalties based
upon a percentage of its net sales of Cherokee branded merchandise with a
minimum guaranteed royalty of $10.0 million over the five-year initial term of
the agreement. Zellers commenced the initial sales of Cherokee branded
merchandise in over 350 stores in July 1998 and during Fiscal 2001 royalty
revenues from Zellers totalled approximately $3.7 million, which is 180.2% of
the guaranteed minimum royalty for Fiscal 2001 under the Zellers license
agreement.
To increase our licensing potential, we purchased all of Sideout Sport Inc.'s
trademarks, copyrights, trade secrets and associated license agreements on
November 7, 1997. The trademarks acquired from Sideout Sport
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Inc. included, among others, Sideout, Sideout Sport and King of the Beach.
Royalty revenues derived from the Sideout brands have grown from $585,000
during our fiscal year ended January 30, 1999 to approximately $3.0 million
during Fiscal 2001.
We are frequently approached by parties seeking to sell their brands and
related trademarks. Should an established and marketable brand become available
on favorable terms, we would be interested in pursuing such an acquisition. In
addition to acquiring brands and licensing our own brands, we assist other
companies, wholesalers and retailers, in identifying licensees or licensors for
their brands or stores. Generally, as an exclusive consultant, we will perform
a range of services including marketing of brands, solicitation of licensees,
contract negotiations and administration and maintenance of license or
distribution agreements. In return for our services we will normally charge a
certain percentage of the net royalties generated by the brands we represent
and manage.
Cherokee was incorporated in Delaware in 1988. Our principal executive
offices are located at 6835 Valjean Avenue, Van Nuys, California 91406,
telephone (818) 908-9868.
Overview of Licensing Business
The Cherokee name, which began as a footwear brand in 1973, has been
positioned to connote quality, comfort, fit, and a "Casual American" lifestyle
with traditional, wholesome values. The Sideout brand and related trademarks,
which represent an active lifestyle, were acquired by us in November 1997. See
"Sideout Agreement" below. Our primary emphasis for the past five years has
been directed toward domestic and international retail direct and wholesale
licensing. As of February 3, 2001, we had twenty-three continuing license
agreements, covering both domestic and international markets, fifteen of which
pertained to the Cherokee brand.
Our license agreements are with retailers and wholesalers and are either
international master agreements or category-specific exclusive or non-exclusive
agreements. Of the twenty-three licensing agreements, seven are with retailers,
five are with domestic wholesalers and eleven are with international
wholesalers or retailers. In retail direct licensing, we grant retailers a
license to use the trademarks on certain categories of merchandise. We provide
design direction and collaborate with our retailers on pre-approved packaging,
graphics and quality control standards. The retailer is responsible for
manufacturing the merchandise. We refer to this practice as our "retail direct"
licensing strategy. Wholesale licensees manufacture and import various
categories of footwear and accessories under our trademarks and sell the
licensed products to retailers. Our retail, wholesale and international license
agreements provide us with final approval of pre-agreed upon quality standards,
packaging and in most cases marketing of licensed products. We have the right
to conduct periodic quality control inspections to ensure that the image and
quality of licensed products remain consistent. We will continue to solicit new
licensees through a small number of executive employees and may retain the
services of outside consultants to assist us in this effort.
Our current business strategy is to maximize the value of our existing and
future brands by exploiting them in a manner that recognizes the relative
market power, in different areas of the world, of the various participants--
manufacturer, wholesaler and retailer--in the chain of supply to the ultimate
consumer. In the United States, market power and accompanying economies of
scale, are generally and increasingly held by a few dominant retailers of
moderately priced merchandise, and, accordingly, in the United States we have
pursued our retail direct licensing strategy. In contrast to the retail market
in the United States, as well as in Canada, in selected international markets
we have sought to develop our brands through wholesale licenses with
manufacturers or other companies who have market power and economies of scale
in their respective markets. Finally, in some countries, we believe that an
owner or licensee of one or more well-known U.S. brands has the opportunity to
become a dominant, vertically integrated manufacturer or retailer or both of
branded apparel, footwear and accessories. Accordingly, in those countries we
have begun to pursue licensing or strategic alignments whereby our brands can
become the basis for such a vertically integrated manufacturer/retailer. This
strategy permits us to operate with minimal working capital, virtually no
capital
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expenditures (other than those associated with acquiring new brands and related
trademarks), no production costs, significantly reduced design, marketing,
distribution and other operating expenses, and a small group of core employees.
United States Retail Direct Licensing
Our retail direct licensing strategy is premised on the proposition that in
the United States nearly all aspects of the moderately priced apparel, footwear
and accessories business, from product development and design, to
merchandising, to sourcing and distribution, can be executed most effectively
by large retailers, who not only command significant economies of scale, but
also interact daily with the end consumer. In addition, we believe that these
retailers in general may be able to obtain higher gross margins on sales and
increase store traffic by directly sourcing, stocking and selling licensed
products bearing widely recognized brand names (such as our brands) than
through carrying strictly private label goods or branded product from third-
party vendors. We also expect that the enhanced profitability to retailers of
private label products and in-store brands, coupled with the substantial and
increasing marketing costs to establish and maintain a widely recognized
apparel brand, will result in further erosion of revenues and profitability for
mid-sized and small apparel manufacturers and corresponding increased
desirability to retailers of well-established brands with broad appeal. Our
strategy in the United States is to capitalize on these trends by licensing our
portfolio of brand names to retailers, who, working in conjunction with us,
develop merchandise for their stores, and to augment that portfolio by
acquiring additional brands, which have high consumer awareness, broad appeal
and applicability to a range of merchandise categories.
On November 12, 1997, we reaffirmed our relationship with Target Stores by
entering into the Amended Target Agreement. This agreement was subsequently
assigned to Spell C and pledged as collateral for the Zero Coupon Secured Notes
issued by Spell C. See "Recapitalization; Sale of Cherokee Trademarks to Spell
C; Issuance of Secured Notes" below. The Amended Target Agreement grants Target
Stores the exclusive right in the United States to use the Cherokee trademarks
in certain specified categories of merchandise including:
. men's, women's and children's apparel, including intimate apparel,
foundations and sleepwear;
. men's, women's and children's fashion accessories;
. bed and bath products and accessories;
. luggage, sports bags and backpacks;
. home textiles;
. domestics and home decor products;
. home furnishings;
. sporting goods; and
. cosmetics, bath and body products.
Some of the above-listed categories are subject to current license agreements
between us and third parties. The Amended Target Agreement provides that upon
the expiration or termination of such agreements, the categories of merchandise
subject to such agreements will become exclusive to Target Stores in the
United States. Due to the broad nature of the rights granted to Target Stores
in the United States, and the restrictions contained in the Amended Target
Agreement, we may not enter into new licensing agreements in the United States
with respect to the Cherokee brand, except for retail license agreements for
cosmetics, bath and body products with several drug chain stores.
Under the Amended Target Agreement, Target Stores has agreed to pay a royalty
each fiscal year, up to and including the fiscal year ending January 31, 2004,
based on a percentage of Target Stores' net sales of Cherokee branded
merchandise during each fiscal year, which percentage varies according to the
volume of sales of merchandise. In any event, Target Stores has agreed to pay a
minimum guaranteed royalty of
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$9.0 million for each of the two fiscal years ending January 31, 1999 and 2000
and $10.5 million for each of the four fiscal years ending January 31, 2001
through 2004.
The initial term of the Amended Target Agreement commenced on February 1,
1998 and ends January 31, 2004. If Target Stores is current in its payments of
the minimum guaranteed royalty, the Amended Target Agreement will automatically
renew for the fiscal year ending in 2005, and will continue to automatically
renew for successive fiscal year terms provided that Target Stores has paid a
minimum guaranteed royalty equal to or greater than $9.0 million for the
preceding fiscal year. Target Stores commenced the initial sales of Cherokee
branded merchandise in July 1996. Royalty revenues from Target Stores were $5.9
million during our fiscal year ended May 31, 1997, $6.4 million during our
eight month fiscal period ended January 31, 1998, $14.6 million during our
fiscal year ended January 30, 1999, $16.3 million during our fiscal year ended
January 29, 2000 ("Fiscal 2000") and $19.3 million during Fiscal 2001, which
accounted for 68%, 75%, 76%, 66% and 68%, respectively, of our consolidated
revenues during such periods. See "Risk Factors."
Our retail direct licensees for the Sideout brand continued to achieve
positive results from sales of merchandise bearing the Sideout brand.
Categories of merchandise under license include men's, women's and children's
sportswear; accessories, luggage, sports bags and backpacks, skin care products
and hats. During Fiscal 2001, royalty revenues from retail direct licensees for
the Sideout brand totaled $2.6 million. Also during Fiscal 2001, Mervyn's
exercised its right to renew its licensing agreement for the Sideout brand for
an additional term of three years on the same terms and conditions. The renewal
term will commence on February 1, 2002 and continue through January 31, 2005.
We intend to continue to actively pursue our retail direct licensing strategy
to further develop the Sideout brand in the United States.
During Fiscal 2001, the non-exclusive United States retail direct licensees
included Brylane, Pamida, Mervyn's, Gart Sport/Sportmart, Bob's Stores and
Casual Male. Generally, royalties on non-exclusive domestic retail licenses
begin at 3% of the retailer's net sales of licensed products and may decrease
depending on the retailer's annual sales of licensed products and the
retailer's guaranteed annual sales of licensed products.
During Fiscal 2001, our license agreement with Brylane expired and was not
renewed. Additionally, ShopKo Stores Inc., as part of its integration of the
Pamida operations, made the decision to discontinue use of the Cherokee brand
in its merchandise assortments and requested a termination of the Pamida
licensing agreement with us. We agreed to terminate the licensing agreement
with Pamida in return for a cash payment of $375,000 as settlement in full of
the remaining minimum royalties due under the existing licensing agreement.
As an incentive for our licensees to achieve higher retail sales of Cherokee
or Sideout branded products, many of our existing license agreements, including
the Amended Target Agreement, are structured to provide royalty rate reductions
for the licensees after they achieve certain levels of retail sales of Cherokee
or Sideout branded products during each fiscal year. As a result, our royalty
revenues as a percentage of our licensees' retail sales of branded products are
highest at the beginning of each fiscal year and decrease throughout each
fiscal year as licensees reach certain retail sales thresholds contained in
their respective license agreements. Therefore, the amount of royalty revenue
received by us in any quarter is dependent not only on retail sales of branded
products in such quarter, but also the resulting attainment of royalty rate
reductions in any preceding quarters in the same fiscal year. The size of the
royalty rate reductions and the level of retail sales at which they are
achieved vary in each licensing agreement.
During Fiscal 2001, we and Spell C received $22.4 million in aggregate
royalties from the United States retail direct license agreements, which
accounted for 79.3% of our consolidated revenues during such period.
United States Wholesale Licensing
We currently have five wholesale license agreements that grant unaffiliated
manufacturers the license to manufacture and market sunglasses, footwear,
handbags, purses and watches under our Cherokee and Sideout trademarks in the
United States. Our wholesale license agreements typically require the wholesale
licensee to
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pay royalties on revenues against a guaranteed minimum royalty that generally
increases over the term of the agreement. Two wholesale licensing agreements
for the Cherokee brand, which included Outlook for sunglasses and Bueno for
luggage, handbags and purses, were terminated during Fiscal 2001. The remaining
wholesale licensing agreements for the Cherokee brand will expire during the
term of the Amended Target Agreement and the categories of merchandise subject
to such terminated license agreements will become exclusive to Target Stores in
the United States.
Our wholesale license agreements for the Sideout brand are for product
categories including footwear, sunglasses, watches and related time products.
The agreements have various expiration dates and contain three- to five-year
renewal options. The total number of wholesale licensing agreements for the
Sideout brand was three as of February 3, 2001.
During Fiscal 2001, we received $1.2 million in aggregate royalties from our
wholesale licensing agreements, which accounted for 4.2% of our consolidated
revenues during such period.
International Licensing
We will continue to seek to develop in several international markets both our
Cherokee and Sideout brands and other brands we represent through retail
direct, master or wholesale licenses with manufacturers or other companies that
have market power and economies of scale in their respective markets.
On August 22, 1997, we entered into an international retail direct licensing
agreement with Zellers Inc., a Canadian corporation, which is a division of
Hudson's Bay Company. Zellers was granted the exclusive right in Canada to use
the Cherokee brand and related trademarks in connection with a broad range of
categories of merchandise, including women's, men's and children's apparel and
footwear, women's intimate apparel, fashion accessories, home textiles,
cosmetics and recreational products. The term of the agreement is for
five years, with automatic renewal options, provided that specified minimums
are met each contract year. Under the agreement, Zellers agreed to pay us a
minimum guaranteed royalty of $10.0 million over the five-year initial term of
the agreement. Zellers commenced the initial sales of Cherokee branded
merchandise in July 1998 and royalty revenues to us from Zellers totaled $3.6
million during Fiscal 2000 and $3.7 million during Fiscal 2001.
During Fiscal 2001, we entered into two exclusive retail direct licensing
agreements for the Cherokee brand, one with DongKwang International Co. Ltd.,
which plans to open retail stores in South Korea and one with Paris, France
based Carrefour, the second largest retailer in the world. The Carrefour Group
is granted the exclusive right to manufacture, promote, sell and distribute a
wide range of products bearing our Cherokee brand in Spain, Mexico and Brazil.
The Carrefour Group is obligated to pay us a royalty based upon a percentage of
our net sales of Cherokee branded products in those countries. We do not expect
to receive royalties until November 2001 under this agreement, and even then
there can be no guarantee that any royalties will be significant in amount. If
the Carrefour Group exceeds certain retail sales thresholds for Cherokee
branded products then the scope of the agreement will be automatically expanded
to grant the Carrefour Group the exclusive right to manufacture, promote, sell
and distribute products bearing the Cherokee brand in certain other European
and South American countries not already covered by the agreement, including,
among others, Italy, Greece, Poland, Argentina, Chile, Colombia, Turkey,
France, the United Kingdom, Portugal and Germany. Even if the retail sales
thresholds are not met, during the term of the agreement, the Carrefour Group
also has a right of first refusal to add any of the European or South American
countries to the territory covered by the agreement. Further, with respect to
Japan, China and several other Asian countries, the Carrefour Group may elect
to add any of those countries to the territory covered by the agreement,
provided that at the time of such election we do not already have an existing
license agreement covering the country to be added. The initial term of the
agreement expires December 31, 2003, however, if the Carrefour Group meets
certain retail sales thresholds with respect to Cherokee branded products, the
agreement may be extended indefinitely by the Carrefour Group for successive
three year terms. We expect to continue to solicit additional licensees for the
Cherokee brand in Asia, Europe and South America, subject to the Carrefour
Group's rights under the agreement.
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Including the Carrefour and DongKwang agreements, we have eight international
wholesale and/or retail license agreements for the Cherokee brand. Other
international licensees include Japan-based Itochu Corporation and its sub-
licensees Takaya, Okudo, and Takaishi, China-based Shanghai Eesli Trading
Company and Philippine-based Magica Holdings Co. Inc. Under the terms of the
Itochu licensing agreement, Itochu will manufacture, promote, sell, distribute
and sublicense products bearing the Cherokee brand in Japan. We are currently
in discussions to possibly terminate our licensee in China, Shanghai Eesli
Trading Company, and we expect to incur no material costs in connection with
the termination. During Fiscal 2001, we terminated our master licensing
agreement with Magica Holding Co. Inc. for the Philippines and our wholesale
licensing agreement with Bravo Enterprises for Mexico and incurred no expense
with regard to the terminations.
During Fiscal 2001, we entered into a non-exclusive retail direct licensing
agreement for the Sideout brand with Sport-Scheck GmBh, which is based in
Munich, Germany. Sport-Scheck is the largest sporting goods retailer in Germany
and a division of Otto Versand. Including Sport-Scheck, we have four
international licensing agreements with respect to the Sideout brand and
related trademarks. Our international licensing agreements for the Sideout and
King of the Beach brands are all exclusive and cover countries including
Argentina, Japan and Mexico, and product categories including men's, boy's and
women's apparel and footwear. Matienzo Mexico, our Mexican licensee, currently
distributes to department and specialty stores and has six Sideout stores
throughout Mexico. During Fiscal 2001, we terminated our international
licensing agreement with AM Moolla and incurred no expense with regard to the
termination.
During Fiscal 2001, we received $4.4 million in aggregate royalties from our
international license agreements, which accounted for 15.5% of our consolidated
revenues during such period.
Other Business Opportunities
We are frequently approached by parties seeking to sell their brands and
related trademarks. Should an established and marketable brand become available
on favorable terms, we would be interested in pursuing such an acquisition. In
addition to acquiring brands and licensing our own brands, we assist other
companies in identifying licensees for their brands. Generally, as an exclusive
consultant, we will perform a range of services including marketing of brands,
solicitation of licensees, contract negotiations and administration and
maintenance of license or distribution agreements. In return for our services
we will normally receive a certain percentage of the net royalties generated by
the brands we represent and manage.
During Fiscal 2001, we assisted Mossimo Inc. in locating Target Stores as a
licensee of the Mossimo brand and entered into a finder's agreement with
Mossimo, which provides that we will receive 15% of the royalties paid to
Mossimo by Target Stores. Under Mossimo's agreement with Target Stores, Target
Stores is obligated to pay Mossimo a royalty based on a percentage of net sales
of Mossimo branded products, with a minimum guaranteed royalty, beginning in
2001, of approximately $27.8 million over the initial three year term of the
agreement. Mossimo's agreement with Target Stores is subject to early
termination under certain circumstances. During the fourth quarter of Fiscal
2001, we received initial revenues from Mossimo of $296,600. Mossimo's filings
with the Securities and Exchange Commission indicate that there is currently
substantial doubt about Mossimo's ability to continue as a growing concern. If
Mossimo should enter into bankruptcy proceedings, under bankruptcy law there is
a possibility Mossimo could reject the finders agreement and prevent us from
receiving any of the royalties paid by Target Stores to Mossimo.
Additionally, we entered into five other exclusive consulting agreements, one
to represent Maui and Sons Inc. in the United States and Canada, one to
represent Pritikin worldwide, one to represent Bum in Mainland China, Hong Kong
and Macao, one to represent Rampage in the Philippines, Mainland China, Hong
Kong, Macao, Korea, Taiwan, Singapore, Malaysia, Indonesia, Thailand, Vietnam
and Cambodia and one with Aspen Licensing International Inc. to represent its
Aspen brand both domestically and internationally. The consulting agreement
with Aspen Licensing International Inc. expired during Fiscal 2001.
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Recapitalization; Sale of Cherokee Trademarks to Spell C; Issuance of Secured
Notes
On December 23, 1997, we completed a recapitalization that resulted in the
issuance of a special dividend of $5.50 per share on January 15, 1998. To
facilitate the recapitalization, we formed Spell C. LLC, a special purpose,
bankruptcy remote, single member Delaware limited liability company, wholly
owned by us. We assigned to Spell C all of our right, title and interest in the
Amended Target Agreement and sold to Spell C all of our right, title and
interest in the Cherokee brand name and related trademarks in the United
States. The sale of the rights to the Cherokee trademarks in the United States
was subject to certain exceptions which allow us to continue to use the
trademarks in the United States in conjunction with our then-existing license
agreements and allow us to use the trademarks in the United States in
conjunction with retail license agreements in the category of cosmetics, bath
and body products. Except for these exceptions, we no longer have the right to
license the Cherokee brand and related trademarks in the United States, but
retain all rights to do so outside of the United States.
On December 23, 1997, Spell C issued for gross proceeds of $47.9 million,
privately placed Zero Coupon Secured Notes (the "Secured Notes"), yielding 7.0%
interest per annum and maturing on February 20, 2004. The proceeds from the
sale of the Secured Notes were used to pay the special dividend described
above. The Secured Notes amortize quarterly from May 20, 1998 through February
20, 2004, in the amount of $9.0 million per year the first two years and $10.5
million per year the third through sixth years. The Secured Notes are secured
by the Amended Target Agreement and the United States Cherokee trademarks and
brand names. The Secured Notes indenture requires that any proceeds due to
Spell C under the Amended Target Agreement and several other license agreements
must be deposited directly into a collection account controlled by the trustee
under the indenture. The trustee distributes from the collection account the
amount of principal due and payable to the holders of the Secured Notes on
quarterly note payment dates. Excess amounts on deposit in the collection
account may only be distributed to Spell C if the amount on deposit in the
collection account exceeds the amount of principal due and payable on the next
quarterly note payment date. Such excess amounts, if any, may then be
distributed by Spell C to us. During Fiscal 2001, of the $19.3 million in
royalty revenues from Target Stores, $10.125 million was paid to the holders of
the Secured Notes. At various times during Fiscal 2001, Spell C distributed a
total of $7.7 million to us (which amount includes royalty revenues received
from Target Stores during both Fiscal 2000 and Fiscal 2001 and interest income
earned on royalty revenues). The minimum guaranteed royalty under the Amended
Target Agreement is $9.0 million for each of the two fiscal years ending
January 31, 1999 and 2000 and $10.5 million for each of the four fiscal years
ending January 31, 2001 through 2004. The aggregate scheduled amortization
under the Secured Notes is $60.0 million and equals the aggregate minimum
guaranteed royalty payable under the Amended Target Agreement, which is also
$60.0 million. While we believe that royalties payable under the Amended Target
Agreement may continue to exceed the minimum guaranteed royalties payable in
upcoming fiscal years, we cannot predict with accuracy whether such royalties
will exceed the minimum guaranteed royalties payable during such years, and if
they do not, we will not receive further distributions from Spell C during the
term of the Amended Target Agreement. See "Risk Factors."
Sideout Agreement
On November 7, 1997, we entered into an Agreement of Purchase and Sale of
Trademarks and Licenses (the "Sideout Agreement") with Sideout Sport Inc.,
pursuant to which we agreed to purchase all of Sideout Sport Inc.'s trademarks,
copyrights, trade secrets and associated license agreements. The trademarks
acquired from Sideout Sport Inc. include, among others, Sideout(R), Sideout
Sport(R) and King of the Beach(R). Pursuant to the Sideout Agreement, we paid
$1.5 million at the closing of the acquisition and agreed to pay an additional
$500,000 upon release of liens on the assets that were purchased. Most of the
liens have since been released and $495,000 of the $500,000 holdback has been
paid. Under the terms of the Sideout Agreement, we will also pay Sideout Sport
Inc., on a quarterly basis, contingent payments of 40% of the first $10.0
million, 10% of the next $5.0 million and 5% of the next $20.0 million, of
royalties and license fees received by us through licensing of the Sideout
trademarks. Upon the earlier of such time as we have paid Sideout a total of
$7.5 million or October 22, 2004, we will have no further obligation to pay
Sideout Sport Inc. During
8
Fiscal 2001, we made payments exceeding $1.2 million under the Sideout
Agreement and since January 1999, we have paid in total over $2.6 million in
contingent payments under the Sideout Agreement.
Trademarks
We hold various trademarks including Cherokee(R), Sideout(R), Sideout
Sport(R), King of the Beach(R) and others, in connection with numerous
categories of apparel and other goods. These trademarks are registered with the
United States Patent and Trademark Office and in a number of other countries.
We also hold trademark applications for Cherokee, Sideout, Sideout Sport and
King of the Beach in numerous countries. We intend to renew these registrations
as appropriate prior to expiration. We monitor on an ongoing basis unauthorized
uses of our trademarks, and we rely primarily upon a combination of trademark,
copyright, know-how, trade secrets, and contractual restrictions to protect our
intellectual property rights both domestically and internationally. See "Risk
Factors."
Marketing
We have positioned the Cherokee name to connote quality, comfort, fit and a
"Casual American" lifestyle with traditional, wholesome values. The Sideout
brand and related trademarks represent an active lifestyle. We integrate our
advertising, product, labeling and presentation to reinforce these brand
images. We intend to continue to promote a positive image in marketing the
Cherokee and Sideout brands through licensee-sponsored advertising. Our retail,
wholesale and international license agreements provide us with final approval
of pre-agreed upon quality standards, packaging and marketing of licensed
products. We principally rely on our licensees to advertise the Cherokee and
Sideout brands, and as a result our advertising costs have been minimal.
We developed a website (www.cherokeegroup.com), which utilizes a business-to-
business E-commerce strategy. The information regarding our website address is
provided for convenience and is not a hyperlink. Our goal in developing the
website is to enhance communication, information flow and networking with
existing and prospective licensees. The website currently includes our profiles
and our brands, certain of our financial statements and press releases, as well
as a secured area to support our licensees with graphics, packaging and trim
items, design concepts, new developments and other administrative needs.
Internationally, we intend to continue to seek to develop both of our
principal brands through license agreements and strategic alliances with
manufacturers or other companies who have market power and economies of scale
in their respective markets. We are also seeking to assist other companies in
identifying licensees for their brands. We will continue to market our brands
and solicit new licensees through a small number of executive employees and may
retain the services of outside consultants to assist us in this effort.
Competition
Royalties paid to us under our licensing agreements are generally based on a
percentage of the licensee's net sales of licensed products. Cherokee and
Sideout brand footwear, apparel, and accessories, which are manufactured and
sold by both domestic and international wholesalers and retail licensees, are
subject to extensive competition by numerous domestic and foreign companies.
Such competitors with respect to the Cherokee brand include Levi Strauss & Co.,
The Gap, Old Navy, Liz Claiborne and VF Corp. and private labels developed for
retailers. Competitors with respect to the Sideout brand include Quicksilver,
Mossimo, Nike and other activewear companies. Factors, which shape the
competitive environment, include quality of garment construction and design,
brand name, style and color selection, price and the manufacturer's ability to
respond quickly to the retailer on a national basis. In recognition of the
increasing trend towards consolidation of retailers and greater emphasis by
retailers on the manufacture of directly sourced merchandise, in the
United States our business plan focuses on creating strategic alliances with
major retailers for their sale of products bearing our brands through the
licensing of our trademarks directly to retailers. Therefore, our success is
dependent on our licensees' ability to design, manufacture and sell products
bearing our brands and to respond to ever-changing consumer demands. Companies
such as Mossimo have entered into and other companies owning established
trademarks could also enter into, similar arrangements with retailers. See
"Risk Factors."
9
Employees
As of February 3, 2001, we employed 14 persons. None of our employees are
represented by labor unions and we believe that our employee relations are
satisfactory.
Risk Factors
In addition to the other information contained herein or incorporated herein
by reference, the risks and uncertainties and other factors described below
could have a material adverse effect on our business, financial condition and
results of operations and could cause our future business, financial condition
and results of operations to differ materially from the results contemplated by
any forward-looking statement we may make herein, in any other document we file
with the Securities and Exchange Commission, or in press release or other
written or oral statement we may make. Please also see "Item 7. Management's
Discussion and Analysis of Financial Condition And Results of Operations -
Cautionary Note Regarding Forward-Looking Statements" for additional risks and
uncertainties applicable to us.
Payments to us from our subsidiary, Spell C, are subject to a number of
restrictions under the Amended Target Agreement.
We cannot assure you that our subsidiary, Spell C, will continue to
distribute any significant amount of cash or property to us until after the
maturity of the Secured Notes, if then. The Secured Notes indenture provides
that any royalties payable under the Amended Target Agreement will be deposited
directly into a collection account controlled by the trustee under the Secured
Notes indenture. The trustee will distribute from the collection account the
amount of principal due and payable to the holders on the Secured Notes on
quarterly note payment dates. Excess amounts in the collection account may only
be distributed to Spell C if the amount in the collection account exceeds the
aggregate amount of principal due and payable on the next quarterly note
payment date. Such excess amounts, if any, may then be distributed by Spell C
to us. The aggregate scheduled amortization under the Secured Notes is $60.0
million and equals the aggregate minimum guaranteed royalty payable under the
Amended Target Agreement, which is also $60.0 million. See "Recapitalization;
Sale of Cherokee Trademarks to Spell C; Issuance of Secured Notes" and "United
States Retail Direct Licensing." There is no assurance, therefore, that in the
future there will be any excess amounts available to be distributed to us. We
do not expect revenues deposited in the collateral account from sources other
than the Amended Target Agreement to be significant during fiscal year 2002. We
cannot predict with accuracy whether payments under the Amended Target
Agreement will exceed the minimum guaranteed royalty, and if they do not, no
distribution will be made to Spell C from the collateral account, and in turn,
Spell C will have no funds available to distribute to us. If Spell C does not
distribute any funds to us during the balance of the initial term of the
Amended Target Agreement it could have a material adverse effect on our
business, financial condition and results of operations.
Our business is subject to intense competition.
Royalties paid to us under our licensing agreements are generally based on a
percentage of our licensee's net sales of licensed products. Cherokee and
Sideout brand footwear, apparel, and accessories, which are manufactured and
sold by both domestic and international wholesalers and retail licensees, are
subject to extensive competition by numerous domestic and foreign companies.
Such competitors with respect to the Cherokee brand include Levi Strauss & Co.,
The Gap, Old Navy, Liz Claiborne and VF Corp. and private labels developed for
retailers. Competitors with respect to the Sideout brand include Quicksilver,
Mossimo, Nike and other activewear companies. Factors, which shape the
competitive environment, include quality of garment construction and design,
brand name, style and color selection, price and the manufacturer's ability to
respond quickly to the retailer on a national basis. In recognition of the
increasing trend towards consolidation of retailers and greater emphasis by
retailers on the manufacture of private label merchandise, in the United States
our business plan focuses on creating strategic alliances with major retailers
for their sale of products bearing our brands through the licensing of our
trademarks directly to retailers. Therefore, our success is dependent on our
licensees' ability to design, manufacture and sell products bearing our brands
and to
10
respond to ever-changing consumer demands, and any significant failure by our
licensees to do so could have a material adverse effect on our business,
financial condition and results of operations. Other companies owning
established trademarks could also enter into similar arrangements with
retailers. See "Competition."
Our business is dependent on Target Stores, which accounted for 68% of our
consolidated licensing revenues in Fiscal 2001.
During Fiscal 2001, 68% of our and Spell C's licensing revenues were
generated from a single source, Target Stores, a division of Target Corp. See
"United States Retail Direct Licensing." We have assigned all our rights in the
Amended Target Agreement to Spell C, which has in turn pledged the Amended
Target Agreement as collateral for the Secured Notes. Spell C will be dependent
on revenues from the Amended Target Agreement for most, if not all, of its
revenues. Although the Amended Target Agreement provides for minimum annual
royalty payments, if for any reason Target Stores does not pay the minimum
royalties, Spell C will likely be unable to meet, and will default on, its
payment obligations under the indenture for the Secured Notes. We are not
guarantors of the Secured Notes; however, the United States Cherokee trademarks
have been pledged as security for the Secured Notes and the permanent loss of
such trademarks as a result of a default would have a material adverse effect
on our business, financial condition and results of operations. The Secured
Notes mature and the initial term of the Amended Target Agreement expire at
approximately the same time. At such time payments from the Amended Target
Agreement, if extended or renewed, may be distributed by Spell C to us. If
Target Stores elects not to extend or renew the Amended Target License
Agreement upon the expiration of its initial term on January 31, 2004, it could
have a material adverse effect on our business, financial condition and results
of operations. There can be no guarantee that we would be able to replace the
Target Stores royalty payments from other sources.The Amended Target Agreement,
however, requires one year's advance notice of termination by Target Stores,
during which period we believe we would successfully enter into one or more
licensing agreements for the Cherokee brand with either retailers and/or
wholesalers, in order to replace the lost revenues from Target Stores.
We are dependent on our intellectual property and we cannot assure you that we
will be able to successfully protect our rights.
We and Spell C hold various trademarks including Cherokee, Sideout, King of
the Beach and others in connection with apparel, footwear and accessories.
These trademarks are vital to the success and future growth of our business.
These trademarks are registered with the United States Patent and Trademark
Office and in several other countries. We and Spell C also hold several
trademark applications for Cherokee, Sideout, and King of the Beach in several
countries. We monitor on an ongoing basis unauthorized uses of our trademarks,
and we rely primarily upon a combination of trademark, copyright, know-how,
trade secrets, and contractual restrictions to protect our intellectual
property rights. We believe that such measures afford only limited protection
and, accordingly, there can be no assurance that the actions taken by us to
establish and protect our trademarks and other proprietary rights will prevent
imitation of our products or infringement of our intellectual property rights
by others, or prevent the loss of licensing revenue or other damages caused
thereby. The Patent and Trademark Office is participating in an ongoing study
directed to the protectability of Native American Indian signs. We cannot
dismiss the possibility that legislation resulting from the study would not
have a material impact upon us. In addition, the laws of several countries in
which we have licensed our intellectual property may not protect our
intellectual property rights to the same extent as the laws of the United
States. Despite our efforts to protect our intellectual property rights,
unauthorized parties may attempt to copy aspects of our intellectual property,
which could have a material adverse effect on our business, financial condition
and results of operations. In the future we may be required to assert
infringement claims against third parties, and there can be no assurance that
one or more parties will not assert infringement claims against us. While we
currently have the resources to pursue or defend most infringement claims, any
resulting litigation could result in significant expense and divert the efforts
of our management personnel whether or not such litigation is determined in our
favor.
11
We are dependent on our key management personnel.
Our success is highly dependent upon the continued services of Robert
Margolis, our Chairman and Chief Executive Officer, who is the primary person
responsible for conceiving and implementing our overall business and marketing
strategy. Mr. Margolis has served as Chairman and Chief Executive Officer since
December 1994 when we emerged from bankruptcy. Mr. Margolis is the beneficial
owner of approximately 20.7% of our outstanding common stock. We have only
fourteen employees and Mr. Margolis' leadership and experience in the apparel
licensing industry is critical to the successful implementation of our business
and marketing strategy. We do not carry key person life insurance covering Mr.
Margolis. While Mr. Margolis' services are provided pursuant to a management
agreement with us, this agreement does not ensure Mr. Margolis' continued
services. The loss of the services of Mr. Margolis could have a material
adverse effect on our business, financial condition and results of operations.
The management agreement with our Chief Executive Officer contains provisions
that provide for a substantial cash payment to our Chief Executive Officer
upon breach or termination of the management agreement by us.
Mr. Margolis' services as Chairman and Chief Executive Officer are provided
to us pursuant to a management agreement. The current term of the management
agreement ends February 1, 2004, however, the term may be extended indefinitely
for additional one year terms so long as we meet certain pre-tax earnings
thresholds. If we terminate the management agreement without cause or Mr.
Margolis terminates the management agreement after we materially breach any of
the terms and conditions thereof or fail to perform any material obligations
thereunder, we must pay Mr. Margolis, within sixty days after the date of
termination, a lump sum in cash equal to three times the sum of the annual base
compensation under the management agreement at the rate in effect at the time
of the termination and the previous year's performance bonus under the
management agreement. Mr. Margolis' annual base compensation in Fiscal 2001 was
$587,450 and his performance bonus for Fiscal 2001 was approximately $2.175
million and, based on those amounts, the lump sum payment referenced above
would exceed $8.0 million.
The occurrence of the following events, among other things, will be deemed to
be a material breach of the management agreement by us:
. the assignment to Mr. Margolis of any duties materially inconsistent
with, or the diminution of his positions, titles, offices, duties and
responsibilities with us or any removal of Mr. Margolis from, or any
failure to re-elect Mr. Margolis to, any titles, offices or positions
held by him under the management agreement, including the failure of our
Board of Directors to elect Mr. Margolis or his designee as Chairman of
the Board or the failure to elect, or the removal of, certain other
nominees as director from the slate of directors recommended to our
stockholders by the Board of Directors;
. a reduction by us in the base compensation or any other compensation
provided to Mr. Margolis in the management agreement; or
. a change or relocation of Mr. Margolis' offices that materially and
adversely affects Mr. Margolis' working environment or any other
substantial, material and adverse changes in Mr. Margolis' working
conditions imposed by us.
We do not have sufficient cash to make the lump sum payment to Mr. Margolis,
and becoming obligated to make such payment would have a material adverse
effect on our business, financial condition and results of operations. Under
certain circumstances, the obligation to make such lump sum payment to Mr.
Margolis could be triggered if a third party were to acquire us, which could
increase the acquisition costs, but, subsequently, each year thereafter reduce
our annual operating expenses due to the elimination of annual bonus payments
to Mr. Margolis pursuant to the management agreement.
12
Item 2. PROPERTIES
We lease a 14,700 square foot office facility in Van Nuys, California. The
initial term of the lease is for three years, expiring in July 2001. The
monthly rent is $8,500 and we have an option to extend the term of the lease
for two additional three-year periods. On February 20, 2001, we exercised our
first option and extended the term of the lease from August 1, 2001 through
July 31, 2004. Our Van Nuys office is well maintained, adequate and suitable
for our purposes.
Item 3. LEGAL PROCEEDINGS
In the ordinary course of business, we from time to time become involved in
legal claims and litigation. In the opinion of management, based on
consultations with legal counsel, the disposition of litigation currently
pending against us is unlikely to have, individually or in the aggregate, a
materially adverse effect on our business financial position or results of
operations.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of holders of Common Stock during the
final quarter of Fiscal 2001.
13
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock traded on the NASDAQ Small Cap Issues Market under the
symbol CHKE until October 28, 1998. On October 29, 1998, our Common Stock began
trading on the Nasdaq National Market System. Our Nasdaq trading symbol has
remained CHKE. The table below sets forth for each of the fiscal quarters
during our last two fiscal years the range of the high and low bid information
for the Common Stock and the cash dividends paid.
Dividends
High Low Paid
------ ----- ---------
Fiscal 2000
Quarter ended May 1, 1999.......................... 8 1/4 7 3/4 0.25
Quarter ended July 31, 1999........................ 9 11/16 7 1/2 0.25
Quarter ended October 30, 1999..................... 8 5/8 7 1/2 --
Quarter ended January 29, 2000..................... 9 1/2 7 5/8 --
Fiscal 2001
Quarter ended April 29, 2000....................... 7 13/16 6 1/4 --
Quarter ended July 29, 2000........................ 9 3/16 6 9/16 --
Quarter ended October 28, 2000..................... 11 15/16 8 3/8 --
Quarter ended February 3, 2001..................... 11 3/8 8 3/8 --
On March 27, 2001, the latest bid price for the Common Stock, reported on the
NASDAQ National Market System, was $9.00 per share. As of March 27, 2001, the
number of stockholders of record of the Common Stock was 139. This figure does
not include beneficial holders whose shares may be held of record by brokerage
firms and clearing agencies.
Through May 1999, we paid a quarterly dividend. However, the payment of any
future dividends will be at the discretion of our Board and will be dependent
upon our financial condition, results of operations, capital requirements and
other factors deemed relevant by our Board.
On July 22, 1999, our Board of Directors authorized the repurchase of up to
one million shares or approximately 11.5% of our outstanding common stock.
Pursuant to this directive, we used cash flow of $2.1 million to repurchase and
retire 249,000 shares of our common stock in Fiscal 2001 and $1.9 million in
cash flow to repurchase and retire 233,000 shares of our common stock during
Fiscal 2000. We are currently authorized to repurchase up to an aggregate of
518,000 shares of our common stock. Continued repurchases of our stock, if any,
will be made from time to time in the open market at prevailing market prices
or privately negotiated transactions.
14
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information, except as noted,
has been taken or derived from our audited consolidated financial statements.
The information set forth below is not necessarily indicative of our results of
future operations and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our consolidated financial statements and related notes included elsewhere in
this Form 10-K. See "--Item 8. Consolidated Financial Statements and
Supplementary Data."
Eight
Months Year
Year Ended Year Ended Year Ended Ended Ended
February 3, January 29, January 30, January 31, May 31,
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -------
($ In Thousands Except Per Share Data)
Statement of Operations
Data:
Royalty revenues/Net
sales.................. $ 28,281 $ 24,714 $ 19,307 $ 8,553 $ 8,718
Cost of goods sold...... -- -- -- -- 184
-------- -------- -------- -------- -------
Gross profit............ 28,281 24,714 19,307 8,553 8,534
Selling, general and
administrative
expenses............... 7,955 7,225 6,428 4,192 3,406
Amortization of
trademarks and
goodwill............... 396 260 200 43 --
Forgiveness of note
receivable............. -- 1,891(1) -- -- --
-------- -------- -------- -------- -------
Operating income........ 19,930 15,338 12,679 4,318 5,128
Other income............ -- -- -- (422) (75)
Interest expense........ 2,367 2,817 3,247 330 3
Investment and interest
income................. (430) (399) (638) (525) (460)
Gain on sale of Uniform
Div and other assets... -- -- -- -- (220)
-------- -------- -------- -------- -------
Income before income
taxes.................. 17,993 12,920 10,070 4,935 5,880
Income tax expense
(benefit).............. 7,227 4,859 3,982 (782) (771)
-------- -------- -------- -------- -------
Net income.............. 10,766 8,061 6,088 5,717 6,651
======== ======== ======== ======== =======
Basic earnings per
share.................. $ 1.29 $ 0.94 $ 0.70 $ 0.73 $ 0.87
Diluted earnings per
share.................. $ 1.29 $ 0.94 $ 0.70 $ 0.68 $ 0.82
Cash distribution of
capital per share...... -- -- -- $ 5.50 --
Cash dividends per
share.................. -- $ 0.50 $ 1.25 $ 0.20 $ 0.35
February 3, January 29, January 30, January 31, May 31,
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -------
Balance Sheet Data:
Working capital
(deficiency)........... $ (2,263) $ (2,236) $ (2,242) $ 4,445 $ 9,148
Total assets............ 19,413 17,518 19,529 24,471 13,601
Long-term debt, net of
current maturities..... 20,255 28,389 35,697 41,675 --
Stockholders' (deficit)
equity................. (15,070) (24,132) (29,879) (25,646) 12,224
- --------
Notes to Selected Financial Data
(1) Represents a non-cash charge of $1.89 million resulting from the partial
forgiveness and cancellation of note receivable from Mr. Margolis during
the year ended January 29, 2000.
15
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Cautionary Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K, our quarterly reports on Form 10-Q, other
filings we may make with the Securities and Exchange Commission, as well as
press releases and other written or oral statements we may make may contain
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. When used, the words "anticipates", "believes,"
"estimates," "objectives", "goals", "aims", "hopes", "may", "likely", "should"
and similar expressions are intended to identify such forward-looking
statements. In particular, the forward-looking statements in this Form 10-K
include, among others, statements regarding our goals or expectations regarding
our future revenues and earnings, the likelihood of increased retail sales by
certain of our current and future licensees, such as Target Stores and
Carrefour, our prospects for obtaining new licensees and our prospects for
obtaining new brands to acquire or represent. Forward-looking statements
involve known and unknown risks and uncertainties that may cause our actual
results, performance or achievements to be materially different from any future
results, performance or achievements expressed or implied by any forward-
looking statements. Such risks and uncertainties, include, but are not limited
to, the effect of national and regional economic conditions, the financial
condition of the apparel industry and the retail industry, the overall level of
consumer spending, the effect of intense competition in the industry in which
we operate, adverse changes in licensee or consumer acceptance of products
bearing the Cherokee or Sideout brands as a result of fashion trends or
otherwise, the ability and/or commitment of our licensees to design,
manufacture and market Cherokee and Sideout branded products, our dependence on
a single licensee for most of our revenues, our dependence on our key
management personnel and the effect of a breach or termination by us of the
management agreement with our Chief Executive Officer. Several of these risks
and uncertainties are discussed in more detail under "Item 1. Business-Risk
Factors" as well as in the discussion and analysis below. You should however,
understand that it is not possible to predict or identify all risks and
uncertainties and you should not consider the risks and uncertainties
identified by us to be a complete set of all potential risks or uncertainties
that could materially effect us. You should not place undue reliance on the
forward-looking statements we make herein because some or all of them may turn
out to be wrong. We undertake no obligation to update any of the forward-
looking statements contained herein to reflect future events and developments.
Overview
The following discussion should be read in conjunction with our consolidated
financial statements and related notes included elsewhere in this Form 10-K.
See "Item 8. Consolidated Financial Statements and Supplementary Data."
Since May 1995, we have principally been in the business of marketing and
licensing the Cherokee brand and related trademarks and other brands we own or
represent. Our operating strategy emphasizes domestic and international retail
direct and wholesale licensing, whereby we grant wholesalers and retailers the
license to use our trademarks on certain categories of merchandise.
In November 1997, we reaffirmed our strategic relationship with Target
Stores, a division of Target Corp., by entering into the Amended Target
Agreement, which grants Target Stores the exclusive right in the United States
to use the Cherokee trademarks in certain categories of merchandise. See "--
Item 1. Business. United States Retail Direct Licensing." Under the Amended
Target Agreement, Target Stores will pay a royalty each fiscal year, up to and
including the fiscal year ending January 31, 2004, based on a percentage of
Target Stores' net sales of Cherokee branded merchandise during each fiscal
year, which percentage varies according to the volume of sales of merchandise.
In any event, Target Stores has agreed to pay a minimum guaranteed royalty of
$9.0 million for each of the two fiscal years ending January 31, 1999 and 2000
and $10.5 million for each of the four fiscal years ending January 31, 2001
through 2004. Under the Amended Target Agreement, in most cases, we or Spell C
must receive Target Stores' consent to enter into additional licensing
agreements in the United States with respect to the Cherokee brand during the
term of the agreement. Therefore, our current focus
16
with respect to the Cherokee brand is to continue to develop that brand in
several international markets through retail direct or wholesale licenses with
manufacturers or other companies who have market power and economies of scale
in the respective markets.
Target Stores currently has over 970 stores in the United States and has
publicly announced that it expects to open another 60 to 100 stores in the next
twelve months. We expect that these additional stores will result in an
increase in the overall sales volume of Cherokee branded products sold by
Target Stores, however, there can be no assurance that overall sales volume
will increase. Target Stores pays royalty revenues to us based on a percentage
of its sales of Cherokee branded products. The Amended Target Agreement,
however, is structured to provide royalty rate reductions for Target Stores
after it has achieved certain levels of retail sales of Cherokee branded
products during each fiscal year. In Fiscal 2001 Target Stores reached the
maximum royalty rate reduction in the end of the second quarter. Additional
stores are expected to cause Target Stores to reach the maximum royalty rate
reduction even earlier in the upcoming year. This trend is expected to have a
positive impact on our licensing revenues in our first quarter ended May 4,
2002 as well as our licensing revenues for our entire fiscal year ended
February 1, 2003, but may have a negative impact on our licensing revenues in
our third quarter ended November 2, 2002.
As part of a recapitalization that occurred in September 1997, we sold to
Spell C, our wholly-owned subsidiary, all of our rights to the Cherokee brand
and related trademarks in the United States and assigned to Spell C all of our
rights in the Amended Target Agreement in exchange for the proceeds from the
sale of the Secured Notes. See "Item 1. Business. Recapitalization; Sale of
Cherokee Trademarks to Spell C; Issuance of Secured Notes." Spell C issued for
an aggregate of $47.9 million, privately placed Zero Coupon Secured Notes,
yielding 7.0% interest per annum and maturing on February 20, 2004. The Secured
Notes amortize quarterly from May 20, 1998 through February 20, 2004, in the
amount of $9.0 million per year the first two years and $10.5 million per year
the third through sixth years. The Secured Notes are secured by the Amended
Target Agreement and the United States Cherokee brand name and trademarks. The
Secured Notes indenture provides that any royalties generated by the Amended
Target Agreement must be deposited directly into a collection account
controlled by the trustee under the indenture for distribution to holders of
the Secured Notes. Excess amounts in the collection account may be distributed
to Spell C only if the excess amounts exceed the aggregate amount of principal
due and payable on the next quarterly note payment date. Such excess amounts,
if any, will then be distributed by Spell C to us. Since the aggregate payments
due under the Amended Target Agreement are $60 million and equal the aggregate
minimum guaranteed royalty payable under the Amended Target Agreement, which is
also $60 million, there is no assurance that there will be any excess amounts
to be distributed. See "Item 1. Risk Factors."
Target Stores commenced the initial sales of Cherokee branded merchandise in
July 1996. Royalty revenues from Target Stores were $5.9 million during the
fiscal year ended May 31, 1997, $6.4 million during the eight month fiscal
period ended January 31, 1998, $14.6 million during the fiscal year ended
January 30, 1999, $16.3 million during Fiscal 2000 and $19.3 million during
Fiscal 2001, which accounted for 68%, 75%, 76%, 66% and 68%, respectively, of
our consolidated revenues during such periods. While all royalties paid under
the Amended Target Agreement appear in our consolidated financial statements,
since the issuance of the Secured Notes, most of such royalties have been, and
most, if not all of such royalties received until the maturity of the Secured
Notes, will be distributed to the holders of the Secured Notes. See "Item 1.
Risk Factors." Prior to the maturity of the Secured Notes, royalties from the
Amended Target Agreement will be offset by principal payments to the holders of
the Secured Notes in the amount of $9.0 million per year during the first two
years and $10.5 million per year during the third through sixth years of the
term of the indenture. During Fiscal 2001, of the $19.3 million in royalty
revenues received from Target Stores, $10.125 million was paid to the holders
of the Secured Notes. At various times during Fiscal 2001, Spell C distributed
a total of $7.7 million to us (which amount includes royalty revenues received
from Target Stores during both Fiscal 2000 and Fiscal 2001 and interest income
earned on royalty revenues). While we believe that royalties payable under the
Amended Target Agreement may continue to exceed the minimum guaranteed royalty
payable thereunder, we cannot predict this with any accuracy. The revenues
generated from all other licensing
17
agreements during the fiscal year ended May 31, 1997 were $2.8 million, during
the eight month fiscal period ended January 31, 1998 were $2.1 million, during
the fiscal year ended January 30, 1999 were $4.7 million, during Fiscal 2000
were $8.4 million and during Fiscal 2001 were $9.0 million, which accounted for
32%, 25%, 24%, 34% and 32%, respectively, of our revenues during such periods.
In November 1997, we purchased the Sideout brand and related trademarks from
Sideout Sport, Inc. for approximately $2.0 million and a portion of the future
royalties generated by the Sideout brand. Under the terms of the Sideout
Agreement, we agreed to pay Sideout Sport Inc., on a quarterly basis, 40% of
the first $10.0 million, 10% of the next $5.0 million and 5% of the next $20.0
million, of royalties and license fees received by us through licensing of the
Sideout trademarks. Upon the earlier of such time as we have paid Sideout a
total of $7.5 million or October 22, 2004, we will have no further obligation
to pay Sideout Sport Inc. During Fiscal 2001, we made additional contingent
payments of $1.2 million under the Sideout Agreement. Since January 1999, we
have paid, in total, $2.6 million in contingent payments under the Sideout
Agreement. The Sideout brand generated licensing revenues from existing
contracts of approximately $3.0 million during Fiscal 2001, which accounted for
approximately 10.6% of our revenues during such period. See "Item 1. Business.
Sideout Agreement."
As an incentive for our licensees to achieve higher retail sales of Cherokee
or Sideout branded products, many of our existing license agreements, including
the Amended Target Agreement, are structured to provide royalty rate reductions
for the licensees after they achieve certain levels of retail sales of Cherokee
or Sideout branded products during each fiscal year. As a result, our royalty
revenues as a percentage of our licensees' retail sales of branded products are
highest at the beginning of each fiscal year and decrease throughout each
fiscal year as licensees reach certain retail sales thresholds contained in
their respective license agreements. Therefore, the amount of royalty revenue
received by us in any quarter is dependent not only on retail sales of branded
products in such quarter, but also on the level of retail sales, and the
resulting attainment of royalty rate reductions in any preceding quarters in
the same fiscal year. The size of the royalty rate reductions and the level of
retail sales at which they are achieved vary in each licensing agreement.
As of November 29, 1999, we and The Newstar Group, d/b/a The Wilstar Group
("Wilstar") entered into a Second Revised and Restated Management Agreement
which revised and restated the terms under which Wilstar agreed to continue to
provide us with the executive management services of our Chief Executive
Officer Robert Margolis. Mr. Margolis is currently the sole stockholder of
Wilstar. On January 3, 2001, Wilstar assigned the management agreement to
Mr. Margolis. As base compensation for services rendered, Mr. Margolis will be
paid $587,450 per fiscal year, subject to annual cost of living increases. Mr.
Margolis is also eligible for annual performance bonuses.
The management agreement provides, that, for each fiscal year after Fiscal
2000, if our EBITDA for such fiscal year is no less than $5.0 million, then Mr.
Margolis will receive a performance bonus equal to (x) 10% of our EBITDA for
such fiscal year in excess of $2.5 million up to $10.0 million, plus (y) 15% of
our EBITDA for such fiscal year in excess of $10.0 million. As a result, for
Fiscal 2001 we accrued a bonus of $2.175 million for Mr. Margolis and if our
EBITDA continues to increase, the bonus payable to Mr. Margolis under the
management agreement will also increase.
We are frequently approached by parties seeking to sell their brands and
related trademarks. Should an established and marketable brand become available
on favorable terms, we would be interested in pursuing such an acquisition. In
addition to acquiring brands and licensing our own brands, we assist other
companies in identifying licensees for their brands.
During Fiscal 2001, we assisted Mossimo Inc. in locating Target Stores as a
licensee of the Mossimo brand and entered into a finder's agreement with
Mossimo, which provides that we will receive 15% of the royalties paid to
Mossimo by Target Stores. Under Mossimo's agreement with Target Stores, Target
Stores is obligated to pay Mossimo a royalty based on a percentage of net sales
of Mossimo branded products, with a minimum guaranteed royalty, beginning in
2001, of approximately $27.8 million over the initial three year term
18
of the agreement. Mossimo's agreement with Target Stores is subject to early
termination under certain circumstances. During the fourth quarter of Fiscal
2001, we received initial revenues from Mossimo of $296,600. Mossimo's filings
with the Securities and Exchange Commission indicate that there is currently
substantial doubt about Mossimo's ability to continue as a growing concern. If
Mossimo should enter into bankruptcy proceedings, under bankruptcy law there is
a possibility Mossimo could reject the finders agreement and prevent us from
receiving any of the royalties paid by Target Stores to Mossimo.
Additionally, we entered into five other exclusive consulting agreements, one
to represent Maui and Sons Inc. in the United States and Canada, one to
represent Pritikin worldwide, one to represent Bum in Mainland China, Hong Kong
and Macao, one to represent Rampage in the Philippines, Mainland China, Hong
Kong, Macao, Korea, Taiwan, Singapore, Malaysia, Indonesia, Thailand, Vietnam
and Cambodia and one with Aspen Licensing International Inc. to represent its
Aspen brand both domestically and internationally. The consulting agreement
with Aspen Licensing International Inc. expired during Fiscal 2001.
In 1997, our Board changed our fiscal year end to a 52 or 53 week fiscal year
ending on the Saturday nearest to January 31 in order to better align us with
our licensees who generally also operate and plan using such a fiscal year.
Prior to this change our fiscal year was a 52 or 53 week fiscal year ending on
the Saturday nearest May 31. As a result, the 1997 fiscal year ended on May 31,
1997 and included 52 weeks, the eight month fiscal period ended on January 31,
1998 and included 35 weeks, the 1999 fiscal year ended on January 30, 1999 and
included 52 weeks, Fiscal 2000 ended on January 29, 2000 and included 52 weeks
and Fiscal 2001 ended on February 3, 2001 and included 53 weeks.
Results of Operations
The following table sets forth for the periods indicated certain of our
consolidated financial data. In December 1997, we assigned the Amended Target
Agreement to Spell C and Spell C issued the Second notes. As a result, during
Fiscal 1999, $6.75 million in royalty revenues, during Fiscal 2000, $9.0
million in royalty revenues, and during Fiscal 2001 $10.125 million in royalty
revenues were distributed to the holders of the Secured Notes.
Year Ended Year Ended Year Ended
February 3, January 29, January 30,
2001 2000 1999
----------- ----------- -----------
Royalty revenues....................... $28,281,000 $24,714,000 $19,307,000
Selling, general, administrative and
amortization expenses................. 8,351,000 7,486,000 6,628,000
Forgiveness of note receivable......... -- 1,890,000(1) --
----------- ----------- -----------
Operating income....................... 19,930,000 15,338,000 12,679,000
Interest expense net of interest
income................................ 1,937,000 2,418,000 2,609,000
Income tax provision................... 7,227,000 4,859,000 3,982,000
----------- ----------- -----------
Net income........................... $10,766,000 $ 8,061,000 $ 6,088,000
=========== =========== ===========
- --------
(1) A non-cash charge of $1.89 million resulting from the partial forgiveness
and cancellation of the note receivable from Mr. Margolis during the year
ended January 29, 2000.
Fiscal 2001 compared to Fiscal 2000
In Fiscal 2001, revenues increased 14.4% to $28.3 million from $24.7 million
for Fiscal 2000. Revenues for Fiscal 2001 were generated from licensing our
trademarks and finders fees for placing Mossimo with Target Stores while
revenues for Fiscal 2000 were generated solely from licensing our trademarks.
Revenues from Target Stores for Fiscal 2001 and Fiscal 2000 were $19.3 million
or 68% of revenues and $16.3 million or 66% of revenues, respectively. Revenues
from all other sources for Fiscal 2001 and Fiscal 2000 were $9.0 million or 32%
of revenues and $8.4 million or 34% of revenues, respectively. Zellers paid
royalties of approximately
19
$3.7 million in Fiscal 2001 compared to $3.6 million in Fiscal 2000. In Fiscal
2001, Mervyn's continued its expansion of the Sideout brand into other product
categories and paid royalties of approximately $2.3 million compared to $1.7
million in Fiscal 2000.
Our royalty recognition policy provides for recognition of royalties in the
quarter earned, although a large portion of such royalty payments are actually
received during the month following the end of a quarter. Our trade receivable
balances of $5.8 million and $4.3 million for Fiscal 2001 and Fiscal 2000,
respectively, included an accrual for Target Stores, Zellers and Mervyn's
royalty revenues earned during the fourth quarters of Fiscal 2001 and Fiscal
2000 and these revenues were subsequently received in February 2001 and
February 2000.
Selling, general and administrative expenses for Fiscal 2001 were $8.4
million or 29% of revenues compared to $9.4 million or 38% of revenues for
Fiscal 2000. Excluding a $1.89 million nonrecurring expense related to the
forgiveness and cancellation of a note receivable to our CEO, Mr. Margolis,
selling, general and administrative expenses for Fiscal 2000 were $7.5 million
or 30% of revenues for Fiscal 2000. After excluding such nonrecurring expense
from Fiscal 2000 results, selling, general and administrative expenses in
Fiscal 2001 increased due to expenses of approximately $341,000 in salaries for
additional marketing staff to intensify our domestic and international efforts
to negotiate contracts, $135,000 in amortization of our trademarks and an
additional bonus expense of $393,000. Amortization expenses are expected to
increase as Sideout contingent payments increase and we purchase other
trademarks, and management and staff bonus expenses are expected to rise as our
EBITDA rises.
Our interest expense for Fiscal 2001 was $2.4 million compared to $2.8
million for Fiscal 2000. The interest expense is attributable to the Secured
Notes. Interest expense is expected to decrease as we continue to make
quarterly payments on the Secured Notes and the outstanding principal of such
notes is reduced. Our investment and interest income for Fiscal 2001 was
$430,000 compared to $399,000 for Fiscal 2000. The increase in investment and
interest income is due to more cash being available for investment.
Our net income for Fiscal 2001 was $10.8 million or $1.29 per diluted share
compared to a net income of $8.1 million or $0.94 per diluted share for Fiscal
2000. A portion of this increase is attributable to our repurchase of 249,000
shares of our common stock during Fiscal 2001. For Fiscal 2001, we booked for
GAAP purposes a tax provision of $7.2 million or $0.86 per diluted share,
compared to $4.9 million or $0.56 per diluted share for Fiscal 2000. We have
fully utilized the net operating losses generated subsequent to our 1994
reorganization, which were not subject to Section 382 limitations. For Fiscal
2001, we utilized $780,450 of our limited Section 382(1)(b) net operating
losses for both federal and state. In Fiscal 2000, we utilized $5.3 million of
our federal net operating loss carryovers and $780,450 of our limited Internal
Revenue Code Section 382(1)(6) net operating loss carryovers for both federal
and state.
Fiscal 2000 compared to Fiscal 1999
In Fiscal 2000, revenues increased 28% to $24.7 million from $19.3 million
for Fiscal 1999. Revenues for both Fiscal 2000 and Fiscal 1999 were generated
solely from licensing our trademarks. Revenues from Target Stores for Fiscal
2000 and Fiscal 1999 were $16.3 million or 66% of revenues and $14.6 million or
76% of revenues, respectively. Revenues from all other sources for Fiscal 2000
and Fiscal 1999 were $8.4 million or 34% of revenues and $4.7 million or 24% of
revenues, respectively. Zellers paid royalties of approximately $3.6 million in
Fiscal 2000 compared to $1.1 million in Fiscal 1999. The increase in royalties
from Zellers is mainly due to the increased acceptance by Canadian consumers of
merchandise bearing the Cherokee brand and Zellers' expansion of the Cherokee
brand into additional product categories. In Fiscal 2000, its first full year
of sales of Sideout merchandise, Mervyn's paid royalties of $1.7 million
during. One of our licensees, Uptons, Inc., closed on December 31, 1999 and as
part of the termination agreement paid, in Fiscal 2000, 90% of the remaining
minimum royalties due, which amounted to $336,000.
20
Selling, general and administrative expenses for Fiscal 2000 were $9.4
million or 38% compared to $6.6 million or 34% of revenues for Fiscal 1999.
During Fiscal 2000, selling, general and administrative expenses increased due
to expenses of approximately $300,000 in marketing and finders fees and
additional bonus expense of $573,000 and the forgiveness and cancellation of
$1.9 million of the note receivable from Mr. Margolis, a one-time event. Finder
fee expenses are expected to increase as Sideout royalties increase and
management and staff bonus expenses are expected to rise as EBITDA rises.
Our interest expense for Fiscal 2000 was $2.8 million compared to $3.2
million for Fiscal 1999. The interest expense is attributable to the Secured
Notes. Interest expense is expected to decrease as we continue to make
quarterly payments on the Secured Notes. Our investment and interest income for
Fiscal 2000 was $399,000 compared to $638,000 for Fiscal 1999. The reduction in
investment and interest income is due to less cash being available for
investment.
Our net income for Fiscal 2000 was $8.1 million or $0.94 per diluted share
compared to a net income of $6.1 million or $0.70 per diluted share for Fiscal
1999. For Fiscal 2000, we booked for GAAP purposes a tax provision of $4.9
million or $0.56 per diluted share, compared to $4.0 million or $0.46 per
diluted share for Fiscal 1999, which amounts were offset against our deferred
tax asset account. In Fiscal 2000, we utilized $5.3 million of our federal net
operating loss carryovers and $780,450 of our limited Internal Revenue Code
Section 382 (1)(6) net operating loss carryovers for both federal and state. At
January 29, 2000, we had fully utilized the net operating loss carryovers
generated subsequent to our 1994 reorganization, which were not subject to
Section 382 limitations.
Liquidity and Capital Resources
On February 3, 2001 we had $5.3 million in cash and cash equivalents,
including restricted cash of $2.7 million. Cash flow needs over the short term
in the next twelve months and in the long term are both expected to be met
through the operating cash flows generated from licensing revenues and our cash
and cash equivalents.
During Fiscal 2001, cash provided by operations was $14.5 million, compared
to $14.2 million in Fiscal 2000. During Fiscal 2001, cash used in investing
activities was $1.5 million due mainly to trademark purchases and registration
fees of $1.8 million offset by the note receivable repayment of $373,000. In
comparison, in Fiscal 2000, cash used in investing activities was $1.7 million,
relating to the purchase of trademarks and property and equipment. During
Fiscal 2001, cash used in financing activities was $12.6 million compared to
$13.1 million in Fiscal 2000. Cash used in financing activities in Fiscal 2001
represents an increase in restricted cash of $400,000, which relates to the
increase in the amount of the quarterly payments on the Secured Notes from
$2.25 million to $2.625 million per quarter. During Fiscal 2001 we made
payments totaling $10.125 million on the Secured Notes. Also during Fiscal
2001, pursuant to our Board of Directors' directive to repurchase our common
stock, we used $2.1 million of our cash flow to repurchase 249,000 shares of
our common stock.
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.
Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES OF MARKET RISK
Market risk generally represents the risk that losses may occur in the values
of financial instruments as a result of movements in interest rates, foreign
currency exchange rates and commodity prices. We do not enter into derivatives
or other financial instruments for trading or speculative purposes.
21
Interest: From time to time we invest our excess cash in interest-bearing
temporary investments of high-quality issuers. Due to the short time the
investments are outstanding and their general liquidity, these instruments are
classified as cash equivalents in our consolidated balance sheet and do not
represent a material interest rate risk to us. Our only long-term debt
obligations are the Secured Notes, which are zero-coupon secured notes yielding
interest of 7.0% interest per annum. This long-term debt obligation does not
represent a material interest rate risk to us.
Foreign Currency: We conduct business in various parts of the world. We are
exposed to fluctuations in exchange rates to the extent that the foreign
currency exchange rate fluctuates in countries where our licensees do business,
however, revenues from international licensing comprise 15.5% of our
consolidated revenues. For Fiscal 2001, a hypothetical 10% strengthening of the
US dollar relative to the foreign currencies of countries where we operate was
not material.
22
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Page
----
CHEROKEE INC.
Report of Independent Accountants......................................... F-1
Consolidated Balance Sheets At February 3, 2001 and January 29, 2000...... F-2
Consolidated Statements of Operations For the Years Ended February 3,
2001, January 29, 2000 and January 30, 1999.............................. F-3
Consolidated Statements of Stockholders' Deficit For the Years Ended
February 3, 2001, January 29, 2000 and January 30, 1999.................. F-4
Consolidated Statements of Cash Flows For the Years Ended February 3,
2001, January 29, 2000 and January 30, 1999.............................. F-5
Notes to Financial Statements............................................. F-6
SCHEDULES
II Valuations and Qualifying Accounts and Reserves......................... F-15
All other schedules for which provision is made in the applicable accounting
regulation of the SEC have been omitted since the required information is not
applicable or is not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the Consolidated
Financial Statements and related notes.
23
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders of
Cherokee Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Cherokee Inc. and its subsidiary at February 3, 2001 and January
29, 2000, and the results of their operations and their cash flows for the
three years ended February 3, 2001, January 29, 2000 and January 30, 1999, in
conformity with accounting principles generally accepted in the United States
of America. In addition, in our opinion, the financial statement schedule
listed in the accompanying index, presents fairly, in all material respects,
the information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in
the United States of America which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
March 14, 2001
F-1
CHEROKEE INC.
CONSOLIDATED BALANCE SHEETS
February 3, January 29,
2001 2000
------------ ------------
Assets
Current assets:
Cash and cash equivalents........................ $ 2,598,000 $ 2,253,000
Restricted cash.................................. 2,724,000 2,324,000
Receivables, net................................. 5,893,000 4,841,000
Prepaid expenses and other current assets........ 37,000 28,000
Deferred tax asset............................... 713,000 1,579,000
------------ ------------
Total current assets........................... 11,965,000 11,025,000
Securitization fees, net of accumulated
amortization of $634,000 and $429,000,
respectively...................................... 606,000 812,000
Deferred tax asset................................. 493,000 797,000
Property and equipment, net of accumulated
depreciation of $202,000 and $156,000,
respectively...................................... 219,000 203,000
Trademarks, net.................................... 6,115,000 4,666,000
Other assets....................................... 15,000 15,000
------------ ------------
Total assets................................... $ 19,413,000 $ 17,518,000
============ ============
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable................................. $ 302,000 $ 600,000
Other accrued liabilities........................ 3,176,000 2,286,000
Current portion of long term notes payable....... 10,500,000 10,125,000
------------ ------------
Total current liabilities...................... 13,978,000 13,011,000
Other liabilities.................................. 250,000 250,000
Notes payable less current portion................. 20,255,000 28,389,000
------------ ------------
Total liabilities.............................. 34,483,000 41,650,000
============ ============
Commitments and Contingencies (Note 8)
Stockholders' Deficit
Preferred stock, $0.02 par value 1,000,000 shares
authorized.
None issued and outstanding...................... -- --
Common stock, $.02 par value, 20,000,000 shares
authorized, 8,231,705 and 8,472,428 shares issued
and outstanding at February 3, 2001 and January
29, 2000, respectively............................ 165,000 170,000
Accumulated deficit................................ (15,235,000) (23,937,000)
Note receivable from stockholder................... -- (365,000)
------------ ------------
Total stockholders' deficit........................ (15,070,000) (24,132,000)
------------ ------------
Total liabilities and stockholders' deficit........ $ 19,413,000 $ 17,518,000
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Year Ended Year Ended
February 3, January 29, January 30,
2001 2000 1999
----------- ----------- -----------
Net revenues........................... $28,281,000 $24,714,000 $19,307,000
Selling, general and administrative
expenses.............................. 7,955,000 9,115,000 6,428,000
Amortization of trademarks............. 396,000 261,000 200,000
----------- ----------- -----------
Operating income................... 19,930,000 15,338,000 12,679,000
Other income (expenses):
Interest expense..................... (2,367,000) (2,817,000) (3,247,000)
Investment and interest income....... 430,000 399,000 638,000
----------- ----------- -----------
Total other income (expenses),
net............................... (1,937,000) (2,418,000) (2,609,000)
Income before income taxes............. 17,993,000 12,920,000 10,070,000
Income tax provision................... 7,227,000 4,859,000 3,982,000
----------- ----------- -----------
Net income........................... $10,766,000 $ 8,061,000 $ 6,088,000
=========== =========== ===========
Basic earnings per share............. $ 1.29 $ 0.94 $ 0.70
=========== =========== ===========
Diluted earnings per share........... $ 1.29 $ 0.94 $ 0.70
=========== =========== ===========
Weighted average shares outstanding:
Basic................................ 8,334,420 8,618,053 8,683,601
Diluted.............................. 8,349,599 8,620,511 8,706,011
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
Common Stock Notes
------------------- Additional Receivable
Par Paid-in Accumulated from
Shares Value Capital Deficit Stockholder Total
--------- -------- ---------- ------------ ----------- ------------
Balance at January 31,
1998................... 8,612,657 $173,000 $ -- $(23,806,000) $(2,013,000) $(25,646,000)
Exercise of director
warrants and employee
stock options.......... 92,771 1,000 667,000 -- -- 668,000
Cash dividend
distributions.......... -- -- (667,000) (10,210,000) -- (10,877,000)
Utilization of pre-
bankruptcy NOL
carryforwards.......... -- -- -- 9,000 -- 9,000
Interest on note
receivable from
stockholder............ -- -- -- -- (121,000) (121,000)
Net income for the year
ended January 30,
1999................... -- -- -- 6,088,000 -- 6,088,000
--------- -------- --------- ------------ ----------- ------------
Balance at January 30,
1999................... 8,705,428 174,000 -- (27,919,000) (2,134,000) (29,879,000)
Purchase and retirement
of treasury shares..... (233,000) (4,000) (1,903,000) (1,907,000)
Cash dividend
distributions.......... (2,176,000) (2,176,000)
Forgiveness of note
receivable from
stockholder............ 1,890,000 1,890,000
Interest on note
receivable from
stockholder............ (121,000) (121,000)
Net income for the year
ended January 29,
2000................... 8,061,000 8,061,000
--------- -------- --------- ------------ ----------- ------------
Balance at January 29,
2000................... 8,472,428 170,000 -- (23,937,000) (365,000) (24,132,000)
Exercise of director
warrants and employee
stock options.......... 8,277 -- -- 12,000 -- 12,000
Purchase and retirement
of treasury shares..... (249,000) (5,000) (2,096,000) (2,101,000)
Stock option tax
benefit................ -- -- -- 20,000 -- 20,000
Interest on note
receivable from
stockholder............ (8,000) (8,000)
Repayment of note
receivable from
stockholder............ 373,000 373,000
Net income for the year
ended February 3,
2001................... 10,766,000 10,766,000
--------- -------- --------- ------------ ----------- ------------
Balance at February 3,
2001................... 8,231,705 $165,000 $ -- $(15,235,000) $ -- $(15,070,000)
========= ======== ========= ============ =========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
February 3, January 29, January 30,
2001 2000 1999
------------ ------------ ------------
Operating activities
Net income.......................... $ 10,766,000 $ 8,061,000 $ 6,088,000
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization..... 46,000 61,000 32,000
Amortization of trademarks........ 396,000 260,000 200,000
Amortization of securitization
fees............................. 206,000 206,000 206,000
Amortization of debt discount..... 2,367,000 2,817,000 3,247,000
Interest income on note receivable
from stockholder................. (8,000) (121,000) (121,000)
Deferred taxes.................... 1,170,000 2,012,000 3,197,000
Forgiveness of note receivable.... -- 1,890,000 --
Changes in current assets and
liabilities:
Receivables..................... (1,052,000) (1,609,000) (885,000)
Inventories..................... -- -- 45,000
Prepaids and other current
assets......................... (9,000) 1,000 191,000
Accounts payable................ (298,000) 320,000 (365,000)
Accrued payroll and related
expenses....................... 909,000 531,000 1,233,000
Other liabilities............... -- (250,000) (250,000)
------------ ------------ ------------
Net cash provided by operating
activities................... 14,493,000 14,179,000 12,818,000
------------ ------------ ------------
Investing activities
Purchases of trademark.............. (1,845,000) (1,750,000) (673,000)
Purchase of property and equipment.. (62,000) (31,000) (216,000)
Repayment on note receivable from
stockholder........................ 373,000 -- --
Change in other assets.............. -- 91,000 (68,000)
------------ ------------ ------------
Net cash used in investing
activities................... (1,534,000) (1,690,000) (957,000)
------------ ------------ ------------
Financing activities
Decrease (increase) in restricted
cash............................... (400,000) 2,176,000 (4,500,000)
Payment of long-term debt........... (10,125,000) (9,000,000) (6,750,000)
Debt issuance costs................. -- -- (6,000)
Proceeds from exercise of stock
options............................ -- -- 668,000
Proceeds from exercise of warrants.. 12,000 -- --
Purchase of treasury shares......... (2,101,000) (1,907,000) --
Cash distributions and dividends.... -- (4,352,000) (8,701,000)
------------ ------------ ------------
Net cash used in financing
activities................... (12,614,000) (13,083,000) (19,289,000)
------------ ------------ ------------
(Decrease) increase in cash and cash
equivalents........................ 345,000 (594,000) (7,428,000)
Cash and cash equivalents at
beginning of period................ 2,253,000 2,847,000 10,275,000
------------ ------------ ------------
Cash and cash equivalents at end of
period............................. $ 2,598,000 $ 2,253,000 $ 2,847,000
============ ============ ============
Total paid during period:
Income taxes...................... $ 5,115,000 $ 3,143,000 $ 221,000
Interest.......................... $ 1,626,000 $ 900,000 $ 298,000
Non-cash transactions:
Declaration of cash dividend...... $ -- $ -- $ 2,176,000
Utilization of pre-bankruptcy NOL
carryforwards.................... $ -- $ -- $ 9,000
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business
Cherokee Inc. (the Company, which may be referred to as WE, US, or OUR) is in
the business of marketing and licensing the Cherokee and Sideout brands and
related trademarks and other brands it owns. We are one of the leading
licensors of brand names and trademarks for apparel, footwear and accessories
in the United States.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of our company and
our wholly-owned subsidiary, SPELL C. LLC, a Delaware limited liability
corporation. All significant intercompany accounts and transactions have been
eliminated in consolidation.
Company Year End
On December 19, 1997, we changed our fiscal year to a 52 or 53 week fiscal
year ending on the Saturday nearest to January 31 in order to better align
ourselves with our licensees who also generally operate and plan using a fiscal
year ending nearest to January 31. Prior to this change, our fiscal year was a
52 or 53 week fiscal year ending on the Saturday nearest to May 31.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires us 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
We consider all highly liquid debt instruments purchased and money market
funds with an original maturity date of three months or less to be cash
equivalents.
The Secured Notes indenture requires the trustee to retain in the collection
account certain amounts sufficient to meet the quarterly note payments. Such
amounts have been classified as restricted cash.
Revenue Recognition
Royalty revenues are recognized when earned based upon contractual agreement.
Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Maintenance and repairs are expensed as incurred. The cost and
related accumulated depreciation of property and equipment sold or retired are
removed from the accounts and the resulting gains or losses are included in
current operations. Depreciation is provided on a straight line basis over the
estimated useful life of the related asset ranging from three to eight years.
F-6
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Trademarks
Trademark registrations, renewal fees and acquired trademarks are stated at
cost and are amortized over their estimated useful life of fifteen years.
Securitization Fees
Securitization fees are the costs associated with the leveraged
recapitalization which have been capitalized and are being amortized over the
term of the Secured Notes indenture.
Long-Lived Assets
The carrying value of long-lived assets is periodically reviewed by us 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 we believe no impairment exists.
Income Taxes
Income tax expense is the tax payable for the period and the change during
the period in deferred tax assets and liabilities. Deferred income taxes are
determined based on the difference between the financial reporting and tax
bases of assets and liabilities using enacted rates in effect during the year
in which the differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized.
Concentrations of Credit Risk
Financial instruments which potentially subject us to concentrations of
credit risk consist principally of cash and cash equivalents and trade
receivables. We limit our credit risk with respect to cash by maintaining cash
balances with quality financial institutions. At February 3, 2001 and January
29, 2000, our 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 our licensing royalty
revenue program. Generally, we do not require collateral or other security to
support customer receivables. One customer accounted for approximately 67% and
68%, respectively, of our trade receivables at February 3, 2001 and January 29,
2000 and approximately 68%, 66% and 76%, respectively, of our revenues during
the fiscal years ended February 3, 2001, January 29, 2000 and January 30, 1999.
Fair Value of Financial Instruments
The amount recorded for financial instruments in our consolidated financial
statements approximates fair value as defined in SFAS No. 107 "Disclosures
about the Fair Value of Financial Instruments", except the long-term debt
described in Note 5 of which the fair value is not readily determinable.
Stock-Based Compensation
SFAS No. 123 "Accounting for the Awards of Stock-Based Compensation to
Employees" encourages, but does not require companies to record compensation
cost for stock-based compensation plans at fair value. We have adopted the
disclosure requirements of SFAS No. 123, which involves proforma disclosure of
net income under SFAS No. 123 and a detailed description of plan terms and
assumptions used in valuing stock option grants. We have chosen to continue to
account for stock-based compensation awards in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees".
F-7
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Advertising
Our retail direct licensees fund their own advertising programs. Our
advertising and promotional costs are immaterial and are expensed as incurred.
Earnings Per Share
Basic earnings per share is computed by dividing the net income attributable
to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed by
dividing the net income attributable to common shareholders by the weighted
average number of common and common equivalent shares outstanding during the
period. Common share equivalents included in the diluted computation represent
shares issuable upon assumed exercise of stock options using the treasury stock
method.
Comprehensive Income
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income,"
which establishes standards for reporting and displaying comprehensive income
and its components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. Comprehensive income includes net income
and other comprehensive income components which under generally accepted
accounting principles ("GAAP") bypass the income statement and are reported in
the balance sheet as a separate component of equity. For the three years ended
February 3, 2001, January 29, 2000 and January 30, 1999, we had no other
comprehensive income components as defined in SFAS No. 130, and accordingly,
net income equals comprehensive income.
Segment Reporting
We adopted SFAS No. 131. "Disclosures about Segments of an Enterprise and
Related Information" for the year ended January 30, 1999. SFAS No. 131
supercedes SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise", replacing the "industry segment" approach with the "management"
approach. The management approach designates the internal organization that is
used by management for making operating decisions and assessing performance as
the source of our reportable segments. SFAS No. 131 also requires disclosures
about products or services, geographic areas and major customers. The adoption
of SFAS No. 131 did not affect the results of operations or financial position
nor the disclosure of segment information, as our reporting structure provides
for only one segment--the marketing and licensing of our trademarks.
3. Receivables
Receivables consist of the following:
February January
3, 2001 29, 2000
---------- ----------
Trade.................................................. $5,784,000 $4,258,000
Other.................................................. 109,000 583,000
---------- ----------
$5,893,000 $4,841,000
========== ==========
Our royalty recognition policy provides for recognition of royalties in the
quarter earned, although a large portion of such royalty payments are actually
received during the month following the end of a quarter. Our trade receivable
balance included an accrual for Target Stores, Zellers and Mervyn's royalty
revenues earned during the fourth quarter of Fiscal 2001 and subsequently
received in February 2001.
F-8
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Trademarks
Trademarks consist of the following:
February 3, 2001 January 29, 2000
---------------- ----------------
Trademarks................................ $7,014,000 $5,169,000
Accumulated amortization.................. (899,000) (503,000)
---------- ----------
Total................................... $6,115,000 $4,666,000
========== ==========
In November 1997, we entered into an agreement with Sideout Sport Inc. (the
"Sideout Agreement") to purchase trademarks and licenses related to Sideout(R),
Sideout Sport(R) and King of the Beach(R). Pursuant to the Sideout Agreement we
paid $1.5 million at the closing date of the acquisition and agreed to pay
$500,000 upon the release of liens, of which $495,000 was paid during the
fiscal year ended January 30, 1999. We will also pay Sideout Sport Inc., on a
quarterly basis, additional consideration contingent upon a formula of
licensing revenues, as defined in the Sideout Agreement. Such contingent
consideration is limited to a maximum of $5.5 million, or the lesser amount
which may be earned through October 22, 2004. Since January 1, 1999, we have
paid in total over $2.6 million in contingent payments under the Sideout
Agreement.
5. Long-Term Debt
On December 23, 1997, we completed the recapitalization described below and
publicly announced that we would declare a special dividend of $5.50 per share,
which was subsequently paid on January 15, 1998. As part of the
recapitalization and in exchange for the proceeds from the Secured Notes (as
defined below), we sold to our wholly-owned subsidiary, Spell C, all our rights
to the Cherokee brand and related trademarks in the United States and assigned
to Spell C all of our rights in an amended licensing agreement (the "Amended
Target Agreement") with Target Stores, a division of Target Corporation. Spell
C issued for gross proceeds of $47.9 million, privately placed Zero Coupon
Secured Notes (the "Secured Notes"), yielding 7.0% interest per annum and
maturing on February 20, 2004. The Secured Notes amortize quarterly from May
20, 1998 through February 20, 2004. The Secured Notes are collateralized by the
Amended Target Agreement and the domestic Cherokee brand name and trademarks.
The Secured Notes indenture requires that any proceeds due to Spell C under the
Amended Target Agreement must be deposited directly into a collection account
controlled by the trustee under the indenture. The trustee will distribute from
the collection account the amount of principal due and payable on the Secured
Notes to the holders thereof on quarterly note payment dates. Excess amounts on
deposit in the collection account may only be distributed to Spell C if the
amount on deposit in the collection account exceeds the aggregate amount of
principal due and payable on the next quarterly note payment date. Such excess
amounts, if any, may then be distributed by Spell C to us. The minimum
guaranteed royalty under the Amended Target Agreement is $9.0 million for each
of the two fiscal years ending January 29, 1999 and 2000 and $10.5 million for
each of the four fiscal years ending January 31, 2001 through 2004. The
aggregate scheduled amortization under the Secured Notes is $60.0 million and
equals the aggregate minimum guaranteed royalty payable under the Amended
Target Agreement which is also $60.0 million. During Fiscal 2001, the trustee
distributed from the collection account $10.125 million to the holders of the
Secured Notes.
F-9
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The maturity schedule of Secured Notes is as follows:
Face Value
-----------
2002............................................................ $10,500,000
2003............................................................ 10,500,000
2004............................................................ 10,500,000
Thereafter...................................................... 2,625,000
-----------
Total......................................................... $34,125,000
Less unamortized note discount.................................. 3,370,000
-----------
30,755,000
Less current portion of long term debt.......................... 10,500,000
-----------
Long term obligation.......................................... $20,255,000
===========
6. Income Taxes
The income tax benefit as shown in the statements of operations includes the
following:
Year Ended Year Ended Year Ended
February January January
3, 2001 29, 2000 30, 1999
---------- ---------- ----------
Current:
Federal................................... $4,299,000 $1,139,000 $ 229,000
State..................................... 1,317,000 1,077,000 410,000
Foreign................................... 447,000 427,000 155,000
---------- ---------- ----------
6,063,000 2,643,000 794,000
Deferred:
Federal................................... 888,000 2,179,000 2,923,000
State..................................... 276,000 37,000 265,000
---------- ---------- ----------
1,164,000 2,216,000 3,188,000
---------- ---------- ----------
$7,227,000 $4,859,000 $3,982,000
========== ========== ==========
Deferred income taxes are comprised of the following:
February 3, 2001 January 29, 2000
-------------------- ----------------------
Current Non-Current Current Non-Current
-------- ----------- ---------- -----------
Deferred tax assets:
Fixed assets............... $ -- $ (16,000) $ -- $ --
Accrued liabilities........ -- -- 978,000 --
Tax effect of NOL
carryovers................ 265,000 2,388,000 334,000 2,655,000
Other...................... 448,000 (21,000) 267,000 --
Valuation allowance........ -- (1,858,000) -- (1,858,000)
-------- ----------- ---------- -----------
Total deferred tax assets.. $713,000 $ 493,000 $1,579,000 $ 797,000
======== =========== ========== ===========
Our deferred tax asset is primarily related to state tax benefits and net
operating loss carryforwards. For the year ended February 3, 2001, no
adjustment was made to the valuation allowance. The valuation allowance relates
to amounts attributable to Internal Revenues Service ("IRC") Section 382 net
operating losses (as described below), which we believe may expire unused.
F-10
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of the actual income tax rates to the federal statutory rate
follows:
Year Ended Year Ended Year Ended
February 3, January 29, January 30,
2001 2000 1999
----------- ----------- -----------
Tax expense at U.S. statutory rate..... 34.0% 34.0% 34.0%
Foreign taxes.......................... -- -- 1.6
State income tax benefit net of federal
income tax............................ 5.8 5.7 4.5
Others................................. .3 (2.1) (.6)
---- ---- ----
Tax provision (benefit)................ 40.1% 37.6% 39.5%
==== ==== ====
At January 29, 2000, we had fully utilized the federal net operating loss
carryovers ("NOL's") generated subsequent to our 1994 reorganization. These
losses are not subject to IRC Section 382 limitations.
In 1994, we filed a prepackaged plan of reorganization pursuant to Chapter 11
of the United States Bankruptcy Code. As a result of the Plan, an ownership
change occurred and the annual limitation of pre-reorganization NOL's and
built-in losses (i.e. the tax bases of assets exceeded their fair market value
at the date of the ownership change) has been substantially limited under IRC
Section 382. The annual limitation amount, computed pursuant to IRC Section
382(1)(6), is approximately $780,000. Any unused IRC Section 382 annual loss
limitation amount may be carried forward to the following year. Those unused
limitation losses are then added to the current IRC Section 382 annual
limitation amount. Given the IRC Section 382 limitations, a substantial portion
of the pre-reorganization losses will expire unused. Such deferred tax assets
relating to the pre-organization losses that will expire unused have been
written off. As of February 3, 2001 we have $7.8 million of federal Section 382
NOLs available that begin to expire in 2008.
7. Earnings Per Share
The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for the three
years ended February 3, 2001, January 29, 2000, January 30, 1999:
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------ ---------
For the year ended February 3, 2001:
Basic earnings per share............. $10,766,000 8,334,420 $1.29
Effect of dilutive securities--stock
options and warrants................ 15,179
----------- --------- -----
Dilutive earnings per share........ $10,766,000 8,349,599 $1.29
----------- --------- -----
For the year ended January 29, 2000:
Basic earnings per share............. $ 8,061,000 8,618,053 $0.94
Effect of dilutive securities--stock
options and warrants................ 2,500
----------- --------- -----
Dilutive earnings per share........ $ 8,061,000 8,620,553 $0.94
----------- --------- -----
For the year ended January 31, 1999:
Basic earnings per share............. $ 6,088,000 8,683,601 $0.70
Effect of dilutive securities--stock
options and warrants................ 22,410
----------- --------- -----
Dilutive earnings per share........ $ 6,088,000 8,706,011 $0.70
----------- --------- -----
F-11
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The computation for diluted number of shares excludes unexercised stock
options and warrants which are anti-dilutive. The number of such shares for the
three years ended February 3, 2001, January 29, 2000, and January 30, 1999 were
291,735, 503,702 and 173,655, respectively.
8. Commitments and Contingencies
Leases
We leased our current facility under an operating lease expiring on July 31,
2001. We have an option to extend the term of the lease for two additional
three-year periods. On February 20, 2001, we exercised our first option and
extended the term of the lease from August 1, 2001 through July 31, 2004. The
future minimum non-cancellable lease payments are as follows:
Operating
Leases
---------
2002............................................................... $102,000
2003............................................................... 102,000
2004............................................................... 102,000
2005............................................................... 51,000
--------
Total future minimum lease payments.............................. $357,000
========
Total rent expense was $102,000, $102,000 and $91,000 for the years ended
February 3, 2001, January 29, 2000 and January 30, 1999, respectively.
9. Related Party Transactions
In 1995, we entered into a Management Agreement (the "Agreement") with The
Newstar Group d/b/a The Wilstar Group ("Wilstar"), pursuant to which Wilstar
agreed to provide management services to us by providing the services of Mr.
Robert Margolis as Chief Executive Officer. On January 3, 2001, Wilstar
assigned the Agreement to Mr. Margolis. The Agreement, as amended, terminates
on February 2, 2002 and provides for certain base compensation and bonuses, as
defined, payable to Mr. Margolis. The Agreement will automatically be extended
for each consecutive one year period in the event of pre-tax earnings, as
defined, exceed specified levels as agreed upon by our Compensation Committee.
The Agreement also provides that Mr. Margolis may elect two directors to the
Board of Directors.
The Agreement may be terminated at any time without cause or in the event of
certain circumstances, as defined. For the years ended February 3, 2001,
January 29, 2000 and January 30, 1999, respectively, we paid to Mr. Margolis
$2.76 million, $4.0 million and $2.0 million of contractual base compensation
and bonuses.
On December 23, 1997 we loaned $2.0 million to Robert Margolis. The loan
yielded 6.0% interest per annum and was recorded as a reduction to
stockholders' equity. The principal amount of the note and all accrued interest
thereon were due and payable on December 23, 2002.
In connection with the amendment of the Agreement, our stockholders approved
the forgiveness and cancellation of approximately $1.9 million of the note
should we meet certain performance goals during the fourth quarter ended
January 29, 2000. We recorded the partial forgiveness and cancellation of $1.9
million of the note receivable from stockholder as a charge against income in
the year ended January 29, 2000. The remaining balance of the note receivable
and accrued interest, totaling $373,000 was paid in full in June 2000.
F-12
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Capitalization
Preferred Stock
We are authorized to issue up to 1,000,000 shares of preferred stock. Our
board of directors can determine the rights, preferences, privileges and
restrictions on the preferred stock and the class and voting rights. As of
February 3, 2001 and January 29, 2000, no shares of preferred stock were
issued.
Stock Option Plan
Our 1995 Incentive Stock Option Plan (the "Plan") was approved at the October
30, 1995 Annual Meeting of Stockholders. The purpose of the Plan is to further
our growth and development by providing an incentive to officers and other key
employees who are in a position to contribute materially to our prosperity. Two
types of stock options (the "Option") may be granted under the plan--Incentive
and Non-Qualified stock options. The Options are vested in equal installments
over a three year period starting at the grant date and have a term of ten
years. The maximum number of shares authorized for grants of options under the
1995 Plan is 900,000. As of February 3, 2001, we have 85,464 shares available
for grants of options.
SFAS No. 123 "Accounting for the Awards of Stock-Based Compensation to
Employees" encourages, but does not require companies to record compensation
cost for stock based compensation plans at fair value. We have chosen to
continue to account for stock based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, " Accounting
for Stock Issued to Employees," and related interpretations. Had compensation
costs for our stock option plan been determined based upon the methodology
prescribed under SFAS No. 123, our net income would approximate the pro forma
amounts below:
2001 2000 1999
----------- ---------- ----------
Pro forma net income...................... $10,381,000 $7,606,000 $5,480,000
Pro forma basic earnings per share........ $ 1.25 $ 0.88 $ 0.63
Pro forma diluted earnings per share...... $ 1.24 $ 0.88 $ 0.63
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions: for 1999,
risk-free interest rates ranging between 4.57% and 5.56%; dividend yields of
12.50%; volatility of 56.67%; and expected life of the option of three years;
for 2000, risk-free interest rates ranging between 4.82% and 5.82%; dividend
yields of zero percent; volatility of 47.5%; and expected life of the option of
three years; and for 2001, risk-free interest rates ranging between 6.27% and
6.70%; dividend yields of zero percent; volatility of 48.16%; and expected life
of the option of three years Because additional stock options are expected to
be granted each year, the above pro forma disclosures are not representative of
pro forma effects on pro forma financial results for future years.
F-13
CHEROKEE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of our stock option activity, and related information for the years
ended February 3, 2001, January 29, 2000 and January 30, 1999 follows:
2001 2000 1999
----------------- ------------------ ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- -------- -------- -------- -------- --------
Outstanding at beginning
of year................ 587,869 $9.01 561,059 $9.06 480,083 $ 9.46
Granted............... 95,000 7.85 155,000 8.33 230,000 8.88
Exercised............. (8,277) 1.48 -- -- (10,000) 10.50
Forfeited............. (75,056) 7.90 (128,190) 8.39 (139,024) 10.03
------- ----- -------- ----- -------- ------
Outstanding at end of
year................... 599,536 8.98 587,869 9.01 561,059 9.06
======= ===== ======== ===== ======== ======
Exerciseable at end of
year................... 460,371 $9.01 320,904 $8.90 276,292 $ 8.61
Weighted average grant
date fair value of
options granted during
the year............... $3.13 $2.76 $ 1.75
The following table summarizes the stock options outstanding and exercisable
as of February 3, 2001:
Options Outstanding Options Exercisable
------------------------------------------- --------------------
Weighted
Number of Weighted Weighted Number of average
shares average average exercise shares exercise
Range outstanding remaining life price outstanding price
----- ----------- -------------- ---------------- ----------- --------
$ 7.00-$ 8.00........... 85,834 8.68 years $ 7.63 85,834 $ 7.63
$ 8.00-$ 9.00........... 303,101 7.34 years $ 8.52 199,769 $ 8.54
$ 9.00-$10.00........... 114,467 6.93 years $ 9.71 81,134 $ 9.85
$10.00-$11.00........... 96,134 6.49 years $10.79 93,634 $10.79
------- -------
599,536 460,371
======= =======
11. Selected Quarterly Financial Data (Unaudited):
The following table summarizes certain financial information by quarter for
2001 and 2000:
Fiscal year ended February 3, 2001
-------------------------------------------
April 29, July 29, October February
2000 2000 28, 2000 3, 2001
---------- ---------- ---------- ----------
Net Sales....................... $9,603,000 $7,686,000 $4,986,000 $6,006,000
Income before income taxes...... 6,929,000 4,728,000 2,907,000 3,429,000
Net Income...................... 4,157,000 2,837,000 1,744,000 2,028,000
Net income per share--basic..... 0.49 0.34 0.21 0.25
Net income per share--diluted... 0.49 0.34 0.21 0.25
Fiscal year ended January 29, 2000
-------------------------------------------
May 1, July 31, October January
1999 1999 31, 1999 29, 2000
---------- ---------- ---------- ----------
Net Sales....................... $6,917,000 $6,382,000 $5,674,000 $5,741,000
Income before income taxes...... 4,406,000 3,630,000 3,401,000 1,483,000
Net Income...................... 2,643,000 2,178,000 2,038,000 1,202,000
Net income per share--basic..... 0.30 0.25 0.24 0.14
Net income per share--diluted... 0.30 0.25 0.24 0.14
F-14
CHEROKEE INC.
SCHEDULE II--VALUATIONS AND QUALIFYING ACCOUNTS AND RESERVES
Charged/
Balance at (Credited) to Charged Balance at
Beginning Costs and to Other End of
Description of Period Expenses Accounts Deductions Period
----------- ---------- ------------- -------- ---------- ----------
Tax Valuation Allowance
Year ended Feb. 3,
2001................. $1,858,000 $ -- $ -- $ -- $1,858,000
Year ended Jan. 29,
2000................. $1,858,000 $ -- $ -- $ -- $1,858,000
Year ended Jan. 30,
1999................. $1,858,000 $ -- $ -- $ -- $1,858,000
F-15
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to directors and
compliance with Section 16(a) of the Exchange Act is incorporated herein by
reference to the information contained in the Proxy Statement relating to our
2001 Annual Meeting of Stockholders scheduled to be held on May 31, 2001, which
will be filed with the SEC no later than 120 days after the close of the fiscal
year ended February 3, 2001. The following table sets forth information with
respect to each of our current executive officers.
Principal Occupation for Past Five
Name, Age and Years;
Present Position with the Company Business Experience
--------------------------------- ----------------------------------
Robert Margolis, 53
Director, Chairman of the Board of
Directors and Chief Executive Mr. Margolis has been our Chairman of
Officer.............................. the Board and Chief Executive Officer
since May 5, 1995 and his services are
provided to us pursuant to a
management agreement. Mr. Margolis was
the co-founder of our Apparel Division
in 1981. He had been our 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 us on October 31, 1993
and entered into a one-year consulting
agreement with us.
Howard Siegel, 45
President-Operations................. Mr. Siegel has been employed by us
since January 1996 as Vice President
of Operations and administration and
became President of Operations on June
1, 1998. Prior to January 1996, Mr.
Siegel had a long tenure in the
apparel business industry working as a
Senior Executive for both Federated
Department stores and Carter Hawley
Hale Broadway stores.
Carol Gratzke, 52
Chief Financial Officer.............. Ms. Gratzke returned to us in November
1995 as our 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 our Apparel & Uniform
Divisions. From July 1994 to September
1995, she was Executive Vice President
of Finance for a Los Angeles based
apparel manufacturing company.
Stephen Ascher, 38
Executive Vice President, New
Business............................. Mr. Ascher joined us in November 1997
when the worldwide rights of the
Sideout brand were purchased in
November 1997. In November 1983, Mr.
Ascher founded Sideout Sport, Inc. He
was the President and CEO of Sideout
Sport through October 1997. and the
former President of Sideout Sport Inc.
24
Nina Leong, 42
Executive Vice President, Brand
Development.......................... Ms. Leong joined us in June 2000 as
Executive Vice President of Brand
Development. Prior to June 2000
Ms. Leong served as Executive Vice
President at Ocean Pacific Apparel
Corp ("Op") where she ran brand
development and licensing. Prior to
Op, Ms. Leong spent ten years at the
Walt Disney Company in Consumer
Products Licensing as Vice President
of Retail development and oversaw
licensing and retail initiatives.
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 our 2001 Annual
Meeting of Stockholders scheduled to be held on May 31, 2001, which will be
filed with the SEC no later than 120 days after the close of the fiscal year
ended February 3, 2001.
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 our 2001 Annual
Meeting of Stockholders scheduled to be held on May 31, 2001, which will be
filed with the SEC no later than 120 days after the close of the fiscal year
ended February 3, 2001.
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 our 2001 Annual
Meeting of Stockholders scheduled to be held on May 31, 2001, which will be
filed with the SEC no later than 120 days after the close of the fiscal year
ended February 3, 2001.
25
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
------- ----------------------
3.1 Amended and Restated Certificate of Incorporation of Cherokee Inc.
(incorporated by reference from Exhibit 3.1 of Cherokee Inc.'s Form
10Q dated October 28, 2000).
3.2 Bylaws of Cherokee Inc. (incorporated by reference from Exhibit 3.2 of
Cherokee Inc.'s Form 10Q dated October 28, 2000).
4.1 Indenture, dated December 23, 1997, among SPELL C. LLC, as issuer, and
Wilmington Trust Company, as trustee, with respect to the Zero Coupon
Secured Notes (incorporated by reference from Exhibit 4.3 of Cherokee
Inc.'s Form 10-K dated January 31, 1998).
4.2 Security Agreement dated December 23, 1997, between SPELL C. LLC and
Wilmington Trust Company (incorporated by reference from Exhibit 4.4
of Cherokee Inc.'s Form 10-K dated January 31, 1998).
10.1 Cherokee Inc. 1995 Incentive Stock Option Plan (incorporated by
reference from Cherokee Inc.'s Form S-8 dated June 23, 1998).
10.2 First Amendment to Cherokee Inc. 1995 Incentive Stock Option Plan
(incorporated by reference from Cherokee Inc.'s Form S-8 dated June
23, 1998).
10.3 Second Amendment to Cherokee Inc. 1995 Incentive Stock Option Plan
(incorporated by reference from Cherokee Inc.'s Form S-8 dated June
23, 1998).
10.4 Form of Director Option (incorporated by reference from Cherokee
Inc.'s Form S-8 dated October 21, 1996).
10.5 Form of Director Warrant (incorporated by reference from Exhibit 10.3
of Cherokee Inc.'s Form 10-K dated April 24, 1995).
10.6 Form of Employee Option Agreement
10.7 Agreement of Purchase and Sale of Trademarks and Licenses between
Cherokee Inc. and Sideout Sport, Inc. dated November 7, 1997
(incorporated by reference from Exhibit 2.1 of Cherokee Inc.'s
Current Report on Form 8-K dated November 7, 1997).
10.8 License Agreement between Cherokee Inc. and Dayton Hudson Stores dated
November 12, 1997 (incorporated by reference from Exhibit 10.1 of
Cherokee Inc.'s Current Report on Form 8-K dated November 7, 1997).
10.9 Note Purchase Agreement dated December 23, 1997, between SPELL C. LLC
and the purchasers listed on the signature pages thereto
(incorporated by reference from Exhibit 10.16 of Cherokee Inc.'s Form
10-K dated January 31, 1998).
10.10 Trademark Purchase and License Assignment Agreement dated December 23,
1997 between SPELL C. LLC and Cherokee Inc. (incorporated by
reference from Exhibit 10.17 of Cherokee Inc.'s Form 10-K dated
January 31, 1998).
26
Exhibit
Number Description of Exhibit
------- ----------------------
10.11 Administrative Services Agreement dated December 23, 1997, between
SPELL C. LLC and Cherokee Inc. (incorporated by reference from
Exhibit 10.18 of Cherokee Inc.'s Form 10-K dated January 31, 1998).
10.12 Limited Liability Company Agreement of SPELL C. LLC dated as of
December 23, 1997, between SPELL C. LLC and Cherokee Inc.
(incorporated by reference from Exhibit 10.19 of Cherokee Inc.'s
Form 10-K dated January 31, 1998).
10.13 Second Revised and Restated Management Agreement dated as of November
29, 1999 between Cherokee Inc. and The Newstar Group d/b/a The
Wilstar Group (incorporated by reference from Exhibit 10.9 of
Cherokee Inc.'s Form 10-K dated January 29, 2000).
21.1 Subsidiaries of Cherokee Inc.
23.1 Consent of Independent Accountants dated March 30, 2001.
(b) Reports on Form 8-K.
We filed no reports on Form 8-K during the three months ended February 3,
2001.
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
CHEROKEE INC.
/s/ Robert Margolis
By __________________________________
Robert Margolis
Chairman and Chief Executive Officer
Date: April 2, 2001
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.
Signature Title Date
--------- ----- ----
/s/ Robert Margolis Chairman and Chief Executive April 2, 2001
____________________________________ Officer and Director
Robert Margolis
/s/ Carol Gratzke Chief Financial Officer / April 2, 2001
____________________________________ Chief Accounting Officer
Carol Gratzke
/s/ Timothy Ewing Director April 2, 2001
____________________________________
Timothy Ewing
/s/ Keith Hull Director April 2, 2001
____________________________________
Keith Hull
/s/ Dave Mullen Director April 2, 2001
____________________________________
Dave Mullen
/s/ Jess Ravich Director April 2, 2001
____________________________________
Jess Ravich
28