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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 [Fee Required]
for the fiscal year ended June 1, 1996 or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
for the Transition Period from _______ to _______
Commission file No. 0-18640
_______________
CHEROKEE INC.
(Exact name of registrant as specified in charter)
DELAWARE 95-4182437
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6835 VALJEAN AVENUE
VAN NUYS, CA 91406
(Address of principal executive office) (Zip Code)
(818) 908-9868
(Registrant's telephone number, including area code)
__________________
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.02 per Share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
(1) YES X NO
----- -----
(2) YES NO X
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
YES NO X
----- -----
Applicable Only to Registrants Involved in Bankruptcy Proceedings During the
Preceding Five Years
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
YES X NO
----- -----
As of August 9, 1996, the registrant had 7,650,813 shares of its Common Stock,
par value $.02 per share, issued and outstanding.
As of August 9, 1996, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $27,441,000 (computed on the
basis of the last trade of the Common Stock on the NASDAQ Small Cap Issue Market
on August 9, 1996).
Certain portions of the following document are incorporated by reference into
Part III of this Form 10-K:
The registrant's proxy statement for the Annual Meeting of Stockholders to be
held on October 14, 1996.
1
CHEROKEE INC.
INDEX
Page
PART I
Item 1. Business........................................... 3
Item 2. Properties......................................... 9
Item 3. Legal Proceedings.................................. 9
Item 4. Submission of Matters to a Vote of Security Holders 9
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters........................ 10
Item 6. Selected Financial Data............................ 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation................. 13
Item 8. Financial Statements and Supplementary Data........ 18
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................ 19
PART III
Item 10. Executive Officers of the Registrant............... 20
Item 11. Executive Compensation............................. 21
Item 12. Security Ownership of Certain Beneficial Owners
and Management..................................... 21
Item 13. Certain Relationships and Related Transactions..... 21
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K........................................ 22
2
PART I
ITEM 1. BUSINESS
RECENT EVENTS
- - -------------
On April 24, 1995, a group including Robert Margolis, who founded Cherokee
Inc.'s (the "Company") Apparel Division in 1981, and who had been the Company's
Chairman and Chief Executive Officer from May 1989 to October 1993, purchased
1,358,000 shares, or approximately 22.3% of the Company's then outstanding
Common Stock ("Common Stock"). On May 5, 1995, Mr. Margolis was appointed
Chairman and Chief Executive Officer of the Company. After a period of
assessment, Mr. Margolis set in motion a strategy which resulted in the
Company's principal business being a marketer and licensor of the Cherokee brand
and other brands it owns or may acquire in the future. The Company has
terminated manufacturing and importing apparel and footwear, has sold most of
its inventories of apparel and footwear and on July 28, 1995 sold the assets of
its Uniform Division. The proceeds from these sales have been used to pay off
all of the Company's indebtedness. As a result of discontinuing the apparel and
footwear business and selling the Uniform Division, the number of employees was
reduced from approximately 345 at May 28, 1994 to 15 by November 1, 1995. (See
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation.)
Prior to this major strategic change, the Company (as defined below) was a
designer, manufacturer, and marketer of casual apparel and footwear primarily
under the Cherokee name. The Company operated four divisions during the fiscal
year ended June 3, 1995 ("Fiscal 1995"): the Apparel Division, the Footwear
Division, the Uniform Division, and the Licensing Division (collectively, the
"Divisions"). The Apparel Division designed, manufactured, imported and
marketed moderately priced, natural fiber women's and young girls' clothing. The
Footwear Division designed, arranged for the manufacture of imported and
marketed Cherokee brand and a broad line of private label footwear for women,
men and children. The Uniform Division designed, manufactured and marketed
Cherokee brand uniforms primarily for the medical industry. The Licensing
Division continues to license the use of the Company's proprietary brand names
to domestic and international licensees for a variety of apparel, footwear,
accessories, home products and other lifestyle related products. Unless the
context requires otherwise, the term the "Company" presently refers to Cherokee
Inc., from June 1, 1993 to May 26, 1994 to Cherokee Inc. and its subsidiary,
Priority Finishing Corporation, and prior to June 1, 1993, to Cherokee Inc., and
The Cherokee Group and their respective predecessors and subsidiaries.
RESTRUCTURINGS
- - --------------
THE 1993 PLAN
The Company, which was founded in 1973 and whose shares first became publicly
traded in 1983, was acquired in a leveraged buy-out in 1989. In connection with
the acquisition, the Company incurred substantial debt. As a result of a
significant decrease in its earnings, the Company was unable to service its
debt. On April 23, 1993, the Company and its then wholly-owned operating
subsidiary, The Cherokee Group ("Group"), filed a petition with the United
States Bankruptcy Court in the District of Delaware (the "Bankruptcy Court") for
relief under Chapter 11 of the United States Bankruptcy Code ("Chapter 11").
Concurrent with such filing, the Company and Group filed a joint "prepackaged"
Plan of Reorganization (the "1993 Plan") which was the result of negotiations
among the Company and unofficial representatives of its subordinated debtholders
and stockholders. On May 28, 1993, the Bankruptcy Court confirmed the 1993
Plan, and on June 1, 1993 the 1993 Plan became effective. As a result of the
1993 Plan, Group was merged into the Company. Furthermore, subsequent to the
effective date of the 1993 Plan, the Apparel Division (including the Uniform
Division), the Footwear Division, the Licensing Division and, prior to its sale
in May 1994, the Priority Finishing Division, were operated by the Company.
3
THE 1994 PLAN
It became apparent by October 1994 that the Company's business was not
generating sufficient cash flow to service its existing debt. On November 7,
1994, the Company filed a petition with the Bankruptcy Court for relief under
Chapter 11. Concurrent with such filing, the Company filed a "prepackaged" Plan
of Reorganization (the "1994 Plan") which was the result of negotiations among
the Company and unofficial representatives of its debtholders and stockholders.
On December 14, 1994, the Bankruptcy Court confirmed the 1994 Plan, and on
December 23, 1994 the 1994 Plan became effective (the "Effective Date"). For
financial statement purposes the effective date of the 1994 Plan was assumed to
be February 25, 1995.
The consummation of the 1994 Plan resulted in the following: (1) a new credit
agreement with the Company's sole secured creditor, the CIT Group/Business
Credit, Inc. ("CIT"), the proceeds of which were used to satisfy the claims of
the secured creditor under the prior credit facility; (2) the cancellation of
all outstanding shares of the Company's common stock, par value $.01 (the "Old
Common Stock") and the Series A, B, and C warrants to purchase Old Common Stock;
(3) the issuance of 4,900,000 shares of Common Stock to the holders of Old Notes
in exchange for the principal amount of $76,565,000 (with accrued and unpaid
interest of approximately $4,211,000 as of November 1, 1994) of Old Notes; (4)
the issuance of 100,000 shares of Common Stock to the holders of Old Common
Stock; and (5) the agreement to issue to the Company's general unsecured
creditors 60.5504 shares of Common Stock for each $1,000 of such creditors'
claims which were allowed by the Bankruptcy Court. To implement distribution of
Common Stock to general unsecured creditors, 1,000,000 shares of Common Stock
were issued to Cherokee's disbursing agent (the "Disbursing Agent"), of which
the Company estimated that between 268,000 and 393,000 shares would be returned
for cancellation. As of June 1, 1996 the Disbursing Agent had distributed
490,561 shares of Common Stock to general unsecured creditors, canceled 475,000
shares at the Company's request and held 34,439 shares of Common Stock.
CHANGES IN MANAGEMENT
- - ---------------------
In accordance with and on the Effective Date, a new Board of Directors was
appointed. The seven directors were Peter Brown, Herschel Elias, Peter Handal,
Jeffrey Schultz, B. Chris Schwartz, David Sarns, and Michael Seyhun. At such
time the Board of Directors undertook a search for a new Chief Executive Officer
of the Company. In the interim, Michael Seyhun, Chief Operating Officer of the
Company, was the highest ranking officer. Concurrent with the appointment of
Mr. Margolis as Chairman of the Board of Directors and Chief Executive Officer
on May 5, 1995, Messrs. Brown, Handal, and Schwartz resigned as Directors and
Mr. Margolis, Jess Ravich, and Douglas Weitman were appointed directors of the
Company by the remaining directors. On June 21, 1995, Patricia Warren was
elected President of the Company, and Michael Seyhun was elected Chief Financial
Officer. On July 5, 1995, the number of authorized directors was increased
from seven to nine and Keith Hull and Avi Dan were appointed directors. On July
25, 1995, David Sarns resigned as a director and on January 5, 1996, Michael
Seyhun resigned as a director and Chief Financial Officer and left the Company.
The Company presently has a seven member Board of Directors.
4
CHEROKEE'S LICENSING BUSINESS
- - -----------------------------
As of June 1, 1996, the Company had 29 continuing license agreements; eight of
which were with retailers, ten of which were with domestic licensees and eleven
of which were with international licensees. The Company's license agreements
are with wholesalers and retailers and are either international masters or
category specific exclusives or non-exclusives. Wholesale licensees manufacture
and import various categories of apparel, footwear and accessories, primarily
under the Cherokee trademark, and sell the licensed products to retailers. The
Company's primary emphasis for the past year has been directed to retail direct
licensing. In retail direct licensing, the Company grants retailers the license
to use the Cherokee trademark on certain categories of merchandise, including
those products that the Company previously manufactured, generally on a non-
exclusive basis, and the retailer is responsible for designing and manufacturing
the merchandise. The Company's license agreements, wholesale and retail, provide
the Company with final approval of pre-agreed upon quality standards, packaging
and marketing of licensed products. The Company has the right to conduct
periodic quality control inspections to ensure that the image and quality of
licensed products remain consistent. The Company will continue to solicit new
licensees through a small number of executive employees and may retain the
services of outside consultants to assist the Company in this regard.
RETAIL DIRECT LICENSING
- - -----------------------
During May, June and July of 1995, Company management met with key retailers,
conducted consumer research and developed its retail direct licensing marketing
strategy. The Company launched its retail direct licensing marketing program on
August 1, 1995.
On August 15, 1995, the Company entered into a major strategic alliance with
Target Stores, a division of Dayton Hudson Corporation ("Target"). Target was
granted the exclusive right to use the Cherokee trademark in connection with the
sale of the following female products in Target Stores: 5-pocket denim jeans and
shorts, all female footwear, all 0-14 girlswear, and all women's and girls
fashion accessories (the "Exclusive Products"). On November 1, 1995 the Company
entered into a second agreement with Target, whereby Target was granted a non-
exclusive right to use the Cherokee trademark in connection with the sale of
merchandise in the following categories in Target Stores: women's casual denim &
sportswear, activewear, golfwear, tenniswear, bodywear, careerwear, daywear,
sleepwear, robes, loungewear, boys' activewear sizes 0-7, junior casual & denim
sportswear, activewear, swimwear and dresses, home textiles (the "Non-exclusive
Products"). During the terms of these agreements, which expire on January 31,
2001, Target has guaranteed minimum sales in excess of $575,000,000 with respect
to the Exclusive and Non-exclusive Products. The royalty rate starts at 3% and
varies, thereafter, based upon annual sales of the Exclusive and Non-exclusive
Products. If Target's sales of the Exclusive Products exceed $200,000,000 in
the last year of the agreement and in each year thereafter, the agreement will
automatically renew for additional one year terms, subject to Target's right to
terminate the agreement every third year. Target has the option beginning on
January 31, 2002, to acquire in perpetuity the exclusive rights to manufacture,
import and sell the Exclusive Products for a purchase price equal to (a) 10
times the royalty it paid Cherokee with respect to the Exclusive Products in the
year prior to exercise of its option but not less than $40,100,000 less (b) the
lesser of (i) one-half of the royalties it has paid during the term of the
agreement with respect to Exclusive Products or (ii) one-half of (a) above;
provided that the maximum price shall be $60,000,000. The agreement prohibits
the Company from granting other exclusive Cherokee retail licenses and from
granting any licenses to certain other major discount retailers in the
territory. Target commenced the initial sales of Exclusive and Non-Exclusive
Products in July 1996.
As of June 1, 1996, the Company had entered into eight retail direct non-
exclusive license agreements and is negotiating with several other retailers for
additional non-exclusive retail direct agreements. The categories of product
available for non-exclusive license agreements include Missy, Large Size,
Petite, and Junior Sportswear and Activewear (historically Cherokee's largest
selling apparel lines), cosmetics, accessories, home, and outdoor products.
Major categories of menswear and boyswear not the subject of existing wholesale
license agreements are also available. Royalties on non-exclusive retail
licenses begin at 3% of the retailer's net sales of licensed product and may
decrease depending on the retailer's annual sales of licensed products and/or
the retailer's guaranteed annual sales of licensed product.
5
WHOLESALE LICENSING
- - -------------------
The Company will continue to grant and administer exclusive wholesale licenses
to unaffiliated manufacturers for the production and marketing under the
Cherokee trademark of apparel, uniform footwear, accessories, and a variety of
other products for men, women and children that are not already the subject of
exclusive licenses. Wholesale licensed products presently include women's
intimate apparel, maternity, socks, sunglasses, watches and men's activewear.
The Company recently entered into a licensing agreement with Westpoint Stevens,
Inc. for the development and distribution of home textile product categories in
the United States. The Company's wholesale license agreements typically require
the wholesale licensee to pay royalties on revenues against a guaranteed minimum
royalty that generally increases over the term of the agreement.
INTERNATIONAL LICENSING
- - -----------------------
The Cherokee brand is broadly licensed in the Far East. Suzuya Co. Ltd.
("Suzuya"), the Far East licensee, operates 21 Cherokee retail stores in Japan,
and has eight sub-licensees that manufacture and sell Cherokee brand apparel and
accessories to the Cherokee stores and to other unaffiliated retailers. The
Company's new strategy includes the expansion of its international licensing
business in other territories. New licensing agreements have been signed with
Mondragon, a Philippines based company, and Blackduck Enterprises, subsidiary of
Kannaouros & Sons Ltd., a Greek corporation.
TRADEMARKS
- - ----------
The Company owns the Cherokee trademark and tradename, and each is registered
with the United States Patent and Trademark Office and in certain other
countries. The Company intends to renew these registrations prior to
expiration. The Company protects its trademarks and trade names domestically
and internationally by seeking to monitor on an ongoing basis any unauthorized
use of its trademarks and trade names.
MARKETING
- - ---------
Historically, the Company had spent between 3% and 4% of its sales on
advertising. Advertising, product, labeling and presentation are integrated to
deliver one clear and consistent message. The advertising is intended to
project a positive image to the consumer and the retailer. The Company and its
licensees intend to promote a positive image in marketing the Cherokee brand
through advertising, public relations programs, and editorial coverage. During
the fiscal year ended June 1, 1996, the Company's advertising costs were
minimal. As the Company's licensing revenues increase, the Company, in
coordination with its licensees, will increase its advertising costs.
COMPETITION
- - -----------
The manufacture and distribution of apparel and footwear are highly
competitive businesses characterized by their ease of entry. The Company
competed with numerous domestic and foreign manufacturers, many of which were
larger or are associated with companies with substantially greater financial
resources than the Company. Traditional competitors of the Company included
Levi Strauss & Co., Liz Claiborne, Guess?, Esprit de Corp., VF Corp., Bernard
Chaus and private labels developed for retailers. 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.
Cherokee brand footwear, apparel, and accessories, manufactured by wholesale
licensees and sold to retailers and retail licensees, will be subject to almost
all of the same competitive pressures that the Company's products were subject.
In recognition of the increasing trend towards consolidation of retailers and
greater emphasis by retailers on the manufacture of private label merchandise,
the Company's business plan principally focuses on creating strategic alliances
with major retailers for their sale of Cherokee products through the licensing
of the
6
Cherokee trademark directly to retailers. Other companies owning established
trademarks could also enter into similar arrangements with retailers.
EMPLOYEES
- - ---------
As of July 15, 1996, with the nature of its business having changed from that
of prior periods, the Company employed approximately 15 persons all of whom are
involved in the Company's sole remaining line of business, licensing. None of
the Company's employees are represented by labor unions and the Company believes
that its employee relations are satisfactory.
FISCAL 1996 AND FISCAL 1995 SALES BY DIVISION
- - ---------------------------------------------
The following chart sets forth the approximate net sales of each of the
Divisions during fiscal year 1996 ("Fiscal 1996") and Fiscal 1995 (which
includes the nine month period ended February 25, 1995 and the three month
period ended June 3, 1995), and the percentage such sales represents of the
Company's Fiscal 1996 and 1995 sales.
1996 FISCAL YEAR 1995 FISCAL YEAR
SALES % SALES %
------------------------ ------------------------
Apparel Division $ 7,846,000 56.4 $47,726,000 55.6
Uniform Division 2,301,000 16.6 17,369,000 20.2
Footwear Division 2,331,000 16.8 18,982,000 22.1
Licensing Division 1,421,000 10.2 1,810,000 2.1
------------------------ ------------------------
$13,899,000 100.0 $85,887,000 100.0
======================== ========================
As a result of the Company's decision to exit the apparel and footwear
manufacturing and wholesaling businesses and to sell the Uniform Division, all
of which were substantially completed during Fiscal 1996, the Company will not
derive any significant sales from these businesses after the first quarter of
Fiscal 1997.
THE COMPANY'S FORMER BUSINESSES
- - -------------------------------
During Fiscal 1995, the Company agreed to sell the Uniform Division, to exit
the apparel and footwear manufacturing, importing and wholesaling businesses and
to dispose of the real estate owned by it. Under Section 271 of the General
Corporate Law of Delaware, these actions could have been deemed to be the sale
of substantially all the assets of the Company. Accordingly, on June 21, 1995,
the Company's Board of Directors adopted resolutions approving the foregoing and
recommended that the matter be submitted for approval of the Company's
stockholders. Such approval was obtained by written consent of a majority of
the Company's stockholders dated June 23, 1995.
APPAREL DIVISION
The Apparel Division manufactured and distributed a product line of moderately
priced Women's apparel and Youthwear. Women's apparel accounted for
approximately 91% of the Apparel Division's sales and Youthwear approximately 9%
during Fiscal 1995. Bottoms and tops retailed in the range of $20 to $35 for
women's and $15 to $25 for Youthwear. The Apparel Division's products were sold
nationwide in a variety of department and discount stores, including Federated
Stores, May Co., J.C. Penney, Kohl's, Mervyn's, and Sears.
By the end of Fiscal 1995, the Company began implementing its new strategy and
all activity relating to new orders and new production in the Apparel Division
ceased and the Company commenced the liquidation of its apparel inventories.
Since its founding in 1981, the Apparel Division was primarily a niche marketer
of novelty fabrication and styles, primarily for the female consumer. During
fiscal year 1994 ("Fiscal 1994") the Apparel Division closed its men's division
and its private label division. In addition, by the end of Fiscal 1994 the
Uniform Division was separated from the Apparel Division and was established as
a separate operating division of the Company. After Mr. Margolis' resignation
in October 1993, the new management of the Apparel Division began to
7
implement a new operating strategy which was first reflected in its back to
school product line for Fall 1994. The new Apparel Division strategy was core
styling and fabrications primarily in casual bottoms for all female age groups.
The new operating strategy failed dramatically. Sales for the first six months
of Fiscal 1995 were substantially less than planned and inventories were
substantially greater than planned. As a result, the Apparel Division returned
to its historic product line during the second half of Fiscal 1995 focusing on
products for the Missy and Special Sizes customer. During Fiscal 1996, most of
the remaining inventory was liquidated. The Company expects to complete the sale
of its inventory by the end of the first quarter of Fiscal 1997.
FOOTWEAR DIVISION
By the end of Fiscal 1995, the Company began implementing its new strategy and
all activity relating to new orders and new production in the Footwear Division
ceased and all inventory was liquidated by the end of Fiscal 1996. The Footwear
Division designed, arranged for the manufacture of, imported and marketed
Cherokee brand footwear for women and children to shoe store chains, specialty
stores and department stores, and a line of private label footwear for major
retailers primarily on a commission basis.
The Cherokee brand footwear line consisted of a full range of shoes, including
Cherokee comfort casuals (such as sandals, moccasins and closed shoes), Cherokee
athletics (such as sports shoes), and sports leisure shoes (such as walking
shoes and hiking shoes). All Cherokee brand footwear products were imported,
primarily from Latin America, the Far East and Italy, and generally retailed in
the $12 to $70 range. For twenty-five years Cherokee brand footwear has been
sold in a variety of department stores, such as Nordstrom's, The Broadway
Stores, Younkers, J. Byrons, Herberger's and Sears; store chains, such as Famous
Footwear and Kinney; and specialty stores such as Big 5, Bob's and Sports
Authority.
UNIFORM DIVISION
The Uniform Division designed, sourced, marketed and distributed Cherokee
brand uniforms primarily for the medical industry. The Division's products
consisted of tops, bottoms and lab coats in white and medical scrub colors,
which generally retailed in the $23 to $40 range. In Fiscal 1995, the Uniform
Division began a school uniform program, which accounted for approximately 3.5%
of its sales. The Uniform Division sold its products in more than 1,500
locations through retail stores and specialty catalogs, including Life Uniforms
and J.C. Penney.
On July 28, 1995, the Company sold the assets of the Uniform Division to
Strategic Partners, Inc. ("Strategic Partners"), a corporation which was formed
by Michael Singer and investors unaffiliated with Cherokee. Mr. Singer was the
President of the Uniform Division until the sale of the Uniform Division and is
the President and Chief Executive Officer of Strategic Partners. The assets
sold included accounts receivable, inventory, furniture and fixtures, equipment,
and the exclusive right to use the Cherokee trademark with respect to the
manufacture and sale of uniforms. The sales price was approximately $11,700,000,
which was $4,000,000 greater than the book value of the assets that were sold.
Of the purchase price, approximately $9,575,000 was paid in cash and $2,125,000
was paid by a 10% subordinated promissory note (the "Note"). The Note requires
quarterly payments of interest and annual principal payments of $300,000 on July
27, 1997, 1998, 1999 and 2000 with the remaining principal amount due on July
27, 2001. In addition, Strategic Partners will pay Cherokee royalties with
respect to its sales of Cherokee brand uniform footwear, and beginning in June
2001, will pay Cherokee, subject to certain conditions, a royalty equal to 2% of
annual sales of Cherokee brand uniforms in excess of $30,000,000.
RAW MATERIALS, MANUFACTURING AND SOURCING
- - -----------------------------------------
The Apparel and Footwear Divisions ceased all activity relating to the
sourcing and manufacturing of product and the Uniform Division was sold on July
28, 1995. The Company's on-going licensing business does not require the
acquisition of new materials or the manufacturing or sourcing of finished goods.
8
DISTRIBUTION AND SALES
- - ----------------------
By the end of Fiscal 1995, the Company's sales efforts were directed towards
the sale of the Company's inventories of finished goods and work-in-process.
The Company has reduced its open-to-sell inventories from approximately 860,000
units of apparel and footwear at June 3, 1995 to approximately 130,000 units at
June 1, 1996. The Company expects to complete the sale of its inventories by
September 30, 1996.
ITEM 2. PROPERTIES
The Company owns a building of approximately 100,000 square feet on ten acres
of land in Sunland, California, which housed its principal offices and fabric
cutting facility. This property is listed for sale or lease. By October 15,
1995 the Company moved all its employees out of this facility and into a 3,000
square foot office facility in Van Nuys, California which the Company shares
with The Wilstar Group ("Wilstar"), a business name used by The Newstar Group,
to which Mr. Margolis serves as Chief Executive Officer. The Company believes
this facility is currently adequate for its expected requirements for the next
few years. The Company leases an 1,158 square foot showroom facility in
Dallas, Texas, which it no longer occupies. The Company has subleased this
facility. The lease expires on February 28, 1998. The Company also shares a
4,000 square foot warehouse storage facility with Wilstar.
ITEM 3. LEGAL PROCEEDINGS
In connection with the 1994 Plan, the Company has settled in principle all
claims submitted by trade creditors and other claimants. Pursuant to the 1994
Plan, the Company will pay all such claims by delivering to the claimant 60.5504
shares of Common Stock per $1,000 of allowed claims. Accordingly, the
resolution of such claims will have no adverse effect on the Company's business,
consolidated financial position or results of operations.
In the ordinary course of business, the Company becomes involved in certain
legal claims and litigation. In the opinion of Management, based upon
consultations with legal counsel, the disposition of litigation currently
pending against the Company will not have, individually or in the aggregate, a
materially adverse effect on its consolidated financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of holders of Common Stock
during the fourth quarter of Fiscal 1996.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On December 29, 1994, the Common Stock began to trade on the NASDAQ Small Cap
Issues Market under the symbol CHKE. The table below sets forth for each of the
fiscal quarters since the Common Stock began such trading the range of the high
and low bid information for the Common Stock.
FISCAL 1995 HIGH LOW
- - ----------- ------ -----
Quarter ended February 25, 1995 $ 4 $ 2
Quarter ended June 3, 1995 3 5/16 1 5/8
FISCAL 1996
- - -----------
Quarter ended September 2, 1995 5 1/2 2 1/2
Quarter ended December 2, 1995 4 7/8 3 1/2
Quarter ended March 2, 1996 4 3/4 2 7/8
Quarter ended June 1, 1996 7 3/8 3 7/8
On May 31, 1996, the latest bid price for the Common Stock reported on the
NASDAQ Small Cap Issues Market was $6.50 per share.
As of May 31, 1996, the number of stockholders of record of the Common Stock
was 155. This figure does not include beneficial holders whose shares may be
held of record by brokerage firms and clearing agencies.
On May 30, 1996, the Company made a tax free distribution of capital to all
shareholders of record as of May 15, 1996. The distribution was $.60 per share
on Common Stock and was made in accordance with Section 316 of the Internal
Revenue Code of 1986. The Company's Board has not established an existing policy
regarding the ongoing payment of dividends. The Company's Board may in the
future declare dividends from time to time based upon the availability of cash
and its evaluation at such time of the Company's ongoing cash requirements and
the most desirable utilization of such cash.
As a result of the 1994 Plan, the Company filed a Form 15 with the Securities
and Exchange Commission (the "SEC") terminating the registration of the Old
Common Stock under the Securities Exchange Act of 1934 (the "Exchange Act"). On
April 25, 1995, the Company filed a Form 10 Registration Statement (the
"Registration Statement") with the SEC to register the Common Stock under the
Act. The Registration Statement became effective on June 27, 1995.
10
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information, except as noted
herein, has been taken or derived from the audited consolidated financial
statements of the Company and its Predecessor and should be read in conjunction
with the consolidated financial statements included herein. The selected
consolidated financial information and accompanying notes should be read in
conjunction with the historical consolidated financial statements of the
Company, including the notes thereto and other financial information pertaining
to the Company included elsewhere herein. See "Financial Statements and
Supplementary Data."
Successor Company Predecessor Company
------------------------ ---------------------------------------------------------
Year 3 Months 9 Months Year Year Year
Ended Ended Ended Ended Ended Ended
STATEMENT OF OPERATIONS DATA: June 1, June 3, Feb. 25, May 28, May 29, May 30,
($ IN THOUSANDS EXCEPT PER 1996 1995 1995 1994 1993 1992
SHARE DATA) ------------------------ ---------------------------------------------------------
Net sales............................... $13,899 $20,264 $ 65,623 $114,087 $157,299 $194,944
Cost of goods sold...................... 10,445 16,310 54,994 83,225 115,630 136,146
------------------------ ---------------------------------------------------------
Gross profit............................ 3,454 3,954 10,629 30,862 41,669 58,798
Selling, general and administrative
expenses............................... 4,460 5,153 19,097 30,974 39,600 40,467
Performance option expense.............. 4,567/(5)/ - - - - -
Amortization of trademarks
and goodwill........................... - - 819 1,691 2,531 2,534
Operational restructuring............... - 3,165 - 6,052 - -
Write-off of reorganization value in
excess of amounts allocable to
identifiable assets.................... - - - 9,281 - -
------------------------ ---------------------------------------------------------
Operating (loss) income................. (5,573) (4,364) (9,287) (17,136) (462) 15,797
Other expense (income).................. (96) (116) (167) 141 975 933
Interest expense........................ 355 587 5,467 11,914/(1)/ 23,512/(1)/ 27,759/(1)
Investment and interest income......... (543) (24) (107) (55) (344) (805)
Gain on sale of Uniform Div
and other assets....................... (3,840) - - - - -
Reorganization items.................... - - 54,093/(3)/ - 40,599/(2)/ -
------------------------ ---------------------------------------------------------
Loss before income taxes................ (1,449) (4,811) (68,573) (29,136) (65,204) (12,090)
Income tax benefit...................... - (400) (5,230) (4,306) (3,146) (3,240)
------------------------ ---------------------------------------------------------
Loss before extraordinary item.......... (1,449) (4,411) (63,343) (24,830) (62,058) (8,850)
Extraordinary item (net of
income taxes)......................... - - 88,291/(3)/ - 82,379/(2)/ -
------------------------ ---------------------------------------------------------
Net (loss) income....................... (1,449) (4,411) 24,948 (24,830) 20,321 (8,850)
Preferred dividend requirement.......... - - - - 973 982
Net (loss) income applicable
to common stock........................ $(1,449) $(4,411) $24,948 $(24,830) $ 19,348 $ (9,832)
Net (loss) per share/(4)/.............. $ (0.22) $ (0.72) -/(4)/ -/(4)/ -/(4)/ -/(4)/
Cash distribution of capital
per share.............................. $ 0.60 - - - - -
BALANCE SHEET DATA: JUNE 1, JUNE 3, FEB. 25, /(3)/ MAY 28, MAY 29, /(2)/ MAY 30,
1996 1995 1995 1994 1993 1992
------------------------ ---------------------------------------------------------
Working capital......................... $ 227 $ 2,836 $27,321 $ 26,517 $ 35,510 $ 55,056
Total assets............................ 8,320 28,260 41,527 93,700 124,622 214,198
Long-term debt, net of
current maturities..................... - - 18,995 83,204 79,338 158,671
Redeemable preferred stock.............. - - - - - 14,429
Stockholders' equity (deficit).......... 6,070 7,222 11,825 (11,630) 13,200 1,118
NOTES TO SELECTED FINANCIAL DATA
/(1)/ Interest expense includes non-cash charges of $12,904 for the year ended
May 30, 1992, $20,451 for the year ended May 29, 1993, $9,420 for the year
ended May 28, 1994 and $4,361 for the nine months ended February 25, 1995.
Non-cash interest for the year ended May 29, 1993 includes the November 1,
1992 Reset Note interest payment that the Company did not pay.
/(2)/ On May 28, 1993, the 1993 Plan was confirmed by the Bankruptcy Court and
became effective on June 1, 1993. For financial statement purposes the
effective date of the 1993 Plan was assumed to be May 29, 1993, the last
day of the Company's fiscal year. The Company has implemented "fresh
start" reporting; therefore all assets and liabilities have been restated
to reflect the reorganization value of the Company, and as such the May
29, 1993 balance sheet is that of a successor company, however identified
as a Predecessor Company as a result of the subsequent reorganization
reflected as of February 25, 1995.
11
/(3)/ On December 14, 1994, the 1994 Plan was confirmed by the Bankruptcy Court
and became effective on December 24, 1994. For financial statement
purposes the effective date of the Plan was assumed to be February 25,
1995, the last day of the third quarter of the Company's fiscal year. The
Company has implemented "fresh start" reporting; therefore all assets and
liabilities have been restated to reflect the reorganization value of the
Company and as such the June 3, 1995 balance sheet is that of a successor
company. See Notes 1 and 2 to the accompanying Consolidated Financial
Statements.
/(4)/ Earnings per share for periods subsequent to the adoption of fresh-start
reporting as of February 25, 1995 is based on the weighted average number
of common shares, including those yet to be distributed by the Disbursing
Agent (See Note 1 to the Consolidated Financial Statements). Per share
data are not presented for periods ending prior to June 3, 1995, due to
the general lack of comparability as a result of the revised capital
structure of the Company under the 1994 Plan.
/(5)/ Represents a non-cash charge of $4,567,000 resulting from the exercise of
The Wilstar Group ("Wilstar") performance options. Wilstar is a related
party, majority owned by Robert Margolis.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Successor Company Predecessor Company
------------------------------- --------------------------------------
Nine Months
Year Ended Three Months Ended Year Ended
June 1, Ended June 3, February 25, May 28,
1996 1995 1995 1994
------------------------------- --------------------------------------
NET SALES
Apparel Division/(1)/.............. $ 7,846,000 $10,510,000 $37,216,000 $ 76,018,000
Footwear Division.................. 2,331,000 4,427,000 14,555,000 20,512,000
Licensing Division................. 1,421,000 325,000 1,485,000 2,335,000
Priority Finishing Division/(2)/... - - - 16,709,000
Other/Uniforms/(3)/................ 2,301,000 5,002,000 12,367,000 (1,487,000)
----------- ----------- ----------- ------------
Total Company.................... $13,899,000 $20,264,000 $65,623,000 $114,087,000
=========== =========== =========== ============
GROSS PROFIT
Apparel Division/(1)/.............. $ 1,217,000 $ 620,000 $ 760,000 $ 20,377,000
Footwear Division.................. 56,000 1,242,000 4,189,000 6,423,000
Licensing Division................. 1,421,000 325,000 1,485,000 2,335,000
Priority Finishing
Division/(2)/..................... - - - 1,946,000
Other/Uniforms/(3)/................ 760,000 1,767,000 4,195,000 (219,000)
----------- ----------- ---------- ------------
Total Company.................... $ 3,454,000 $ 3,954,000 $10,629,000 $ 30,862,000
=========== =========== =========== ============
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES............. $ 4,460,000 $ 5,153,000 $19,097,000 $ 30,974,000
PERFORMANCE OPTION EXPENSE............ $ 4,567,000/(4)/ - - -
OPERATING LOSS........................ $(5,573,000) $(4,364,000)/(5)/ $(9,287,000)/(5)/ $(17,136,000)/(5)/
- - -------------------
/(1)/ By the end of Fiscal 1994, the Uniform Division was separated from the
Apparel Division and was established as a separate Division of the
Company. The Uniform Division's sales of approximately $12,923,000
during Fiscal 1994 are included in the Apparel Division's sales of
$76,018,000. The Apparel Division's gross profit for Fiscal 1994
includes the gross profit of the Uniform Division.
/(2)/ The Company's percentage ownership in Priority Finishing Division was
sold on May 26, 1994 to Priority Finishing Corporation.
/(3)/ Other consists of the elimination of intercompany transactions and the
Uniform Division's results for periods ending February 25, 1995 and June
3, 1995.
/(4)/ A non-cash charge of $4,567,000 resulting from the exercise of
performance options for the year ended June 1, 1996.
/(5)/ Operating loss includes an operational restructuring charge for the
three months ended June 3, 1995 and fiscal year ended May 28, 1994
totaling $3,165,000 and $6,052,000 respectively, and the write off of
reorganization value in excess of amounts allocable to identifiable
assets of $9,281,000 for the fiscal year ended May 28, 1994.
FISCAL 1996
Historically, the Company's principal business was manufacturing, importing and
wholesaling casual apparel and footwear primarily under the Cherokee brand, and
licensing the Cherokee trademark to unaffiliated manufacturers for the
production and marketing of apparel, footwear, and accessories that the Company
did not manufacture, import or market. In May 1995, the Company set in motion a
new strategy which resulted in the Company's principal business being a marketer
and licensor of the Cherokee brand and other brands it owns or may acquire in
the future. The Company has terminated manufacturing and importing apparel and
footwear, has sold most of its inventories and on July 28, 1995 sold the assets
of its Uniform Division.
In previous years, the Company's Licensing Division operated primarily a
wholesale licensing program; it licensed the Cherokee trademark to unaffiliated
manufacturers for the production and marketing of apparel, footwear, and
13
accessories that the company did not manufacture, import or market. The
Company's current operating strategy emphasizes retail direct licensing whereby
the Company grants retailers the license to use the Cherokee trademark on
certain categories of merchandise, including those products that the Company
previously manufactured. Under this operating strategy the Company has been
able to significantly reduce its overhead and ongoing operating costs.
As a result of this newly adopted strategy, the Company today is no longer
comparable to the former Cherokee.
RESULTS OF OPERATIONS
Net sales for Fiscal 1996 were $13,899,000, of which $1,421,000 represented
licensing revenues. As a percentage of total sales, licensing revenues
represented 10.2%, and the terminated businesses represented 89.8%. It is
anticipated that the remaining inventory will be liquidated by September 30,
1996. Product sales will continue to decrease as compared to previous periods,
as revenue will be generated primarily through the licensing of the Company's
trademarks.
The Company's gross profit margin for Fiscal 1996 was $3,454,000 or 25% of net
sales. The gross profit percentage is not comparable to historical levels as a
result of the Company ceasing to manufacture and import apparel and footwear and
selling its inventories.
Selling, general and administrative expenses for Fiscal 1996 were $4,460,000 or
32% of net sales. During the year, selling, general and administrative expenses
have declined from historical levels primarily as a result of the termination of
the manufacturing and importing of apparel and footwear and the sale of its
Uniform Division. These actions enabled the Company to significantly reduce its
work force, space requirements and other operating expenses.
In Fiscal 1996 the Company recorded a non-cash charge to expense of $4,567,000
for Wilstar performance options, which is the difference between the exercise
price and the value of certain performance options granted to and exercised by
Wilstar (See Note 13: Employment and Management Agreements).
The Company's interest expense for Fiscal 1996 was $355,000. The Company's
investment and interest income for the same period was $543,000. The Company
has no debt and anticipates having interest income from investing its excess
cash.
For Fiscal 1996, the Company's gain on sale of assets was attributable to the
sale of the Uniform Division and the "Rockers" trademark. On July 28, 1995, the
Company sold the assets of the Uniform Division to Strategic Partners. The
assets sold included accounts receivable, inventory , furniture and fixtures,
equipment and the exclusive right to use the Cherokee trademark with respect to
the manufacture and sale of uniforms. The sales price was $11,700,000, which
was $4,000,000 greater than the book value of the assets that were sold. Of the
purchase price, $9,575,000 was paid in cash and $2,125,000 was paid by a 10%
subordinated promissory note (the "Note"). The Note requires quarterly
payments of interest and annual principal payments of $300,000 on July 27, 1997,
1998, 1999 and 2000 with the remaining principal amount due on July 27, 2001.
The Company has recorded the note at its estimated fair value of $1,588,000,
which represents a discount of $537,000. In addition, Strategic Partners will
pay Cherokee royalties with respect to its sales of Cherokee brand uniform
footwear, and beginning in June 2001, will pay Cherokee, subject to certain
conditions, a royalty equal to 2% of annual sales of Cherokee brand uniform in
excess of $30,000,000. On December 1, 1995, the Company sold its patents and
trademarks related to the "Rockers" brand footwear to Strategic Partners. for
$250,000. A royalty will be paid to Cherokee if the "Rockers" trademark is used
in connection with the sale of Cherokee footwear to the uniform trade.
Based on the Company's anticipated results for Fiscal 1997, management believes
that it has available sufficient net operating loss carry forwards to offset
taxable income.
14
LIQUIDITY AND CAPITAL RESOURCES
On December 23, 1994, the Company refinanced its then outstanding revolving
credit facility and term loan with The CIT Group ("CIT"). Pursuant to the
Company's operational restructuring plan, as of August 21, 1995, the term loan
was fully paid and borrowings under the revolving credit facility was
approximately $200,000. Cash to repay the debt was generated from approximately
$9,575,000 in cash proceeds from the sale of the Uniform Division and the
liquidations of inventories and receivables of the Apparel and Footwear
Divisions. At September 1995, borrowings under the revolving credit facility
and the term loan were fully paid. The Company terminated its borrowing
agreements with CIT effective September 30, 1995.
On June 1, 1996, the Company had $1,517,000 in cash and cash equivalents.
Capital needs over the next 12 months are expected to be met through the
continued liquidation of the Apparel Division inventories and receivables,
operating cash flows generated from licensing revenues, and the Company's cash
and cash equivalents.
During Fiscal 1996, cash provided by operations of $19,710,000 resulted from the
reduction of inventories and receivables associated with the closure of the
Apparel and Footwear Divisions, and sale of the assets of the Uniform Division,
partially offset by cash utilized in connection with the operational
restructuring. During the same period cash used in financing activities of
$18,414,000 represented the pay-down of the Company's revolving credit facility
and term loan and the cash distribution of capital with cash generated from the
reduction of inventories, receivables and the sale of the Uniform Division.
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.
FISCAL 1995
Net Sales for the three months ended June 3, 1995 were $20,264,000, which
accounted for approximately 24% of Fiscal 1995 sales. As a percentage of total
fourth quarter sales, the Apparel Division represented 52%, the Footwear
Division represented 22%, the Uniform Division represented 24%, and the
Licensing Division represented 2%. Sales continued to decrease during the
fourth quarter of Fiscal 1995 as compared to previous periods as a result of a
lack of retailer confidence stemming from the 1994 Plan and the Company's May
1995 announcement that it would be exiting apparel and footwear manufacturing
and wholesaling businesses.
The Company's gross profit margin for the three months ended June 3, 1995 was
$3,954,000 or 20% of net sales. The gross profit percentage has declined from
previous levels of 27% in Fiscal 1994 and 26% in Fiscal 1993 primarily as a
result of deteriorating margins for the Company's Apparel Division, which has
experienced continued pricing pressures and lack of retailer confidence. The
overall performance of the Apparel Division was a key contributing factor to the
1994 Plan and 1995 operational restructuring.
Selling, general and administrative expenses for the three months ended June 3,
1995 were $5,153,000, which accounted for approximately 21% of Fiscal 1995
selling, general and administrative expenses. Selling, general and
administrative expenses declined in the fourth quarter of Fiscal 1995 as a
result of the 1994 Plan which enabled the Company to reduce operating expenses
through the rejections of leases and other executory contracts and personnel
reduction.
The Company's net interest expense was $587,000 for the three months ended June
3, 1995, as compared to $5,467,000 for the nine months ended February 25, 1995.
The decrease in net interest expense is attributable to the 1994 Plan which
eliminated $76,565,000 in Subordinated Notes.
15
NINE MONTHS ENDED FEBRUARY 25, 1995 COMPARED TO NINE MONTHS ENDING FEBRUARY 26,
1994
Net sales for the nine months ended February 25, 1995 (the "1995 Nine Months")
were $65,623,000, a decrease of $19,170,000, or 22.6%, from $84,793,000 for the
nine months ended February 26, 1994 (the "1994 Nine Months"). Net sales in the
1994 Nine Months include sales of $10,201,000 of Priority Finishing Corporation
("Priority"), which was sold in May 1994. After adjusting for Priority's sales,
sales for the 1995 Nine Months declined by $8,969,000, or 12.0%, from the 1994
Nine Months.
The Apparel Division accounted for approximately 57% of the Company's net sales
during the 1995 Nine Months. Net Sales in the Apparel Division for the 1995
Nine Months were $37,217,000, a decrease of $12,612,000, or 25.3%, from
$49,829,000 for the 1994 Nine Months. The Company's decision to de-emphasize
the junior and youthwear business in order to focus on the women's apparel
business, and to limit its sales efforts to the moderate department store level
distribution, contributed to the sales decline.
The Footwear Division accounted for approximately 22% of the Company's Net Sales
during the 1995 Nine Months. Net sales for the Shoe Division for the 1995 Nine
Months were $14,554,000, an increase of $989,000, or 7.3%, from the 1994 Nine
Months sales of $13,565,000. The increase in sales in the 1995 period was
primarily due to the successful introduction of the Division's new athletic
shoes in February and a significant increase in sales to one customer during the
third quarter of Fiscal 1995.
During the 1995 Nine Months, the Uniform Division accounted for approximately
19% of the Company's sales. Net sales for the 1995 Nine Months were
$12,367,000, an increase of approximately $3,130,000, or 33.9%, from the 1994
Nine Months' sales of $9,237,000. The increase in sales was primarily due to an
expansion of the Division's product line.
The Licensing Division's revenues decreased to $1,485,000 in the 1995 Nine
Months, or 24.3%, from $1,961,000 in the 1994 Nine months.
The decline in gross profit from $23,336,000 in the 1994 Nine Months to
$10,629,000 in the 1995 Nine Months and in gross profit as a percentage of sales
from 27.5% in the 1994 Nine Months to 16.2% in the 1995 Nine Months was
primarily due to the disposition of a portion of the 14 oz. denim 5-pocket jean
and corduroy bottoms inventory by the Apparel Division at less than normal
margins. The excess inventory of these products which resulted from late
deliveries and over-buying necessitated such action. The Operational
restructuring charge of $6,052,000 recorded in the 1994 Nine Months included
approximately $1,075,000 in cash payments and non-cash charges of approximately
$4,977,000. These charges covered the costs of restructuring the Apparel
Division in order to implement the division's new operating strategy which was
introduced in the 1994 Back-to-School selling season. The failure of this
strategy resulted in the excess Apparel Division's inventory.
Selling, general and administrative expenses, including amortization of
trademarks and goodwill of the Company, decreased by $8,420,000 in the 1995 Nine
Months to $19,916,000 from $28,336,000 (including the Operational restructuring
charge of $6,052,000) in the 1994 Nine Months. As a percentage of sales,
selling, general and administrative expenses decreased to 30.3% in the 1995 Nine
Months from 33.4% in the 1994 Nine Months. The decrease in selling, general and
administrative expenses in the 1995 Nine Months from the 1994 Nine Months is
primarily attributable to cost reduction in the Apparel Division related to
headcount, rent and other cost savings, and approximately $872,000 was due to
reduced amortization expense attributed to the reorganization.
The operating loss in the 1995 Nine Months was $9,287,000 compared to $5,000,000
in the 1994 Nine Months.
The Company's net interest expense decreased $3,405,000 in the 1995 Nine Months
from the 1994 Nine Months. The decrease in net interest expense in the 1995
period from the 1994 period is attributable to the fact that interest on the
Company's subordinated debt accrued for the entire 1994 Nine Months but, because
of the Company's
16
reorganization which eliminated the Company's subordinated debt, no interest was
charged with respect to the subordinated debt during the third quarter of fiscal
year 1995.
For the 1995 Nine Months, reorganization expenses include professional fees and
expenses of $3,429,000 which consist primarily of legal, accounting, investment
banking and banking fees paid in connection with the negotiation, implementation
and completion of the Company's reorganization. Adjustments to fair market
value of $50,664,000 represent the charge to earnings necessary to reduce the
carrying value of the Company's current assets, property and equipment,
trademarks, and other assets to their values in accordance with fresh start
accounting. The extraordinary gain of $88,291,000 represents the Company's
basis in the debt securities (including accrued interest with respect to such
debt securities) and trade debt that were extinguished in the reorganization.
The tax benefit of 21% for the 1995 Nine Months is lower than the statutory rate
because of the reversal of deferred tax liabilities required as a result of an
increase in deferred tax assets arising from a taxable loss generated in the
1995 Nine Months.
17
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
- - -----------------------------
CHEROKEE INC.
- - -------------
Page
Reports of Independent Accountants and Auditors........................... F-1
Balance Sheets
at June 1, 1996 and June 3, 1995........................................ F-3
Consolidated Statements of Operations
for the Year Ended June 1, 1996 (Successor Company), and
for the Three Months Ended June 3, 1995 (Successor Company), and
for the Nine Months Ended February 25, 1995 (Predecessor Company), and
for the Year Ended May 28, 1994 (Predecessor Company).................... F-4
Consolidated Statements of
Stockholders' Equity (Deficit)
for the Year Ended June 1, 1996 (Successor Company), and
for the Three Months Ended June 3, 1995 (Successor Company), and
for the Nine Months Ended February 25, 1995 (Predecessor Company), and
for the Year Ended May 28, 1994 (Predecessor Company).................... F-5
Consolidated Statements of Cash Flows
for the Year Ended June 1, 1996 (Successor Company), and
for the Three Months Ended June 3, 1995 (Successor Company), and
for the Nine Months Ended February 25, 1995 (Predecessor Company), and
the Year Ended May 28, 1994 (Predecessor Company)........................ F-6
Notes to Consolidated Financial
Statements.............................................................. F-8
SCHEDULES
- - ---------
II Valuations and Qualifying Accounts and Reserves....................... F-23
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.
18
Report of Independent Accountants
The Board of Directors and Stockholders
Cherokee Inc.
We have audited the accompanying balance sheets of Cherokee Inc. (the "Company")
as of June 1, 1996 and June 3, 1995, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the year ended June 1,
1996, the three months ended June 3, 1995 and the nine months ended February 25,
1995. Our audits also included the financial statement schedule listed in the
accompanying index. These financial statements and schedule are the
responsibility of management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the financial statements, the Company's reorganization
plan was confirmed by the United States Bankruptcy Court on December 14, 1994
and became effective on February 25, 1995 for financial reporting purposes. In
accordance with the American Institute of Certified Public Accountants Statement
of Position No. 90-7, "Financial Reporting by Entities in Reorganization Under
the Bankruptcy Code," the Company was required to account for the reorganization
using "Fresh-Start Reporting." Accordingly, all financial statements prior to
February 25, 1995, are not comparable to the financial statements for periods
after the implementation of fresh-start reporting.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cherokee Inc. at June 1, 1996
and June 3, 1995 and the results of its operations and its cash flows for the
year ended June 1, 1996, the three months ended June 3, 1995 and the nine months
ended February 25, 1995 in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
Coopers & Lybrand L.L.P.
Los Angeles, California
August 9, 1996
F-1
Report of Independent Auditors
The Board of Directors and Stockholders
Cherokee Inc.
We have audited the accompanying consolidated statements of operations, common
stockholders' equity (deficit) and cash flows of Cherokee Inc. for the year
ended May 28, 1994. Our audit also included the financial statement schedule
listed in the accompanying index. These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and
cash flows of Cherokee Inc. for the year ended May 28, 1994 in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
The accompanying consolidated financial statements referred to above have been
prepared assuming that Cherokee Inc. will continue as a going concern. The
Company, which filed for relief under Chapter 11 of the U.S. Bankruptcy Code in
April 1993, emerged from its Chapter 11 bankruptcy status effective June 1,
1993. Since emerging from Chapter 11, the Company has continued to incur
operating losses, and is not expected to be able to meet its scheduled fiscal
year 1995 debt service payments on its Senior Subordinated Notes. The Company
has obtained a waiver of certain financial covenants which it did not meet at
May 28, 1994 with respect to its revolving credit facility and term loan. It is
uncertain as to whether the Company will be in compliance with these and other
financial covenants for the fiscal year 1995. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
The consolidated financial statements do not include any adjustments to reflect
the possible future effects on the recoverability and classification of assets
or the amounts and classification of liabilities that may result from the
outcome of these uncertainties.
/s/ Ernst & Young LLP
Los Angeles, California
August 25, 1994
F-2
CHEROKEE INC.
BALANCE SHEETS
Successor Company
---------------------------
June 1, 1996 June 3, 1995
------------ ------------
(Note 2)
ASSETS
Current assets:
Cash and cash equivalents $ 1,207,000 $ 285,000
Restricted cash 310,000 -
Receivables, net 694,000 11,553,000
Inventories 256,000 11,530,000
Other current assets 10,000 506,000
----------- -----------
Total current assets 2,477,000 23,874,000
Property and equipment, net 44,000 37,000
Assets held for sale 3,576,000 3,665,000
Notes receivable 1,961,000 500,000
Other assets 262,000 184,000
----------- -----------
Total assets $ 8,320,000 $28,260,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term revolving credit and other $ - $14,213,000
Accounts payable 112,000 1,360,000
Accrued payroll and related expenses - 1,559,000
Other accrued liabilities 288,000 2,306,000
Other current liabilities 1,500,000 1,500,000
Customer deposits 350,000 -
Income taxes payable - 100,000
----------- -----------
Total current liabilities 2,250,000 21,038,000
COMMITTMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.02 par value, 20,000,000
shares authorized, 7,650,813 and 6,096,000
shares issued and outstanding at June 1,
1996 and June 3, 1995, respectively 153,000 122,000
Additional paid-in capital 11,977,000 11,703,000
Accumulated deficit (5,916,000) (4,411,000)
Note receivable from stockholder (144,000) (192,000)
----------- -----------
Total stockholders' equity 6,070,000 7,222,000
----------- -----------
Total liabilities and stockholders' equity $ 8,320,000 $29,760,000
=========== ===========
See accompanying notes.
F-3
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Successor Company Predecessor Company
--------------------------- ---------------------------
Year Ended Three Months Nine Months Year Ended
June 1, Ended Ended February May 28,
1996 June 3, 1995 25, 1995 1994
----------- ------------ -------------- -------------
Revenues:
Product sales, net $12,478,000 $19,939,000 $ 64,138,000 $111,752,000
Licensing revenues 1,421,000 325,000 1,485,000 2,335,000
----------- ----------- ------------ ------------
Total net sales 13,899,000 20,264,000 65,623,000 114,087,000
Cost of goods sold 10,445,000 16,310,000 54,994,000 83,225,000
----------- ----------- ------------ ------------
Gross profit 3,454,000 3,954,000 10,629,000 30,862,000
Selling, general and administrative
expenses 4,460,000 5,153,000 19,097,000 30,974,000
Performance option expense 4,567,000 - - -
Amortization of trademarks and goodwill - - 819,000 1,691,000
Operational restructuring charge - 3,165,000 - 6,052,000
Write-off of reorganization value in
excess of amounts allocable to
identifiable assets - - - 9,281,000
----------- ----------- ------------ ------------
Operating loss (5,573,000) (4,364,000) (9,287,000) (17,136,000)
Other expenses (income):
Interest expense 355,000 587,000 5,467,000 11,914,000
Investment and interest income (543,000) (24,000) (107,000) (55,000)
Gain on sale of Uniform Division and
other assets (3,840,000) - - -
Minority interest and others (96,000) (116,000) (167,000) 141,000
----------- ----------- ------------ ------------
Total other expenses (income), net (4,124,000) 447,000 5,193,000 12,000,000
Reorganization items:
Professional fees and expenses - - 3,429,000 -
Fresh start adjustments - - 50,664,000 -
----------- ----------- ------------ ------------
Total reorganization items - - 54,093,000 -
Loss before income taxes and
extraordinary item (1,449,000) (4,811,000) (68,573,000) (29,136,000)
Income tax benefit - (400,000) (5,230,000) (4,306,000)
----------- ----------- ------------ ------------
Loss before extraordinary item (1,449,000) (4,411,000) (63,343,000) (24,830,000)
Extraordinary item:
Gain on extinguishment of debt - - 88,291,000 -
----------- ----------- ------------ ------------
Net (loss) income $(1,449,000) $(4,411,000) $ 24,948,000 $(24,830,000)
=========== =========== ============ ============
Net loss per outstanding common share $ (0.22) $ (0.72) * *
=========== ===========
* Per share results are not presented for periods prior to June 3, 1995, due
to the general lack of comparability as a result of the revised capital
structure of the Company.
See accompanying notes.
F-4
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Notes
Common Stock Additional Receivable
--------------------- Paid-in Accumulated from
Shares Par Value Capital Deficit Stockholders Total
-----------------------------------------------------------------------------
Predecessor Company balance at May 29, 1993 5,000,000 $ 50,000 $ 13,150,000 $ - $ - $ 13,200,000
Issuance of new common stock 16,298 - - - - -
Net loss for the year ended May 28, 1994 - - - (24,830,000) - (24,830,000)
- - -----------------------------------------------------------------------------------------------------------------------------------
Balance at May 28, 1994 5,016,298 50,000 13,150,000 (24,830,000) - (11,630,000)
===================================================================================================================================
Net loss for the nine months ended prior to fresh
start adjustments - - - (12,679,000) - (12,679,000)
Recapitalization and fresh start adjustments
(Notes 1 and 2)
Cancellation of old common stock (5,016,298) (50,000) (13,150,000) - - (13,200,000)
Issuance of new common stock 6,096,000 122,000 11,703,000 - - 11,825,000
Issuance of note receivable to stockholder - - - - (192,000) (192,000)
Fresh start adjustments - - - 37,509,000 - 37,509,000
- - -----------------------------------------------------------------------------------------------------------------------------------
Successor Company balance at February 25, 1995 6,096,000 122,000 11,703,000 - (192,000) 11,633,000
Net loss for three months ended June 3, 1995 - - - (4,411,000) - (4,411,000)
- - -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 3, 1995 6,096,000 122,000 11,703,000 (4,411,000) (192,000) 7,222,000
===================================================================================================================================
Issuance of new common stock 366,667 7,000 (7,000) - - -
Exercise of director warrants, employee stock
options and performance options 1,694,739 35,000 4,620,000 - - 4,655,000
Purchase and retirement of treasury shares (31,593) (1,000) (60,000) (56,000) - (117,000)
Cancellation of shares held and returned by
disbursing agent (475,000) (10,000) 10,000 - - -
Distribution of capital - - (4,289,000) - - (4,289,000)
Repayment on note receivable - - - - 48,000 48,000
Net loss for the year ended June 1, 1996 - - - (1,449,000) - (1,449,000)
- - -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 1, 1996 7,650,813 $153,000 $ 11,977,000 $ (5,916,000) $(144,000) $ 6,070,000
===================================================================================================================================
See accompanying notes.
F-5
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Successor Company Predecessor Company
--------------------------- ---------------------------
Three
Year Ended Months Nine Months Year Ended
June 1, Ended Ended February May 28,
1996 June 3, 1995 25, 1995 1994
----------- ------------ -------------- -------------
(Note 2)
OPERATING ACTIVITIES
Net (loss) income $(1,449,000) $(4,411,000) $ 24,948,000 $(24,830,000)
Adjustments to reconcile net (loss) income to
net cash provided by (used in)
operating activities:
Depreciation and amortization 18,000 26,000 690,000 1,596,000
Amortization of goodwill and trademarks - - 819,000 1,691,000
Provision for bad debts 112,000 72,000 696,000 402,000
Non-cash portion of operational
restructuring charge - 2,551,000 - 4,977,000
Non-cash gain on Sale of Uniform Division (1,588,000) - - -
Write-off of reorganization value in excess
of amounts allocable to identifiable assets - - - 9,281,000
Loss on sale of assets - - - 650,000
Benefit from deferred taxes - (500,000) (5,230,000) (4,825,000)
Minority interest - - - (149,000)
Amortization of deferred financing costs
and debt discount - - 85,000 452,000
Interest paid in-kind - - - 8,948,000
Gain on extinguishment of debt - - (88,291,000) -
Fresh start adjustments - - 50,664,000 -
Amortization of discount on note receivable 108,000 - - -
Non-cash expense for performance option
exercise 4,567,000 - - -
Changes in current assets and liabilities:
Receivables 10,747,000 5,010,000 (2,441,000) (100,000)
Inventories 11,274,000 5,724,000 (1,880,000) (122,000)
Other current assets 496,000 (141,000) (88,000) (114,000)
Accounts payable (1,248,000) (1,802,000) 7,811,000 2,153,000
Accrued payroll and related expenses (1,559,000) 1,152,000 (227,000) 228,000
Income taxes payable (100,000) 8,000 (24,000) 47,000
Other liabilities (1,668,000) (521,000) 364,000 1,181,000
----------- ----------- ------------ ------------
Net cash provided by (used in) operating activities 19,710,000 7,168,000 (12,104,000) 1,466,000
Continued
F-6
CHEROKEE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Successor Company Predecessor Company
---------------------------- ------------------------------
Three
Year Ended Months Nine Months Year Ended
June 1, Ended Ended February May 28,
1996 June 3, 1995 25, 1995 1994
----------- ------------ -------------- -------------
(Note 2)
INVESTING ACTIVITIES
Purchases of long term assets $ (25,000) $ (13,000) $ (296,000) $ (501,000)
Proceeds from sales of assets held for sale 89,000 - 435,000 -
Purchase of treasury shares (117,000) - - -
Investment in restricted cash (310,000) - - -
Repayment on note receivable from stockholder 48,000 - - -
(Increase) decrease in other assets 59,000 108,000 383,000 (804,000)
Cash received from sale of Priority Finishing
Corporation (net of cash sold) - - - 410,000
------------ ----------- ------------ ------------
Net cash (used in) provided by investing activities (374,000) 95,000 522,000 (895,000)
FINANCING ACTIVITIES
Payment of long-term debt, including
revolving credit which was classsified
as current at June 3, 1995 - (7,065,000) (2,383,000) (16,413,000)
Net proceeds from the issuance of long-term debt - - 14,719,000 11,931,000
Net (payments on) proceeds from revolving
credit and other (14,213,000) 64,000 (1,232,000) 396,000
Proceeds from exercise of stock options 64,000 - - -
Proceeds from exercise of warrants 24,000 - - -
Distribution of capital (4,289,000) - - -
------------ ----------- ------------ ------------
Net cash (used in) provided by financing activities (18,414,000) (7,001,000) 11,104,000 (4,086,000)
------------ ----------- ------------ ------------
Increase (decrease) in cash and cash equivalents 922,000 262,000 (478,000) (3,515,000)
Cash and cash equivalents at beginning of period 285,000 23,000 501,000 4,016,000
------------ ----------- ------------ ------------
Cash and cash equivalents at end of period $ 1,207,000 $ 285,000 $ 23,000 $ 501,000
============ =========== ============ ============
TOTAL PAID DURING PERIOD:
Income taxes $ - $ 92,000 $ 17,000 $ 94,000
Interest $ 355,000 $ 587,000 $ 1,644,000 $ 1,846,000
See accompanying notes.
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. REORGANIZATION
Cherokee Inc. ("Cherokee" or the "Company") up until May 1995 was a designer,
manufacturer, importer and marketer of casual apparel and footwear primarily
under the Cherokee brand name and on July 28, 1995 sold its Uniform Division.
The Company's principal business now is that of a licensor and marketer of the
Cherokee trademark to wholesalers and retailers. See Note 10.
The Company filed a prepackaged plan of reorganization (the "1994 Plan")
pursuant to Chapter 11 of the United States Bankruptcy Code ("Chapter 11") with
the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court") on November 7, 1994. An order confirming the 1994 Plan was entered by
the Court on December 14, 1994 and the Plan became effective on December 23,
1994 (the "Effective Date"). The confirmed 1994 Plan provided for the
following:
Common Stock: On the Effective Date Cherokee issued 5,000,000 shares of Common
Stock, par value of $.02 per share, ("Common Stock") to holders of 11% Senior
Subordinated Notes due 1999 ("Old Notes") and common stock par value $.01 per
share ("Old Common Stock"). The Company also issued 1,000,000 shares of Common
Stock to a disbursing agent, which shares will be issued to Holders of Allowed
General Unsecured Claims following allowance and settlement of such Claims. The
Company estimated that between 268,000 and 393,000 shares would be returned for
cancellation. To implement distribution of Common Stock to general unsecured
creditors, 1,000,000 shares of Common Stock were issued to Cherokee's disbursing
agent (the "Disbursing Agent"). As of June 1, 1996 the Disbursing Agent had
distributed 490,561 shares of Common Stock to general unsecured creditors,
canceled 475,000 shares at the Company's request and still holds 34,439 shares
of Common Stock.
Old Notes: For each $1,000 principal amount of Old Notes (an aggregate of
$76,565,000), Holders received 63.9978 shares of Common Stock (or an aggregate
of 4,900,000 shares of Common Stock). Accrued and unpaid interest through the
petition date was taken into account in determining the exchange ratio.
Allowed General Unsecured Claims: Holders of Allowed General Unsecured Claims
have received or will receive 60.5504 shares of Common Stock for each $1,000
amount of Allowed General Unsecured Claims. The Company estimates that between
607,000 and 732,000 shares will be delivered to creditors to satisfy unsecured
claims.
Allowed General Unsecured Claims of Less than $1,000: Holders of Allowed
General Unsecured Claims of Less than $1,000 received full payment in cash.
Old Common Stock: Holders of Old Common Stock received .019935 shares of Common
Stock for each share of Old Common Stock (or an aggregate of 100,000 shares of
Common Stock).
Old Warrants: Series A, Series B and Series C Warrants were cancelled and
holders received no consideration under the Plan.
Reorganization items included in the statement of operations for the nine months
ended February 25, 1995 consist of professional fees and expenses of $3,429,000,
which consist primarily of legal, accounting, investment banking and banking
fees.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. BASIS OF PRESENTATION
BANKRUPTCY REORGANIZATION
For financial reporting purposes, the effective date of the 1994 reorganization
was assumed to be February 25, 1995, the last day of the third quarter of the
Company's fiscal year.
The Company has implemented the recommended accounting principles for entities
emerging from Chapter 11 set forth in the American Institute of Certified Public
Accountants Statement of Position 90-7 on Financial Reporting by Entities in
Reorganization under the Bankruptcy Code ("SOP 90-7"). This results in the use
of "fresh start" reporting, since the reorganization value, as defined, was less
than the total of all post-petition liabilities and pre-petition claims, and
holders of voting shares immediately before confirmation of the 1994 Plan
received less than fifty percent of the voting shares of the emerging entity.
Under this concept, all assets and liabilities are restated to reflect the
reorganization value of the reorganized entity, which approximates its fair
value at the date of reorganization. In addition, the accumulated deficit of
the Company was eliminated and its capital structure was recast in conformity
with the 1994 Plan.
1994 PLAN
The Company's Balance Sheet as of February 25, 1995 which is presented below
represents that of a successor company which, in effect, is a new entity with
assets, liabilities and a capital structure having carrying values not
comparable with prior periods and with no beginning retained earnings or
deficit. Accordingly, the Company's Balance Sheet at June 3, 1995 was prepared
as if the Company were a new reporting entity at February 25, 1995, and reflects
certain reorganization adjustments that include the restatement of assets and
liabilities to approximate fair value and the discharge of outstanding
liabilities relating to creditors' claims against the Company, which have been
satisfied primarily by Common Stock. The Statement of Operations and the
Statement of Cash Flows for the three months ended June 3, 1995, incorporate the
effects of fresh-start reporting. However, the Statement of Operations and the
Statement of Cash Flows for the nine months ended February 25, 1995 and year
ended May 28, 1994 are based on historical costs. Accordingly, the Company has
presented the Statement of Operations and the Statement of Cash Flows for the
three months ended June 3, 1995, and the nine months ended February 25, 1995,
and has not presented a Statement of Operations and a Statement of Cash Flows
for the twelve months ended June 3, 1995.
The reorganization value of $11,825,000 was determined by the Company with the
assistance and analysis of its financial advisors. A number of methodologies
were considered and/or utilized to determine the reorganization value of the
Company, including (a) public comparable trading analysis; (b) discounted cash
flow analysis; (c) acquisition transaction multiple analysis; (d) new investor
methodology - recapitalization analysis, and (e) liquidation analysis. In
addition, previous offers for the Company's equity during the Chapter 11
proceedings were considered, recent operating results were reviewed and future
projected cash flows were evaluated.
The effects of the consummation of the 1994 Plan and the adoption of fresh-start
reporting, including the gain on extinguishment of pre-petition debt of
$88,291,000 and the adjustment of $50,664,000 to record assets and liabilities
at their estimated fair values, has been reflected in the Balance Sheet as of
February 25, 1995 which is presented as follows:
F-9
NOTES TO FINANCIAL STATEMENTS
BALANCE SHEETS
FEBRUARY 25, 1995
($000 OMITTED)
Pre-Fresh Start Fresh Start Fair Fresh Start
Balance Sheet Cancellation Debt Value Balance Sheet
Feb. 25, 1995 of Stock Discharge Adjustment Feb. 25, 1995
--------------- ------------ --------- ---------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 23 $ - $ - $ - $ 23
Receivables, net 16,857 - - (622) (3) 16,235
INVENTORIES:
Raw materials 5,643 - - (1,831) (3) 3,812
Work in process 1,802 - - (41) (3) 1,761
Finished goods 16,616 - - (2,833) (3) 13,783
-------- ---- -------- -------- -------
24,061 - - (4,705) (3) 19,356
Deferred income taxes 2,511 - - (2,511) (4) -
Other current assets 415 - - (1) (3) 414
TOTAL CURRENT ASSETS 43,867 - - (7,839) 36,028
Property & Equipment 12,578 - - (8,863) (3) 3,715
Less accumulated depreciation and amortization (1,455) - - 1,455 (3) -
-------- ---- -------- -------- -------
11,123 - - (7,408) (3) 3,715
-------- ---- -------- -------- -------
Trademarks, net of amortization 36,290 - - (36,290) (5) -
Other assets 3,156 192 (2) - (1,564) (3) 1,784
-------- ---- -------- -------- -------
TOTAL ASSETS $ 94,436 $192 (2) $ - $(53,101) $41,527
======== ==== ======== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Short-term revolving credit and other $ 439 $ - $ - $ - $ 439
Current maturities of long-term debt 1,780 - - - 1,780
Accounts payable and accrued expenses 13,754 - (7,365) (2) 29 (3) 6,418
Accrued interest payable 4,361 - (4,361) (2) - -
Income tax payable 70 - - - 70
Senior subordinated notes due 1999 76,565 - (76,565) (2) - -
-------- ---- -------- -------- -------
TOTAL CURRENT LIABILITIES 96,969 - (88,291) 29 8,707
Long-term debt, net of current maturities 18,995 - - - 18,995
Deferred incomes taxes 2,781 - - (781) (4) 2,000
-------- ---- -------- -------- -------
TOTAL LIABILITIES 118,745 - (88,291) (752) 29,702
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $.01 par value, 20,000,000
authorized, 5,016,298 shares issued and
outstanding 50 (50) (1) - - -
Common stock, $.02 par value, 20,000,000
authorized, 6,096,000 shares issued and
outstanding - 4 (1) 118 (2) - 122
Additional paid-in capital 13,150 238 (1) (1,685) (2) 11,703
Deficit (37,509) - 88,173 (2) (50,664) (3) -
-------- ---- -------- -------- -------
STOCKHOLDERS' EQUITY (DEFICIT) (24,309) 192 88,291 (52,349) 11,825
-------- ---- -------- -------- -------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT) $ 94,436 $192 $ - $(53,101) $41,527
======== ==== ======== ======== =======
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Exchange Common Stock for Old Common Stock.
(2) Exchange of Old Notes and accounts payable for Common Stock and related
gain on debt extinguishment.
(3) Record assets and liabilities at their fair value pursuant to the
reorganization value of the Company and eliminate any retained earnings
or deficit.
(4) Record income tax effect of fresh start adjustments.
(5) Based on the Company's continued poor operating performance and its second
bankruptcy reorganization since fiscal year 1993, no value was attributed
to trademarks in connection with the fresh start accounting for the 1994
Plan.
F-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary Priority Finishing Corporation
(Priority) until May 26, 1994. Priority, a processor of specialty textiles, was
organized on August 14, 1986. The Company owned 81% of Priority's outstanding
common stock since Priority's formation until May 26, 1994, when the Company
sold all of its interest in Priority at a loss of $650,000. The Company uses a
52 or 53 week fiscal year ended on the Saturday nearest May 31.
ACCW, Inc. ("ACCW"), a garment laundry, was organized on April 5, 1988 and the
Company was issued 50% of ACCW's outstanding common stock. This investment was
accounted for on the equity basis. On January 25, 1994, the Company sold its
investment in ACCW.
All material intercompany accounts and transactions have been eliminated in
consolidation.
ESTIMATES
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent asset and liabilities at the
dates of the financial statements and revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with an
original maturity date of three months or less to be cash equivalents.
The Company has restricted cash of $310,000 at June 1, 1996, held as collateral
for a stand by letter of credit ("LC"). The LC secures a custom's bond in the
Company's name. The LC has been returned and the cash was released to the
Company on August 23, 1996.
INVENTORIES
Inventories are valued at the lower of cost or market, determined by the use of
the first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation and
amortization.
Assets held for sale at June 1, 1996 and June 3, 1995 include the Company
facility in Sunland, California.
REVENUE RECOGNITION
Product sales are recognized on the date of shipment. Royalty revenues are
recognized when earned based upon contractual agreement.
F-12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DEPRECIATION AND AMORTIZATION
In accordance with fresh start reporting related to the 1994 Plan, the
pre-effective date accumulated depreciation and amortization of $1,455,000 at
February 25, 1995 was eliminated and a new depreciation and amortization base
was established equal to the estimated fair market value of the existing fixed
asets at that date.
Depreciation of furniture and fixtures, stated at cost, is provided on a
straight-line method over the estimated useful lives of the assets ranging from
three to eight years.
INTANGIBLE ASSETS
Based on the Company's continued poor operating performance and its second
bankruptcy reorganization since fiscal year 1993, no value was attributed to
trademarks in connection with the fresh start accounting for the 1994 Plan.
For the year ended May 28, 1994, the Company determined that the projections
used in the determination of the reorganization value would not be attained and
the reorganization value in excess of amounts allocable to identifiable assets,
totalling $9,281,000, was written off as of May 28, 1994.
LONG-TERM ASSETS
In 1995, Statement of Financial Accounting Standards No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
("SFAS No. 121"), was issued and was adopted by the Company for the year ended
June 1, 1996. This statement requires that long-lived assets and certain
identifiable intangible assets to be held and used be reviewed for impairment
whenever events or changes in circumstances indicate the carrying amount of such
assets may not be recoverable. The carrying value of long-term assets is
periodically reviewed by management, and impairment losses, if any, are
recognized when the expected nondiscounted future operating cash flows derived
from such assets are less than their carrying value. The adoption of SFAS No.
121 did not have any impact on the financial position, results of operations, or
cash flows of the Company.
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.
The Company and its majority-owned subsidiary filed a consolidated tax return
for the year ended May 28, 1994.
Under fresh-start reporting and SFAS No. 109, the tax benefits realized from net
operating loss carryforwards that survive the reorganization will be a direct
credit to additional paid-in-capital.
F-13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentration of
credit risk consist principally of cash and cash equivalents and trade
receivables. The Company limits its credit risk with respect to cash by
maintaining cash balances with quality financial institutions. Concentrations of
credit risk with respect to trade receivables are minimal due to the limited
amount of open receivables and due to the nature of the Company's licensing
royalty revenue program. Generally, the Company does not require collateral or
other security to support customer receivables. As of June 1, 1996, the Company
had 29 continuing license agreements; eight of which were with retailers, ten of
which were with domestic licensees and eleven of which were with international
licensees.
SIGNIFICANT LICENSEES/CUSTOMERS
No customer accounted for more than 10% of sales during the period ended June 1,
1996. One customer accounted for approximately 10% of the Company's sales during
the fiscal year ended May 28, 1994.
STOCK-BASED COMPENSATION
In fiscal year 1997 the Company will adopt the disclosure requirements only of
SFAS No. 123, "Accounting for Stock-Based Compensation". This standard
establishes a fair value method for accounting for stock-based compensation
plans either through recognition or disclosure. The Company intends to adopt
this standard by disclosing the pro forma net income and earnings per share
amounts assuming the fair value method was adopted on June 4, 1995. The adoption
of this standard will not impact the Company's results of operations, financial
position or cash flows.
ADVERTISEMENT
Advertising costs are expensed as incurred. For Fiscal 1996, advertising costs
totalled $33,000.
EARNINGS PER SHARE
Earnings per share for periods subsequent to the adoption of fresh-start
reporting as of February 25, 1995 is based on the weighted average number of
common shares, including an estimate for those yet to be distributed by the
Disbursing Agent (See Note 1). Stock options and warrants outstanding as of June
3, 1995 have not been considered in average shares outstanding as the effect is
antidilutive. For the year ended June 1, 1996, the Company recorded a non-cash
charge to recognize performance option expense of $4,567,000, resulting in a
reduction in earnings per share of $0.70.
Per share data are not presented for periods ending prior to June 3, 1995, due
to the general lack of comparability as a result of the revised capital
structure of the Company under the 1994 Plan.
RECLASSIFICATIONS
Certain reclassifications have been made to the June 3, 1995 financial
statements to conform to the June 1, 1996 presentation.
F-14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. STATEMENT OF CASH FLOWS
During the year ended June 1, 1996, the Company recorded a non-cash charge to
recognize performance option expense of $4,567,000, which represents the
difference between the exercise price and the value of the Performance Options
granted to and exercised by Wilstar (see Note 13: Employment and Management
Agreement). Also, the Company recorded a note receivable, net of discount,
related to the sale of the Uniform Division (see Note 18: Sale of Uniform
Division).
During the year ended May 28, 1994, the Company recorded noncash investing
activities related to the sale of all of its interest in Priority and other
assets of $1,650,000 of notes receivable and $1,100,000 of investment in
preferred stock.
5. RECEIVABLES
Receivables consist of the following:
JUNE 1, 1996 JUNE 3, 1995
------------ ------------
Trade $ 621,000 $ 993,000
Due from Factor 43,000 10,525,000
Other 621,000 1,041,000
---------- -----------
1,285,000 12,559,000
Less allowance for doubtful accounts (591,000) (1,006,000)
---------- -----------
$ 694,000 $11,553,000
========== ===========
Management has made its best estimate as to the collectibility of accounts
receivable considering the fact that the Company has sold or terminated its
significant operations. In establishing its allowance for doubtful accounts,
the Company has taken into consideration termination of its customer relations
in determining the adequacy of its allowance for doubtful accounts.
6. INVENTORIES
Inventories consist of the following:
JUNE 1, 1996 JUNE 3, 1995
------------ ------------
Raw Materials $256,000 $ 2,021,000
Work in Process - 1,326,000
Finished Goods - 8,183,000
-------- -----------
$256,000 $11,530,000
======== ===========
The Company sold most of its inventories as a result of the termination of its
manufacturing and importing of apparel and footwear.
F-15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. PROPERTY AND EQUIPMENT
Property and equipment, stated at cost or estimated fair market value for assets
revalued in conjunction with the 1994 Plan at June 1, 1996 and June 3, 1995,
consist of the following:
JUNE 1, 1996 JUNE 3, 1995
------------ ------------
Machinery and equipment $25,000 $28,000
Furniture and fixtures 40,000 35,000
------- -------
65,000 63,000
------- -------
Less accummulated depreciation and amortization 21,000 26,000
------- -------
$44,000 $37,000
======= =======
8. LONG-TERM DEBT
REVOLVING CREDIT FACILITY AND TERM LOAN
On December 23, 1994, the Company entered into a revolving credit facility and
term loan with CIT (the "CIT Agreement").
The interest rates on the revolving credit facility and the term loan were equal
to the Chemical Bank base rate plus 1.5% and plus 2%, respectively. The
weighted average interest rate on the Company's short term borrowings was
10.54%, and 8.25%, for the year ended June 3, 1995, and May 28, 1994,
respectively. As of September 30, 1995 both the revolving credit facility and
term loan were repaid.
In consideration for CIT entering into the CIT Agreement, the Company granted
CIT a Warrant to purchase up to 10% of the shares of Common Stock to be issued
in connection with the 1994 Plan (approximately 570,000 shares). In April 1995,
an unaffiliated third party ("Investor") paid CIT $500,000 to surrender the CIT
Warrant to the Company. The fair market value of the Warrant was considered in
the reorganization value of the Company determined in conjunction with the 1994
Plan.
In April 1995, the Company entered into agreements in principle pursuant to
which the Company would have issued to Avi Dan, an unaffiliated investor, a
warrant to purchase 440,000 shares of Common Stock at an exercise price of $.02
per share and the Company would have caused Mr. Dan to be appointed a director
of the Company in consideration for his (a) paying $500,000 to CIT to purchase
the warrant held by CIT entitling CIT to purchase up to 10% of the shares of
Common Stock to be issued in connection with the 1994 Plan (approximately
570,000 shares) at an exercise price of $.02 per share and surrendering such
warrant to the Company, (b) guaranteeing a $4,000,000 overadvance facility to be
provided the Company by CIT until August 31,1995 and a $2,000,000 overadvance
facility from September 1, 1995 to January 31, 1996 and (c) securing such
guarantee with standby bank letters of credit. Mr. Dan paid CIT $500,000 and
the CIT warrant was surrendered to the Company. Prior to the issuance of the
new warrant to Mr. Dan, the Company made a major change of strategy as a result
of which the Company no longer required the CIT overadvance. The Company
negotiated a new agreement with Mr. Dan pursuant to which he and the Company
agreed to surrender all of their rights under the original agreement between
them and the Company agreed to issue to him or his nominee 366,667 shares of
Common Stock and to reimburse Mr. Dan for his legal fees up to $10,000. On
June 21, 1995, Mr. Dan became a director of the Company
F-16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. LONG-TERM DEBT (CONTINUED)
and on August 21, 1995, the Company issued 366,667 shares of Common Stock to
Axicom Capital Group, Mr. Dan's nominee.
9. INCOME TAXES
The income tax benefit as shown in the statements of operations includes the
following:
SUCCESSOR COMPANY PREDECESSOR COMPANY
--------------------------- ----------------------------
NINE MONTHS
YEAR ENDED THREE MONTHS ENDED YEAR ENDED
JUNE 1, ENDED FEBRUARY 25, MAY 28,
1996 JUNE 3, 1995 1995 1994
---------- ------------ ------------ -----------
(Note 2)
Current:
Federal $ - $ - $ - $ -
State - 100,000 - 100,000
------ --------- ----------- -----------
- 100,000 - 100,000
Deferred:
Federal - (250,000) (3,355,000) (4,058,000)
State - (250,000) (1,875,000) (348,000)
------ --------- ----------- -----------
- (500,000) (5,230,000) (4,406,000)
------ --------- ----------- -----------
$ - $(400,000) $(5,230,000) $(4,306,000)
====== ========= =========== ===========
Deferred income taxes are comprised of the following:
June 1, 1996 June 3, 1995
--------------------- -------------------------
Current Non-Current Current Non-Current
------- ------------ ------------ -----------
Deferred tax assets:
Fixed assets - - - 442,000
Inventory reserve - - 2,583,000 -
Uniform capitalization - - 418,000 -
Bad debt reserve - - 436,000 -
Accrued liabilities - - 967,000 -
Tax effect of NOL carryovers - 16,249,000 - 14,823,000
Other - 167,000 - 232,000
Valuation allowance - (16,416,000) (4,404,000) (15,497,000)
------- ------------ ----------- -----------
Total deferred tax assets $ - $ - $ - $ -
------- ------------ ----------- -----------
Due to the uncertainty surrounding the realization of net operating loss
carryovers and other net deferred tax assets, the Company has provided a full
valuation reserve against the net federal deferred tax asset position. Any
valuation allowance reduction relating to the net operating loss carryovers will
be credited to additional paid-in-capital.
F-17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. INCOME TAXES (CONTINUED)
A reconciliation of the actual income tax rates to the federal statutory rate
follows:
SUCCESSOR COMPANY PREDECESSOR COMPANY
--------------------------- ---------------------------
NINE MONTHS
YEAR ENDED THREE MONTHS ENDED YEAR ENDED
JUNE 1, ENDED FEBRUARY 25, MAY 28,
1996 JUNE 3, 1995 1995 1994
----------- ------------ ------------- ----------
Tax (benefit) expense at U.S.
statutory rate (34.0)% (34.0)% 34.0 % (34.0)%
Net gain from extraordinary gain from
extinguishment of debt not taxable - - (51.2) -
Net operating loss for which no tax
benefit was recognized 34.0 33.9 12.5 -
Writedown of net deferred taxes - (5.2) (21.0) -
Nondeductible amortization and
write-off of goodwill - - - 13.4
Loss of tax benefit attributes related
to sale of interest in Priority - - - 6.9
Nondeductible reorganization costs - - 4.7 -
State income tax benefit net of federal
income tax - (3.1) - (.6)
Minority interest and others - .4 - (.5)
----- ----- ----- -----
Tax benefit - (8.0)% (21.0)% (14.8)%
======= ===== ===== =====
At June 1 1996 the Company has federal and California tax net operating loss
carryovers ("NOL's"), generated subsequent to the Company's 1994 reorganization,
of approximately $11,800,000 and $4,500,000, respectively, which will begin to
expire in 2010 and 2000, respectively. The utilization of these losses is not
subject to Internal Revenue Code ("IRC") Section 382 limitations.
As a result of the 1994 Plan discussed in Note 1, an ownership change occurred
and the annual utilization of pre-reorganization NOL's and built-in losses (i.e.
the tax bases of assets exceeded their fair market value at the date of the
ownership change) has been substantially limited under IRC Section 382. The
annual limitation amount, computed pursuant to IRC Section 382(1)(6), is
approximately $780,000. Any unused IRC Section 382 annual loss limitation
amount may be carried forward to the following year. Those unused limitation
losses are then added to the current IRC Section 382 annual limitation amount.
For financial reporting purposes, utilization of NOL's and built-in losses
generated prior to the 1994 reorganization would be a credit to additional paid-
in capital. The pre-reorganization NOL's and built-in losses subject to the
limitations discussed above are $35,200,000 and $15,700,000 for federal and
California purposes, respectively, and will begin to expire in 2007 and 1999,
respectively. Given the IRC Section 382 limitations, a substantial portion of
the pre-reorganization losses will expire unused.
F-18
10. OPERATIONAL RESTRUCTURING CHARGE
The operational restructuring charge of $3,165,000 which was taken in the three
months ended June 3, 1995, covers the costs and charges of exiting from apparel
and footwear manufacturing, importing and wholesaling businesses in order to
implement the Company's new licensing strategy. Historically, the Company
operated a wholesale licensing program; it licensed the Cherokee trademark to
unaffiliated manufacturers for the production and marketing of apparel, footwear
and accessories that the Company did not manufacture, import or market. The
Company's new operating strategy now includes retail direct licensing whereby
the Company grants retailers the license to use the Cherokee trademark on
certain categories of merchandise, including those products that the Company
previously manufactured. Under its licensing operating strategy, the Company was
transformed into a significantly smaller, more focused organization.
The Company completed the transition out of the apparel and footwear
manufacturing and importing businesses in November 1995. The $3,165,000
restructuring charge includes $614,000 in severance payments, $2,027,000 in
writedowns of inventory to estimated realizable values, and $524,000 for
cancellation of inventory orders, prepaid expenses, deposits and others. The
Company's work force was reduced from approximately 165 on June 3, 1995 to
approximately 15 by November 1, 1995. As of June 3, 1995, approximately
$1,504,000 of the $3,165,000 was included in liability accounts and has since
been paid.
Revenues and gross profit for the Company's terminated businesses were
$84,077,000 and $12,772,000 in Fiscal 1995 and $111,752,000 and $28,527,000 in
Fiscal 1994.
The operational restructuring charge of $6,052,000 which was taken in the
quarter ended November 27, 1993, covers the costs and charges of restructuring
the Company's apparel division to implement a new core marketing strategy.
Prior to August 1993, the Apparel Division was primarily a niche marketer of
novelty fabrication and styles for both the male and female consumer. The
$6,052,000 restructuring charge consists of approximately $1,075,000 in cash
payments and non-cash charges of approximately $4,977,000. The restructure
charge includes severance payments of $811,000, $4,533,000 in writedowns of
inventory which will not be part of the Company's new product line to estimated
realizable values, and $708,000 in writedowns of certain equipment and other
assets to estimated realizable values which will be sold because they are not
essential in implementing the new operating strategy. The core marketing
strategy failed and a decision was made prior to June 3, 1995 to close the
Apparel Division.
11. COMMITMENT AND CONTINGENCIES
LEASES
The Company leases real property under a lease agreement expiring on February
28, 1998. Monthly rent is $1,496 plus operating expenses. The Company entered
into a sublease agreement on August 30, 1995 with an unaffiliated third party.
The term of this sublease is from September 1, 1995 to February 28, 1998.
Sublessee is to pay rent of $1,280 per month for the property. Total rent
expense was $198,000, $149,000, $730,000 and $1,447,000, for the year ended June
1, 1996, the three months ended June 3, 1995, the nine months ended February 25,
1995, and the year ended May 28, 1994, respectively. Rent expense for the year
ended June 1, 1996 was netted against $17,000 of rental income received.
F-19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENT AND CONTINGENCIES (CONTINUED)
BANKRUPTCY CLAIMS
In connection with the 1994 Plan, the Company has settled in principle all
claims submitted by trade creditors and other claimants. Pursuant to the 1994
Plan, the Company will pay all such claims by delivering to the claimant 60.5504
shares of Common Stock per $1,000 of allowed claims.
12. SEGMENT INFORMATION
Prior to implementing its strategy to change its business to that of a licensor,
the Company was primarily engaged in the manufacturing, importing and the
distribution of apparel and shoes; therefore, its business is within one
industry segment.
13. EMPLOYMENT AND MANAGEMENT AGREEMENTS
On April 24, 1995, a group which included Mr. Margolis (a former Chairman and
Chief Executive Officer of the Company) acquired approximately 22.3% of the
Company's then outstanding Common Stock (the "Group"). The Group sought to have
Mr. Margolis installed as Chief Executive Officer of the Company and to have Mr.
Margolis appointed a director of the Company. On May 4, 1995, the Company and
The Newstar Group d/b/a The Wilstar Group ("Wilstar") entered into a Management
Agreement (the "Agreement") pursuant to which Wilstar agreed to provide
executive management services to the Company by providing the services of Robert
Margolis as Chief Executive Officer. The Agreement will terminate on May 31,
1998; however, the Agreement will automatically extend for additional one-year
terms as long as the Company's pre-tax earnings are equal to at least 80% of the
pre-tax earnings contained in the budget submitted to and approved by the Board
of Directors for such fiscal year. Wilstar will receive an annual management
fee of $400,000 and a bonus equal to 10% of the Company's pre-tax earnings in
excess of $2,666,000 in Fiscal 1996 and in excess of $2,500,000, thereafter. In
addition, Wilstar received options to purchase 7-1/2% of the Common Stock on a
fully diluted basis (675,700 shares) at a purchase price of $3.00 per share (the
"Wilstar Options"). Two thirds of these options are currently exercisable and
the remaining one third of the options will vest on May 3, 1997. Wilstar's
ability to exercise the Wilstar Options accelerates and such options become
fully exercisable upon the occurrence of certain events, including a termination
of the Wilstar Agreement without cause, termination due to the Company's breach,
or under certain circumstances, the merger of the Company, sale of substantially
all of its assets, or sale of a majority of its common stock.
In the original Agreement Wilstar had the right to purchase up to an additional
22.5% of the Common Stock at a price of $.02 per share until May 3, 2000 based
on the equity value of the Company as follows:
CUMULATIVE PERCENTAGE OF DILUTED
COMMON STOCK EXERCISABLE EQUITY VALUE OF THE COMPANY /i/
7.5% Equal to or Greater than $32,500,000
7.5% Equal to or Greater than $52,500,000
5.0% Equal to or Greater than $72,500,000
2.5% Equal to or Greater than $92,500,000
-----
22.5%
=====
/i/ The "Equity Value" of the Company shall be computed as the product
of the average closing trading price of the Common Stock for any
ninety (90) day period ending on or before May 3, 2000 during the term
of the agreement, multiplied by the weighted average number of
outstanding shares of Common Stock during such period.
F-20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. EMPLOYMENT AND MANAGEMENT AGREEMENTS (CONTINUED)
On April 24, 1996, the Board of Directors revised the original Agreement to
accelerate the vesting of Wilstar's performance options so that Wilstar has been
immediately vested in its right to purchase up to 20% of the Company's fully
diluted Common Stock. Wilstar agreed to relinquish its rights to purchase up to
an additional 2.5% of the Company's fully diluted stock pursuant to the
performance options. Wilstar exercised the performance options in full on April
25, 1996 and purchased 1,674,739 shares. The Company accounted for this
transaction as a non-cash charge to earnings of $4,567,000.
The Agreement further provides that Wilstar and the Group each have the right to
elect two members of the Company's Board of Directors.
Mr. Margolis was employed pursuant to an employment agreement which would have
expired on May 31, 1994. Under such agreement, Mr. Margolis would have received
an annual salary of $780,550 during Fiscal 1994; Mr. Margolis was actually paid
$345,140 in salary prior to his resignation. Mr. Margolis resigned all of his
positions with the Company on October 31, 1993 and entered into a consulting
agreement with the Company pursuant to which he agreed to make himself available
as a consultant to the Company for a period of one year for a fee of $1,130,000
of which $880,000 was paid during Fiscal 1994. The $250,000 which was owed to
Mr. Margolis became an unsecured creditor's claim in the Company's 1994 Plan;
Mr. Margolis received the same treatment as all other unsecured creditors and
received 15,259 shares of the Company's Common Stock in full satisfaction of
such claim.
Mr. Seyhun, the Chief Operating Officer and the Chief Financial Officer of the
Company, was employed pursuant to a 28 month agreement expiring May 31, 1997.
In connection with the agreement on February 1, 1995, Mr. Seyhun purchased
96,000 shares of Common Stock from the Company at a price of $2.00 per share.
Mr. Seyhun paid for these shares with a $192,000, 7% Promissory Note for which
$48,000 was paid in May 1996. The note has been recorded as a reduction to
stockholders equity. Proceeds from the sale of such stock must be applied first
to accrued and unpaid interest and then to unpaid principal. All unpaid
interest and principal is due on January 3, 2001. Mr. Seyhun also received an
option to purchase 96,000 shares for a price of $2.00 per share which was
cancelled upon termination of his employment agreement. Mr. Seyhun terminated
his employment on January 5, 1996.
Ms. Warren, the President of the Company, is employed pursuant to a three-year
agreement expiring on May 30, 1998 which provides for a salary at an annual rate
of $100,000 from June 21, 1995 to May 31, 1996 and $325,000 from June 1, 1996 to
May 31, 1998. Ms. Warren could earn bonuses in Fiscal 1996, Fiscal 1997 and
Fiscal 1998 ranging from 10% of her salary up to $400,000 in Fiscal 1996 and up
to $175,000 in Fiscal 1997 and Fiscal 1998 based upon the Company's earnings
before interest and taxes. The agreement gives the Company the right to
terminate Ms. Warren's employment without cause at any time. If the Company
exercised such right before November 30, 1995 it would have been obligated to
pay Ms. Warren $50,000; if it exercises such right any time thereafter, it must
pay Ms. Warren $162,500.
F-21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. CERTAIN TRANSACTIONS
Pursuant to a consulting agreement, Cherokee Management Corp., wholly-owned by
Everett Clayton and Jeffrey Deutschman (former directors of the Company),
provided consultation services to the Company, and were paid $250,000 related to
this agreement during fiscal 1994.
In fiscal year 1996, Wilstar purchased apparel and trim from the Company
totalling $154,000.
15. COMMON AND PREFERRED STOCK
In connection with the 1994 Plan, 6,000,000 shares of Common Stock were issued,
including 1,000,000 shares to a disbursing agent to implement the distribution
of shares to unsecured creditors. 475,000 of these shares have been returned to
the Company and have been canceled.
In accordance with the 1994 Plan, the Company's Certificate of Incorporation was
amended to authorize 20,000,000 shares of Common Stock par value $.02 per share,
and 1,000,000 shares of New Preferred Stock par value $.02 per share. The terms
and conditions of the New Preferred Stock shall be determined from time to time
by the Company's Board of Directors.
16. WARRANTS
On February 1, 1995, the Company granted warrants to purchase 5000 shares of
Common Stock at an exercise price of $2.43 to each of the Company's five outside
directors of the Board. On July 25, 1995, the Company granted warrants to
purchase 5000 shares of Common Stock at an exercise price of $3.00 to any new
outside directors of the Board. The warrants expire on January 31, 2000 and June
30, 2000, respectively. On April 25, 1996 two Board members exercised their
warrants in full and each purchased 5,000 shares.
17. STOCK OPTION PLAN
The Company's 1995 Incentive Stock Option Plan (the "Option Plan") was approved
at the October 30, 1995 Annual Meeting of Stockholders. The purpose of the
Option Plan is to further the growth and development of the Company by providing
an incentive to officers and other key employees who are in a position to
contribute materially to the prosperity of the Company. Two types of Stock
Options may be granted under the plan - Incentive and Non-Qualified stock
options.
Any employee is eligible to receive a Stock Option under the Option Plan;
provided, however that no person who owns stock possessing more than 10% of the
total combined voting power of all classes of stock of the Company shall be
eligible to receive an Incentive Stock Option unless at the time such Stock
Option is granted the Stock Option price is at least 110% of the fair market
value of the shares subject to the Stock Option.
The aggregate number of shares which may be issued upon the exercise of Stock
Options granted under the Option Plan shall not exceed 600,000 shares of Common
Stock. The Stock Options are vested in equal installments over a three year
period, starting from the date of grant and have a term of ten years. As of
June 1, 1996, 180,000 Stock Options have been granted to the Company's employees
at a range of $3.00 to $3.88 per share of which 10,000 shares were exercised by
acceleration of the vesting period and of the remaining shares none were
exercisable at June 1, 1996.
F-22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. SALE OF UNIFORM DIVISION
On July 28, 1995, the Company sold the Uniform Division to Strategic Partners,
Inc. ("Strategic Partners"), a corporation which was formed by Michael Singer
and investors unaffiliated with Cherokee. Mr. Singer was the President of
Cherokee's Uniform Division until the sale of the Uniform Division and is the
President and Chief Executive Officer of Strategic Partners. The assets sold
included accounts receivable, inventory, furniture and fixtures, equipment, and
the exclusive right to use the Cherokee trademark with respect to the
manufacture and sale of uniforms. The sales price was approximately $11,700,000,
which was $4,000,000 greater than the book value of the assets that were sold.
Of the purchase price, approximately $9,575,000 was paid in cash and $2,125,000
was paid by a 10% subordinated promissory note ("Note"). The Company has
recorded the Note at its estimated fair value of $1,588,000, which represents a
discount of $537,000, resulting in an effective interest rate of 16%. The Note
requires quarterly payments of interest and principal payments of $300,000 on
July 27, 1997, 1998, 1999 and 2000 with the remaining principal amount due on
July 27, 2001.
F-23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cherokee Inc.
Schedule II - Valuations and Qualifying Accounts and Reserves
BALANCE AT CHARGED TO CHARGED TO BALANCE
BEGINNING COSTS AND OTHER AT END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- - -----------------------------------------------------------------------------------------------------------------------
DEDUCTED FROM ASSETS TO WHICH THEY
APPLY:
ALLOWANCE FOR DOUBTFUL ACCOUNTS
YEAR ENDED JUNE 1, 1996 $ 1,006,000 $ 112,000 $ - $ 527,000(1) $ 591,000
YEAR ENDED JUNE 3, 1995 $ 2,885,000 $1,602,000 $ - $3,481,000(1) $ 1,006,000
YEAR ENDED MAY 28, 1994 $ 1,554,000 $1,815,000(2) $ - $ 484,000(1) $ 2,885,000
INVENTORY RESERVE
YEAR ENDED JUNE 1, 1996 $ 6,011,000 $ - $ - $6,011,000 $ -
YEAR ENDED JUNE 3, 1995 $ 2,146,000 $3,865,000 $ - $ - $ 6,011,000
YEAR ENDED MAY 28, 1994 $ 1,653,000 $ 538,000 $ - $ 45,000 $ 2,146,000
TAX VALUATION ALLOWANCE
YEAR ENDED JUNE 1, 1996 $19,901,000 $ $ - $3,485,000 $16,416,000
YEAR ENDED JUNE 3, 1995 $ - $ - $19,901,000 $ - $19,901,000
YEAR ENDED MAY 28, 1994 $ - $ - $ - $ - $ -
(1) Uncollectible accounts receivable written off against the allowance.
(2) Includes amounts expensed related to barter.
F-24
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
The Company has engaged Coopers & Lybrand L.L.P. ("Coopers") to serve as its
principal independent accountant to audit its financial statements, effective
May 30, 1995. Coopers replaced Ernst & Young LLP ("Ernst & Young"), which had
served as Cherokee's independent accountant since 1989. The decision to dismiss
Ernst & Young and change independent accountants was made by Cherokee management
and was approved by the Audit Committee of the Company's Board of Directors.
The report of Ernst & Young with respect to the consolidated financial
statements of Cherokee as of, and for the year ended, May 28, 1994 contained a
going concern qualification. The qualification was based upon Cherokee's
continuing operating losses and the expectation that it would not meet its
scheduled Fiscal 1995 debt service payments on its outstanding debt securities.
To the knowledge of Cherokee, there have been no disagreements between
Cherokee and Ernst & Young on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure. Furthermore,
there have been no reportable events as set forth in Item 304(a)(1)(v) of
Regulation S-K. Ernst & Young furnished the Securities and Exchange Commission
with a letter stating they agree with the above statements.
19
PART III
ITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to directors and compliance
with Section 16(a) of the Exchange Act is incorporated herein by reference to
the information contained in the Proxy Statement relating to the Company's
Annual Meeting of Stockholders scheduled to be held on October 14, 1996, which
will be filed with the SEC no later than 120 days after the close of the fiscal
year ended June 1, 1996. The following table sets forth information with respect
to each of the Company's executive officers.
NAME, AGE AND PRINCIPAL OCCUPATION FOR PAST FIVE YEARS;
PRESENT POSITION WITH THE COMPANY BUSINESS EXPERIENCE
- - ----------------------------------- ---------------------------------------------------
Robert Margolis, 48 Mr. Margolis was appointed Chairman of the Board and Chief
Director, Chairman of the Board of Executive Officer of the Company on May 5, 1995. Mr.
Directors and Chief Executive Officer Margolis was the co-founder of the Company's Apparel
Division in 1981. He had been the Co-Chairman of the Board
of Directors, President and Chief Executive Officer of the
Company since June 1990 and became Chairman of the Board
on June 1, 1993. Mr. Margolis resigned all of his positions with
the Company on October 31, 1993 and entered into a one-year
consulting agreement with the Company. In 1994 Mr. Margolis
became Chief Executive Officer and a Director of The Newstar
Group, which does business as The Wilstar Group ("Wilstar").
Wilstar through its subsidiaries, operates various textile and
apparel related enterprises including a private label apparel
manufacturer.
Patricia Warren, 49 Ms. Warren has been employed by Cherokee since May 1995
President and became its President on June 21, 1995. From October 1989
to May 1993 she was Senior Vice President and General
Merchandise Manager of The Bon Marche, a division of
Federated Department Stores. From May 1993 to May 1994,
she was Executive Vice President, Merchandising for The
Broadway Department Stores. From September 1994 until May
1995, she was an independent consultant to wholesalers and
retailers.
Carol Gratzke, 48 Ms. Gratzke returned to Cherokee in November 1995 as its
Chief Financial Officer Chief Financial Officer. From August 1986 to July 1994, she
was the Controller and, for a portion of such period, the Chief
Financial Officer of the Apparel & Uniform Divisions. From
July 1994 to September 1995 she was Executive Vice President
of Finance for Rampage Clothing Company & Rampage Retailing.
20
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference
to the information contained in the Proxy Statement relating to the Company's
Annual Meeting of Stockholders scheduled to be held on October 14, 1996, which
will be filed with the SEC no later than 120 days after the close of the fiscal
year ended June 1, 1996.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference
to the information contained in the Proxy Statement relating to the Company's
Annual Meeting of Stockholders scheduled to be held on October 14, 1996, which
will be filed with the SEC no later than 120 days after the close of the fiscal
year ended June 1, 1996.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference
to the information contained in the Proxy Statement relating to the Company's
Annual Meeting of Stockholders scheduled to be held on October 14, 1996, which
will be filed with the SEC no later than 120 days after the close of the fiscal
year ended June 1, 1996.
21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) The Consolidated 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 Consolidated Financial Statements filed as Item 8 of Part
II of this Form 10-K].
(3) List of Exhibits.
The exhibits listed in the accompanying Index to Exhibits are filed
as part of this Form 10-K.
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT
- - -------------- ----------------------
2.1 Plan of Reorganization of Cherokee Inc. as confirmed on
December 14, 1994 (incorporated by reference from Exhibit 2.1
to Cherokee Inc.'s Current Report on Form 8-K dated January
5, 1995).
3.1 Amended and Restated Certificate of Incorporation of Cherokee
Inc. (incorporated by reference from Exhibit 3.1 of Cherokee
Inc.'s Form 10-K dated April 24, 1995).
3.2 Bylaws of Cherokee Inc. (incorporated by reference from
Exhibit 3.2 of Cherokee Inc.'s Form 10-K dated April 24,
1995).
4.1 Financing Agreement dated as of December 23, 1994, between
Cherokee Inc. and The CIT Group/Business Credit, Inc.
(incorporated by reference from Exhibit 4.1 of Cherokee
Inc.'s Form 10-K dated April 24, 1995).
4.2 Amendment to Financing Agreement dated June 2, 1995 between
Cherokee Inc. and The CIT Group/Business Credit Inc.
(incorporated by reference from Exhibit 4.2 of Cherokee's
Form 10-K dated April 24, 1995).
10.1 Form of Director Warrant (incorporated by reference from
Exhibit 10.3 of Cherokee Inc.'s Form 10-K dated April 24,
1995).
10.2 Management Agreement dated as of May 4, 1995 between Cherokee
Inc. and The Newstar Group Inc., d/b/a The Wilstar Group
("Wilstar") (incorporated by reference from Exhibit 10.5 of
Cherokee Inc.'s 10-K dated June 3, 1995).
10.3 Option Agreement dated as of May 4, 1995 between Cherokee
Inc. and Wilstar (incorporated by reference from Exhibit 10.5
of Cherokee Inc.'s 10-K dated June 3, 1995).
10.4 Registration Rights Agreement dated as of May 4, 1995 between
Cherokee Inc. and Wilstar (incorporated by reference from
Exhibit 10.6 of Cherokee Inc.'s 10-K dated June 3, 1995).
22
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT
- - -------------- ----------------------
10.5 Amendment No. 1 to the Non-Qualified Stock Option Agreement
dated October 30, 1995.
10.6 Amendment No. 2 to the Non-Qualified Stock Option Agreement
dated March 23, 1996.
10.7 Amendment No. 1 to the Revised and Restated Wilstar
Management Agreement dated April 26, 1996.
10.8 Asset Purchase Agreement dated July 17, 1995 between Cherokee
Inc. and Strategic Partners, Inc. (incorporated herein by
reference from Exhibit 2.1 to Cherokee Inc.'s Current Report
on Form 8K dated August 10, 1995).
10.9 Stock Purchase Agreement dated July 28, 1995 between Cherokee
Inc. and Axicom Capital Group (incorporated by reference from
Exhibit 10.8 of Cherokee Inc.'s 10-K dated June 3, 1995).
10.10 License Agreement between Cherokee Inc. and Target Stores, a
division of Dayton-Hudson Corporation, dated August 15, 1995
(incorporated by reference from Exhibit 10.9 of Cherokee
Inc.'s 10-K dated June 3, 1995).
16.1 Letter of Ernst & Young L.L.P. regarding change in
accountants (incorporated herein by reference from Exhibit
16.1 to Cherokee Inc.'s Current Report on Form 8-K dated June
5, 1995).
27.1 Article 5 Financial Data Schedule.
(b) Reports on Form 8-K.
The Company filed no reports on Form 8-K during the last quarter of
fiscal year 1996.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CHEROKEE INC.
By Robert Margolis
------------------------------------
Robert Margolis
Chairman and Chief Executive Officer
Date: August 28, 1996
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Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Robert Margolis
- - ------------------------
Robert Margolis Chairman and Chief Executive August 28, 1996
Officer and Director
Carol Gratzke
- - ------------------------
Carol Gratzke Chief Financial Officer August 28, 1996
Herschel Elias
- - ------------------------
Herschel Elias Director August 28, 1996
Jeffrey Schultz
- - ------------------------
Jeffrey Schultz Director August 28, 1996
Douglas Weitman
- - ------------------------
Douglas Weitman Director August 28, 1996
Jess Ravich
- - ------------------------
Jess Ravich Director August 28, 1996
Keith Hull
- - ------------------------
Keith Hull Director August 28, 1996
Avi Dan
- - ------------------------
Avi Dan Director August 28, 1996
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