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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended August 1, 2015.

o         Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period From            to            .

Commission file number 0-18640

CHEROKEE INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (818) 908-9868

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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CHEROKEE INC.

INDEX

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Part 1. Financial Information

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CHEROKEE INC.

CONSOLIDATED BALANCE SHEETS

Unaudited

(amounts in thousands, except share and per share amounts)

See the accompanying notes which are an integral part of these consolidated financial statements.

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CHEROKEE INC.

CONSOLIDATED STATEMENTS OF INCOME

Unaudited

(amounts in thousands, except per share amounts)

See the accompanying notes which are an integral part of these consolidated financial statements.

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CHEROKEE INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Unaudited

(amounts in thousands)

See the accompanying notes which are an integral part of these consolidated financial statements.

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CHEROKEE INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

(amounts in thousands)

See the accompanying notes which are an integral part of these consolidated financial statements.

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CHEROKEE INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(amounts in thousands)

See the accompanying notes which are an integral part of these consolidated financial statements.

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CHEROKEE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except percentages, share and per share amounts)

(1)   Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as of August 1, 2015 and for the three and six month periods ended August 1, 2015 and August 2, 2014 have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and Article 10 of Regulation S-X. These consolidated financial statements include the accounts of Cherokee Inc. (“Cherokee” or the “Company”) and its subsidiaries and have not been audited by independent registered public accountants, but include all adjustments, consisting of normal recurring accruals, which in the opinion of management of Cherokee are necessary for a fair statement of the financial position and the results of operations for the periods presented.  All material intercompany accounts and transactions have been eliminated during the consolidation process. The accompanying consolidated balance sheet as of January 31, 2015 has been derived from audited consolidated financial statements, but does not include all disclosures required by GAAP.  The results of operations for the three and six month periods ended August 1, 2015 are not necessarily indicative of the results to be expected for the fiscal year ending January 30, 2016.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2015.

As used herein, the term “First Quarter” refers to the three months ended May 2, 2015; the term “Second Quarter” refers to the three months ended August 1, 2015; the term “Six Months” refers to the six months ended August 1, 2015;  the term “Fiscal 2016” refers to the fiscal year ending January 30, 2016; the term “Fiscal 2015” refers to the most recent past fiscal year ended January 31, 2015; and the term “Fiscal 2014” refers to the fiscal year ended February 1, 2014.

(2)   Summary of Significant Accounting Policies

Receivables

Receivables are reported at amounts the Company expects to be collected, net of allowance for doubtful accounts.

Allowance for Doubtful Accounts

The Company records its allowance for doubtful accounts based upon its assessment of various factors, such as: historical experience, age of accounts receivable balances, credit quality of the Company’s licensees, current economic conditions, bankruptcy, and other factors that may affect the Company’s licensees’ ability to pay. There was no allowance for doubtful accounts as of August 1, 2015 or January 31, 2015.

Recent Accounting Pronouncements

In May 2014, the FASB issued new guidance surrounding revenue from contracts with customers noting that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB deferred the effective date for all entities by one year. This guidance is effective for fiscal periods beginning after December 15, 2017. The anticipated impact of the adoption of this guidance on the Company is still being evaluated.

In August 2014, the Financial Accounting Standards Board issued authoritative guidance that requires an entity’s management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern and requires additional disclosures if certain criteria are met. This guidance is effective for fiscal periods ending after December 15, 2016. The adoption of this guidance will not impact the Company’s consolidated financial statements or related disclosures.

In February 2015, the Financial Accounting Standards Board issued authoritative guidance which modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. This guidance is effective for fiscal periods beginning after December 15, 2015, and allows for either full retrospective or modified retrospective adoption, with early adoption permitted. The adoption of this guidance is not expected to impact the Company’s consolidated financial statements or related disclosures.

Use of Estimates

On an ongoing basis, the Company evaluates its estimates and assumptions, including those related to revenue recognition, allowance for doubtful accounts, valuation of long-lived assets, stock based compensation and income taxes. The Company bases its estimates on historical and anticipated results, trends and on various other assumptions that it believes are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results could differ materially from these estimates.

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Cash and Cash Equivalents

The Company considers all highly liquid debt instruments purchased and money market funds purchased with an original maturity date of three months or less to be cash equivalents.  At August 1, 2015 and January 31, 2015, the Company’s cash and cash equivalents exceeded Federal Deposit Insurance Corporation (“FDIC”) limits.

Revenue Recognition and Deferred Revenue

The Company recognizes revenue when persuasive evidence of a sale arrangement exists, delivery has occurred or services have been rendered, the buyer’s price is fixed or determinable and collection is reasonably assured. Revenues from royalty and brand representation agreements are recognized when earned by applying contractual royalty rates to quarterly point of sale data received from the Company’s licensees.

The Company’s royalty revenue recognition policy provides for recognition of royalties in the quarter earned. The Company’s agreement with Target Corporation (“Target”) for the Cherokee brand in the U.S. accounts for the majority of the Company’s historical revenues and is structured to provide royalty rate reductions once certain cumulative levels of retail sales are achieved by Target. With respect to Target’s sales in the U.S. of Cherokee branded products other than in the school uniforms category and adult products sold on Target’s website, revenue is recognized by applying the reduced contractual royalty rates prospectively to point of sale data after defined sales thresholds are exceeded. The royalty rate reductions do not apply retroactively to sales since the beginning of the fiscal year. As a result, the Company’s royalty revenues as a percentage of Target’s retail sales in the U.S. are highest at the beginning of each fiscal year and decrease during the fiscal year as Target exceeds sales thresholds as set forth in the Company’s agreement with Target. The amount of Cherokee brand royalty revenue earned by the Company from Target in any quarter is dependent not only on Target’s retail sales of Cherokee branded products in the U.S. in each quarter, but also on the royalty rate then in effect after considering Target’s cumulative level of retail sales for Cherokee branded products in the U.S. for the fiscal year. Historically, with Target, this has caused the Company’s first quarter to be the Company’s highest revenue and most profitable quarter and the Company’s fourth quarter to be the Company’s lowest revenue and least profitable quarter. However, such historical patterns may vary in the future depending upon the terms of any new license agreements, retail sales volumes achieved in each quarter from Target and revenues the Company receives from Target or other licensees that may or may not be subject to reduced royalty rates based upon cumulative sales, including with respect to the Company’s Liz Lange and Completely Me by Liz Lange brands, Cherokee brand in the school uniforms category, Cherokee adult products sold on Target’s website, and the Hawk and Tony Hawk brands.

In order to ensure that Cherokee’s licensees are appropriately reporting and calculating royalties owed to Cherokee, all of Cherokee’s license agreements include audit rights to allow Cherokee to validate the amount of the royalties paid. Any revenue resulting from these audits, or other audits, is recognized in the financial statement of the current reporting period.

Deferred Financing Costs and Debt Discount

Deferred financing costs and debt discounts are capitalized and amortized into interest expense over the life of the debt.

Foreign Withholding Taxes

Licensing revenue is recognized gross of withholding taxes that are remitted by the Company’s licensees directly to their local tax authorities.

Property and Equipment

Property and equipment consist of the following:

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Property and equipment are stated at cost, less accumulated depreciation. Maintenance and repairs are expensed as incurred. The cost and related accumulated depreciation of property and equipment sold or retired are written off, and the resulting gains or losses are included in current operations. Depreciation is provided on a straight line basis over the estimated useful life of the related asset.

Computers and related equipment and software are depreciated over three years. Furniture and store fixtures are depreciated over the shorter of seven years, or the remaining term of the licensee agreement. Leasehold improvements are depreciated over the shorter of five years, or the remaining life of the lease term.  Depreciation expense was $111 and $206 for the three and six month periods ended August 1, 2015 and $107 and $209 for the three and six month periods ended August 2, 2014, respectively.

Earnings Per Share Computation (amounts in thousands, including share amounts)

The following table provides a reconciliation of the numerator and denominator of the basic and diluted per-share computations for the three month periods ended August 1, 2015 and August 2, 2014:

The computation for diluted number of shares excludes unexercised stock options which are anti-dilutive. There were 193 and 129 anti-dilutive shares for the three and six month periods ended August 1, 2015, respectively, and 961 and 884 anti-dilutive shares for each of the three and six months periods ended August 2, 2014.

Basic earnings per share (“EPS”) is computed by dividing the net income attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS is similar to the computation for basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued.

Significant Contracts

The terms of the Company’s relationship with Target as of the date of this report are set forth in a restated license agreement with Target, which was entered into effective as of February 1, 2008 and amended (i) on January 31, 2013 to add the category of school uniforms, (ii) on April 3, 2013 to provide for a fixed royalty rate of 2% for sales of Cherokee branded products in the category of adult merchandise sold on Target’s website (target.com) in Fiscal 2015 and in future periods and (iii) on January 6, 2014 to reflect Target’s election to renew the agreement through January 31, 2017 and to provide that Target can renew the agreement for successive two (2) year periods, provided that it satisfies the minimum guaranteed royalty payment of $10,500 for the preceding fiscal year (the “Restated Target Agreement”). The Restated Target Agreement grants Target the exclusive right in the United States to use the Cherokee trademarks in various specified categories of merchandise. On September 3, 2015, Target orally informed the Company that the Restated Target Agreement would not be renewed and will terminate at the end of its current term, which expires January 31, 2017.  The non-renewal was confirmed in writing on September 4, 2015.  The Restated Target Agreement, including the existing royalty obligations, will remain in effect and continue to generate revenues to Cherokee in Fiscal 2016 and 2017 through its expiration.

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Under the current terms of the Restated Target Agreement, the minimum annual guaranteed royalty for Target is $10,500 and applies to all sales made by Target in the United States, other than sales of Cherokee branded products in the school uniforms category (which products are subject to a separate minimum guaranteed royalty of $800). Under the Restated Target Agreement, Target has agreed to pay royalties based on a percentage of Target’s net sales of Cherokee branded merchandise during each fiscal year which percentage varies according to the volume of sales of merchandise other than for sales of Cherokee branded products in the school uniforms category and, beginning in Fiscal 2015, other than for sales of Cherokee branded products in the adult merchandise category that are made on Target’s website. The Company assumed a separate license agreement with Target for the Liz Lange brand in connection with the Company’s acquisition of the assets in September 2012.

In connection with the acquisition of the “Hawk” and “Tony Hawk” signature apparel brands and related trademarks (the “Hawk Acquisition”), Cherokee and Kohl’s Department Stores (“Kohl’s”) entered into an amended license agreement. Pursuant to such amendment, Kohl’s is granted the exclusive right to sell Tony Hawk and Hawk branded apparel and related products in the United States and has agreed to pay Cherokee an annual royalty rate for its sales of Hawk branded signature apparel and related products in the United States subject to a minimum annual guaranteed royalty of $4,800 for four years.

Stock-Based Compensation

Effective July 16, 2013, the Company’s stockholders approved the 2013 Stock Incentive Award Plan (the “2013 Plan”). The 2013 Plan serves as the successor to the 2006 Incentive Award Plan (which includes the 2003 Incentive Award Plan as amended by the adoption of the 2006 Incentive Award Plan) (the “2006 Plan”). The 2013 Plan authorized to be issued (i) 700,000 additional shares of common stock, and (ii) 102,483 shares of common stock previously reserved but unissued under the 2006 Plan. No future grants will be awarded under the 2006 Plan, but outstanding awards previously granted under the 2006 Plan continue to be governed by its terms. Any such shares of common stock that are subject to outstanding awards under the 2006 Plan which are forfeited, terminate or expire unexercised and would otherwise have been returned to the share reserve under the 2006 Plan will be available for issuance as common stock under the 2013 Plan. The 2013 Plan provides for the issuance of equity-based awards to officers, other employees, and directors.

Stock Options

Stock options issued to employees are granted at the market price on the date of grant, generally vest over a three-year period, and generally expire seven to ten years from the date of grant. The Company issues new shares of common stock upon exercise of stock options. The Company has also granted non-plan options to certain executives as a material inducement for employment. The Company accounts for stock options under authoritative guidance, which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors based on estimated fair values.

The Company estimates the fair value of stock-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service period in the consolidated statements of income. The compensation expense recognized for all stock-based awards is net of estimated forfeitures over the award’s service period.

Stock-based compensation expense recognized in selling, general and administrative expenses for stock options for the Six Months was $943, as compared to $424 for the comparable period in the prior year.

A summary of all activity for the Company’s stock options for the Six Months is as follows:

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As of August 1, 2015, total unrecognized stock-based compensation expense related to non-vested stock options was approximately $2,665, which is expected to be recognized over a weighted average period of approximately 2.48 years. The total fair value of all options which vested during the Six Months was $603.

Restricted Stock and Restricted Stock Units

In 2013, the Compensation Committee of the Company’s board of directors (the “Board of Directors”) granted certain performance-based equity awards to executives under the Company’s 2006 Stock Plan.

The performance metric applicable to such awards is compound stock price growth, using the closing price of the Company’s Common Stock on February 1, 2013, or $13.95, as the benchmark. The target growth rate is 10% annually, which results in an average share price target of (i) $15.35 for Fiscal 2014, (ii) $16.88 for Fiscal 2015 and (iii) $18.57 for the Company’s fiscal year ending in 2016.  The average share price will be calculated as the average of all market closing prices during the January preceding fiscal year end. If a target is met at the end of a fiscal year, one third of the shares subject to the award will vest. If the stock price target is not met, the relevant portion of the shares subject to the award will not vest but will roll over to the following fiscal year. The executive must continue to be employed by the Company through the relevant vesting dates to be eligible for vesting. The target average share price was met for Fiscal 2015, which resulted in the vesting of two thirds of the shares subject to each award

Since the vesting of these performance-based equity awards are subject to market based performance conditions, the fair value of these awards were measured on the date of grant using the Monte Carlo simulation model for each vesting tranche. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the performance conditions stipulated in the award grant and calculates the fair market value for the performance units granted. The Monte Carlo simulation model also uses stock price volatility and other variables to estimate the probability of satisfying the performance conditions and the resulting fair value of the award.

Pursuant to a compensation program for non-employee directors adopted by the Compensation Committee, at the meeting of the Board of Directors held immediately following the annual stockholder meeting in June each year, each non-employee member of the Board of Directors must make an election regarding the percentage, up to 100%, of his annual compensation for service on the Board of Directors to be paid in equity, in the form of restricted stock units (“RSU’s”). All of the RSU’s issuable under this program in June 2014 were approved and granted on July 28, 2014. The RSU’s awarded to the non-employee directors are subject to the terms of the 2013 Plan and RSU agreements that provide for quarterly vesting over a one year service period of August 4, 2014 through August 3, 2015, subject to acceleration of vesting upon the earlier to occur of the following: (i) a change in control of the Company, (ii) the death of the recipient or (iii) the recipient’s failure to be re-elected to the Board of Directors in any election in which the recipient stands for re-election. The fair value of these awards was measured on the effective date of grant using the price of the Company’s common stock. At the Board meeting held immediately following the annual stockholder meeting in June 2015, all of the non-employee directors elected to take all of their annual compensation for service on the Board in cash for the following year.

In June 2015, the Compensation Committee of the Company’s Board of Directors granted RSUs and stock options to each member of the Board of Directors and to each of the Company’s executive officers under the 2013 Plan. All of the equity awards approved at that meeting vest in equal annual installments over three years, such that the full grants shall be vested on the 3rd anniversary of the grant date. The fair value of the RSU awards was measured on the effective date of grant using the price of the Company’s common stock.

In August 2014, the Compensation Committee of the Company’s Board of Directors granted a sales-based performance-based equity award to an employee under the 2013 Plan, which vests in five increments dependent upon achievement of certain annual sales targets. The fair value of this award was measured on the effective date of grant using the price of the Company’s common stock.

Stock-based compensation expense for shares of restricted stock and performance stock units for the Six Months was $488 compared to $96 for the comparable period in the prior year.

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As of August 1, 2015, total unrecognized stock-based compensation expense related to restricted stock and performance stock units was approximately $231, which is expected to be recognized over a weighted average period of approximately 2.4 years.

Trademarks

The Company holds various trademarks including Cherokee®, Liz Lange®, Completely Me by Liz Lange®, Hawk®, Tony Hawk®, Everyday California®, Sideout®, Sideout Sport®, Carole Little®, Saint Tropez-West®, Chorus Line®, All That Jazz®, and others, in connection with numerous categories of apparel and other goods. These trademarks are registered with the United States Patent and Trademark Office and corresponding government agencies in a number of other countries. The Company also holds trademark applications for Cherokee, Liz Lange, Completely Me by Liz Lange, Hawk, Tony Hawk, Sideout, Sideout Sport, Carole Little, Chorus Line, Saint Tropez-West, All That Jazz, and others in numerous countries. The Company intends to renew these registrations, as appropriate, prior to expiration. The Company monitors on an ongoing basis unauthorized uses of the Company’s trademarks, and relies primarily upon a combination of trademark, copyright, know-how, trade secrets, and contractual restrictions to protect the Company’s intellectual property rights both domestically and internationally.

Trademark registration and renewal fees are capitalized and are amortized on a straight-line basis over the estimated useful lives of the assets. Trademark acquisitions are capitalized and are either amortized on a straight-line basis over the estimated useful lives of the assets, or are capitalized as indefinite-lived assets, if no legal, regulatory, contractual, competitive, economic, or other factors limit its useful life to Cherokee. Trademarks are evaluated for the possibility of impairment at least annually.

Acquisition of Everyday California® Lifestyle Brand

On May 14, 2015, Cherokee consummated an asset purchase agreement with Everyday California Holdings, LLC, under which it acquired various assets related to the Everyday California® Lifestyle Brand and related trademarks. The consideration for the assets consisted of an initial cash payment and contingent cash payments dependent upon performance of the assets during Fiscal years 2017 and 2018.

Trademarks consist of the following:

Fair Value of Financial Instruments

Authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:

Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets

Level 2: Other inputs that are observable directly or indirectly, such as quoted prices for similar assets or liabilities or market-corroborated inputs

Level 3: Unobservable inputs for which there is little or no market data, which require the owner of the assets or liabilities to develop its own assumptions about how market participants would price these assets or liabilities

The carrying amount of receivables, accounts payable and accrued liabilities approximates fair value due to the short-term nature of these instruments. Long-term debt approximates fair value due to the variable rate nature of the debt.

The realizability of long-lived assets is evaluated periodically as events or circumstances indicate a possible inability to recover the carrying amount. Long-lived assets that will no longer be used in business are written off in the period identified since they will no longer generate any positive cash flows for the Company. Periodically, long-lived assets that will continue to be used by the Company need to be evaluated for recoverability. Such evaluation is based on various analyses, including cash flow and profitability projections. The analyses involve management judgment. In the event the projected undiscounted cash flows are less than the net book value of the assets, the carrying value of the assets will be written down to their estimated fair value, in accordance with authoritative guidance. The estimated undiscounted cash flows used for this nonrecurring fair value measurement are considered a Level 3 input, which consist of unobservable inputs that reflect assumptions about what market participants would use in pricing the asset or liability. These inputs would be based on the best information available, including the Company’s own data.

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Income Taxes

Income tax expense of $1,045 was recognized for the Second Quarter, resulting in an effective tax rate of 35.1% in the Second Quarter, as compared to 35.7% in the second quarter of last year and compared to 32.4% for the full year of Fiscal 2015. The effective tax rate for the Second Quarter differs from the statutory rate due to the effect of certain permanent nondeductible expenses, the apportionment of income among state jurisdictions, and the benefit of certain tax credits.

The amount of unrecognized tax benefits was approximately $449 and $449, respectively, at August 1, 2015 and January 31, 2015. At August 1, 2015, approximately $296 of unrecognized tax benefits would, if recognized, affect the effective tax rate.

In accordance with authoritative guidance, interest and penalties related to unrecognized tax benefits are included within the provision for taxes in the consolidated statements of income. The total amount of interest and penalties recognized in the consolidated statements of income for the Second Quarter was $5 as compared with $1 in the second quarter of last year. As of August 1, 2015 and January 31, 2015, respectively, the total amount of accrued interest and penalties included in the liability for unrecognized tax benefits was $94 and $84.

The Company has unrecognized tax benefits pertaining to the issue of its taxability in various state tax jurisdictions.  It is reasonably possible that the amount of unrecognized tax benefits may decrease within the next 12 months as a result of the Company’s interaction with these various state tax jurisdictions.  The Company anticipates that the total amount of unrecognized tax benefits may decrease in the next 12 months by approximately $449.

The Company files income tax returns in the U.S. federal and California and certain other state jurisdictions. For federal income tax purposes, the fiscal 2012 and later tax years remain open for examination by the tax authorities under the normal three year statute of limitations. For state tax purposes, the fiscal 2011 and later tax years remain open for examination by the tax authorities under a four year statute of limitations.

Marketing and Advertising

Generally, the Company’s “Direct to Retail” licensees fund their own advertising programs. Cherokee’s marketing, advertising and promotional costs totaled $730 and $664 for the six month periods ended August 1, 2015 and August 2, 2014, respectively. These costs are expensed as incurred and were accounted for as selling, general and administrative expenses.

The Company provides marketing expense money to certain large licensees based upon sales criteria to help them build the Company’s licensed brands in their respective territories, thus providing an identifiable benefit to Cherokee. The amounts paid for such marketing expenses during the six month periods ended August 1, 2015 and August 2, 2014 were $332 and $118, respectively, and are included in the total marketing, advertising and promotional costs.

Deferred Rent and Lease Incentives

When a lease includes lease incentives (such as a rent abatement) or requires fixed escalations of the minimum lease payments, rental expense is recognized on a straight-line basis over the term of the lease and the difference between the average rental amount charged to expense and amounts payable under the lease is included in deferred rent and lease incentives in the accompanying consolidated balance sheets. For leasehold allowances, the Company records a deferred lease credit on the consolidated balance sheets and amortizes the deferred lease credit as a reduction of rent expense in the consolidated statements of income over the term of the lease.

Comprehensive Income

Authoritative guidance establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources. For the three months ended August 1, 2015 and August 2, 2014, the Company has no comprehensive income components and accordingly, net income equals comprehensive income.

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Treasury Stock

Repurchased shares of the Company’s common stock are held as treasury shares until they are reissued or retired. When the Company reissues treasury stock, and the proceeds from the sale exceed the average price that was paid by the Company to acquire the shares, the Company records such excess as an increase in additional paid-in capital.

Conversely, if the proceeds from the sale are less than the average price the Company paid to acquire the shares, the Company records such difference as a decrease in additional paid-in capital to the extent of increases previously recorded, with the balance recorded as a decrease in retained earnings.

(3)    Debt

Credit Agreement with JPMorgan Chase

On September 4, 2012, and in connection with the acquisition of the “Liz Lange” and “Completely Me by Liz Lange” brands, Cherokee and JPMorgan Chase (or “JPMorgan”) entered into a credit agreement (as amended, the “Credit Agreement”), which was amended on January 31, 2013 in connection with the Company’s acquisition of rights related to the Cherokee brand in the school uniforms category and was further amended on January 10, 2014 in connection with the Hawk Acquisition. Effective January 10, 2014, Cherokee and JPMorgan entered into amendments to each of (i) the Credit Agreement, (ii) the existing term note, which was originally issued by Cherokee in favor of JPMorgan as of September 4, 2012 and previously amended by the parties effective January 31, 2013 (as amended, the “2013 Term Note”) and (iii) the line of credit note, which was issued by Cherokee in favor of JPMorgan as of September 4, 2012 (as amended, the “Revolver”). In addition, pursuant to the Credit Agreement, JPMorgan issued to Cherokee a new term note (the “2014 Term Note” and, together with the foregoing amendments, the “Loan Agreement Amendments”) in the principal sum equal to the purchase price in the Hawk Acquisition, or $19,000. The 2014 Term Note bears interest equal to either: (i) an adjusted annual LIBOR rate reset monthly, bimonthly or quarterly, plus 2.75% or 3.00% depending on the applicable senior funded debt ratio or (ii) JPMorgan’s annual prime rate or such annual prime rate plus 0.25% depending on the applicable senior funded debt ratio, with a floor equal to the one month LIBOR rate plus 2.5%. Pursuant to the Credit Agreement, the definition of “senior funded debt ratio” requires that Cherokee not exceed a ratio equal to (i) 2.50 to 1.00 until the fiscal quarter ending October 31, 2014, (ii) 2.25 to 1.00 from the fiscal quarter ending January 31, 2015 until the fiscal quarter ending January 31, 2016, and (iii) 2.00 to 1.00 thereafter. Prior to the effectiveness of the January 2014 amendment to the Credit Agreement, such limitation on Cherokee’s senior funded debt ratio was fixed at 2.00 to 1.00 for all periods. In addition, pursuant to the Loan Agreement Amendments, the interest rate that applies to the 2013 Term Note and to the Revolver was amended to equal either: (i) an adjusted annual LIBOR rate reset monthly, bimonthly or quarterly, plus 2.25% or 2.5% depending on the applicable senior funded debt ratio or (ii) the JPMorgan’s annual prime rate or such annual prime rate plus 0.25% depending on the applicable senior funded debt ratio, with a floor equal to the 1 month LIBOR Rate plus 2.5%.

Following the issuance of the 2014 Term Note, Cherokee’s total borrowings under the Credit Agreement (collectively, the “Loan”) is evidenced by (i) the 2013 Term Note, which was issued in the principal amount of $16,600 and is payable on a quarterly basis through August 2017 and of which $7,975 was outstanding as of August 1, 2015, (ii) the Revolver, which provides Cherokee with a revolving line of credit in the principal amount of $2,000, none of which is outstanding as of August 1, 2015 and (iii) the 2014 Term Loan, which was issued in the principal amount of $19,000 and is payable on a quarterly basis through November 2018 and of which approximately $13,617 is outstanding as of August 1, 2015. Cherokee paid an upfront fee equal to $95 in connection with the issuance of the 2014 Term Loan.

Consistent with the existing terms of the Credit Agreement, the Loan is secured by continuing security agreements, trademark security agreements and continuing guarantees executed by Cherokee and its subsidiaries, as applicable. In addition, the Credit Agreement includes various restrictions and covenants regarding the operation of Cherokee’s business, including covenants that require Cherokee to obtain JPMorgan’s consent in certain circumstances before Cherokee can: (i) incur additional indebtedness, (ii) make acquisitions, mergers or consolidations in excess of $5,000 on an aggregate basis following the Hawk Acquisition, (iii) issue any equity securities other than pursuant to Cherokee’s employee equity incentive plans or programs and (iv) repurchase or redeem any outstanding shares of common stock or pay dividends or other distributions, other than stock dividends, to Cherokee’s stockholders. The Credit Agreement also imposes financial covenants, including: (i) a minimum “fixed charge coverage ratio” of at least 1.2 to 1.0 and (ii) a limitation of Cherokee’s “senior funded debt ratio” as described above. Further, Cherokee has granted a security interest in favor of JPMorgan in all of Cherokee’s assets (including trademarks) as collateral for the Loan. In the event of a default under the Credit Agreement, JPMorgan has the right to terminate its obligations under the Credit Agreement, accelerate the payment on any unpaid balance of the Credit Agreement and exercise its other rights, including foreclosing on Cherokee’s assets under the security agreements. As of August 1, 2015, the Company was in compliance with these financial covenants.

Target’s election not to renew the Restated Target Agreement triggered an event of default under the Credit Agreement, but JPMorgan and the Company have entered into a Forbearance Agreement pursuant to which JPMorgan has agreed that it will not exercise any of its rights or remedies under the Credit Agreement solely with respect to such event of default through October 12, 2015.  The Company intends to seek a waiver of the event of default during the forbearance period, but no assurance can be given that such waiver will be issued, or if issued, that it will be on terms favorable to the Company.

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(4) Commitments and Contingencies

Trademark Indemnities

Cherokee indemnifies certain customers against liability arising from third-party claims of intellectual property rights infringement related to the Company’s trademarks. These indemnities appear in the licensing agreements with the Company’s customers, are not limited in amount or duration and generally survive the expiration of the contracts. Given that the amount of any potential liabilities related to such indemnities cannot be determined until an infringement claim has been made, the Company is unable to determine the range of estimated losses that it could incur related to such indemnifications.

Litigation

Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in the consolidated balance sheets. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the expected probable favorable or unfavorable outcome of each claim. As additional information becomes available, the Company assesses the potential liability related to new claims and existing claims and revises estimates as appropriate. As new claims arise or existing claims evolve, such revisions in estimates of the potential liability could materially impact the results of operations and financial position. The Company may also be involved in various other claims and other matters incidental to the Company’s business, the resolution of which is not expected to have a material adverse effect on the Company’s financial position or results of operations. No material amounts were accrued as of August 1, 2015 or January 31, 2015 related to any of the Company’s legal proceedings.

(5) Segment Reporting

Authoritative guidance requires public companies to report financial and descriptive information about their reportable operating segments. The Company identifies reportable segments based on how management internally evaluates separate financial information, business activities and management responsibility.

The Company operates in a single business segment, the marketing and licensing of brand names and trademarks for apparel, footwear and accessories. Cherokee’s marketing and licensing activities extend to brands which the Company owns and to brands owned by others. Cherokee’s operating activities relating to owned and represented brands are identical and are performed by a single group of marketing professionals. While Cherokee’s principal operations are in the United States, the Company also derives royalty revenues from some of the Company’s licensees that are located all around the world. Revenues by geographic area based upon the licensees’ country of domicile consisted of the following:

Long-lived tangible assets have been located in the U.S., United Kingdom, Mexico and Asia with net values of approximately $926, $0, $267 and $58 as of August 1, 2015 and net values of approximately $794, $0, $299 and $72 as of January 31, 2015.

(6) Subsequent Events

On September 3, 2015, Target orally informed the Company that it would not renew the Restated Target Agreement which expires at the end of its current term on January 31, 2017.  Target confirmed the non-renewal in writing on September 4, 2015.  The Restated Target Agreement, including the existing royalty obligations, will remain in effect and continue to generate revenues to Cherokee in Fiscal 2016 and 2017 through its expiration. Target’s election not to renew the Restated Target Agreement triggered an event of default under the Credit Agreement, but JPMorgan and the Company have entered into a Forbearance Agreement pursuant to which JPMorgan has agreed that it will not exercise any of its rights or remedies under the Credit Agreement solely with respect to such event of default through October 12, 2015.  The Company intends to seek a waiver of the event of default during the forbearance period, but no assurance can be given that such waiver will be issued, or if issued, that it will be on terms favorable to the Company.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (this “MD&A”) should be read together with the unaudited condensed consolidated financial statements and the related notes included in this report. For additional context with which to understand our financial condition and results of operations, refer to the MD&A for the fiscal year ended January 31, 2015 contained in our 2015 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission (“SEC”) on April 16, 2015, as well as the consolidated financial statements and notes contained therein (collectively, our “Annual Report”).  In addition to historical information, the following discussion and analysis contains forward-looking statements based upon our current views, expectations and assumptions that are subject to risks and uncertainties. Actual results may differ substantially from those expressed or implied by any forward-looking statements due to a number of factors, including, among others, the risks described in Part II, Item 1A, “Risk Factors” and elsewhere in this Quarterly Report. In preparing this MD&A, we presume that readers have access to and have read the MD&A in our Annual Report pursuant to Instruction 2 to paragraph (b) of Item 303 of Regulation S-K. We undertake no duty to update any of these forward-looking statements after the date we file this report to conform such forward-looking statements to actual results or revised expectations, except as otherwise required by law.

As used in this discussion and analysis, “Cherokee”, the “Company”, “we”, “us” and “our” refer to Cherokee Inc. and its consolidated subsidiaries, unless the context indicates or requires otherwise. Additionally, as used herein, the term “First Quarter” refers to the three months ended May 2, 2015; the term “Second Quarter” refers to the three months ended August 1, 2015; the term “Six Months” refers to the six months ended August 1, 2015;  the term “Fiscal 2016” refers to the fiscal year ending January 30, 2016; the term “Fiscal 2015” refers to the most recent past fiscal year ended January 31, 2015; and the term “Fiscal 2014” refers to the fiscal year ended February 1, 2014.

We have a 52- or 53-week fiscal year ending on the Saturday nearest to January 31, which aligns us with our retail licensees who generally also operate and plan using such a fiscal year. This results in a 53-week fiscal year approximately every four or five years. Each of Fiscal 2015, Fiscal 2014 and Fiscal 2013 was a 52-week, 52-week and 53-week fiscal year, respectively. Certain of our international licensees report royalties to us for quarterly and annual periods that may differ from ours. We do not believe that the varying quarterly or annual period ending dates from our international licensees have a material impact upon our reported financial results, as these international licensees maintain comparable annual periods in which they report retail sales and royalties to us on a year-to-year basis.

Overview

Cherokee is a global marketer and manager of a portfolio of fashion and lifestyle brands it owns or represents, licensing the Cherokee, Liz Lange, Completely Me by Liz Lange, Hawk, Tony Hawk, Sideout, Carole Little, Everyday California and àle by alessandra brands and related trademarks and other brands in multiple consumer product categories and sectors. We are one of the leading global licensors of style focused lifestyle brands for apparel, footwear, home and accessories. As part of our business strategy, we frequently evaluate other brands and trademarks for acquisition into our portfolio. We enter into license agreements with recognizable retail partners in their respective global locations to provide them the rights to design, manufacture and sell products bearing our brands and to provide them our proprietary 360-degree platform. Cherokee provides its licensees with a proprietary 360-degree platform that seamlessly integrates with the DTR model. Our retail responsiveness process and 360-degree unique value proposition have allowed for Cherokee to address the growing power of the consumer and the present and future needs of the retailers that are selling our portfolio of lifestyle brands. Based on consumer research, retail insights and brand insights that are constantly being measured, evaluated and incorporated into our 360-degree platform, we believe Cherokee has become a key strategic partner to our licensees. We refer to this strategy as our “Direct to Retail” or “DTR” licensing model. As of August 1, 2015, we had thirty-one continuing license agreements covering both domestic and international markets, thirteen of which pertained to the Cherokee brand.

We derive revenues from licensing our trademarks to retailers all over the world. Our current retail licensee relationships cover over fifty countries and over 8,000 retail stores and online businesses and include relationships with Target, Kohl’s, RT Mart, Comercial Mexicana, TJ Maxx, Nishimatsuya, Sears Canada and Argos. Our two most significant licensees are Target Corporation (“Target”) and Kohl’s Illinois, Inc. (“Kohl’s”).

Recent Developments

On September 3, 2015, Target orally informed us that it would not renew the restated license agreement for the Cherokee brand in the U.S which expires at the end of its current term on January 31, 2017.  Target confirmed the non-renewal in writing on September 4, 2015.  The restated Target license agreement, including the existing royalty obligations, will remain in effect and continue to generate revenues to Cherokee in Fiscal 2016 and 2017 through its expiration.

Target’s election not to renew the license agreement for the Cherokee brand in the U.S. triggered an event of default under our credit agreement with JPMorgan, but we and JPMorgan have entered into a Forbearance Agreement pursuant to which JPMorgan has agreed that it will not exercise any of its rights or remedies under the credit agreement solely with respect to such event of default through October 12, 2015.  We intend to seek a waiver of the event of default during the forbearance period, but no assurance can be given that such waiver will be issued, or if issued, that it will be on terms favorable to us.

Critical Accounting Policies and Estimates

There has been no material change to our critical accounting policies and estimates from the information provided in our Annual Report.

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates, including those related to revenue recognition, deferred taxes, impairment of long-lived assets, contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may materially differ from these estimates.

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We consider accounting policies relating to the following areas to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment:

·                                                    Revenue recognition;

·                                                    Provision for income taxes and deferred taxes;

·                                                    Impairment of long-lived assets;

·                                                    Contingencies and litigation; and

·                                                    Accounting for stock-based compensation.

You should refer to our Annual Report for a discussion of our policies on revenue recognition, deferred taxes, impairment of long-lived assets, contingencies and litigation and accounting for stock-based compensation.

Results of Operations

The following table sets forth for the periods indicated certain of our consolidated financial data.

Revenues

In the three and six month periods ended August 1, 2015, our revenues totaled $8.5 million and $18.7 million, respectively, as compared to $8.8 million and $18.7 million in the three and six month periods ended August 2, 2014. Revenues for the second quarter and six month periods ended August 1, 2015 and August 2, 2014 were primarily generated from licensing our trademarks to retailers and to a lesser extent wholesalers and our share of licensing revenues from brand representation licensing agreements with other brand owners. The decrease in revenues was principally due to the strengthening of the U.S. dollar and the transition and timing around the launches of Sears Canada and Argos.  We are transitioning in Canada from Target Canada to Sears Canada for our Cherokee and Liz Lange brands and from Tesco to Argos in the United Kingdom for our Cherokee brand. We expect revenues from these new licensees to begin during the third quarter of Fiscal 2016 for Argos and during the first quarter of Fiscal 2017 for Sears Canada.

Total worldwide retail sales of merchandise bearing the Cherokee brand totaled $302 million and $632 million and approximately $321 million and $663 million in the second quarter and six month periods of Fiscal 2016 and Fiscal 2015, respectively.

Because we do not have direct oversight over our licensees, we may not have all the information necessary to determine or predict the specific reasons why revenue may increase or decrease in any given period. Given our contractual royalty rate reductions as certain sales volume thresholds are achieved for Cherokee branded products and Hawk and Tony Hawk branded products in various product categories in the U.S., we expect that our first quarter will continue to be our highest revenue and profitability quarter and our fourth quarter will continue to be our lowest revenue and profitability quarter.

The following table sets forth our revenues by brand for the three and six months ended August 1, 2015 and August 2, 2014.

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Geographic Revenues

The following table sets forth our geographic licensing revenues for the three and six months ended August 1, 2015 and August 2, 2014.

U.S. and Canada

Target

Target currently has approximately 1,790 stores in the United States. Retail sales of Cherokee branded products at Target in the U.S. were slightly higher in the Second Quarter at approximately $230 million from $229 million in the second quarter of last year. Target pays royalty revenues to us based on a percentage of its sales of Cherokee branded products pursuant to our license agreement with Target. The license agreement is structured to provide royalty rate reductions for Target after it has achieved certain levels of retail sales of Cherokee branded products in certain product categories in the U.S. during each fiscal year. Target also pays fixed royalty rates for Target’s sales of Cherokee branded products in the adult merchandise category that are made by Target through its website (target.com) and sales of Cherokee branded products in the category of school uniforms. In addition, Target pays a fixed percentage of net sales of its products bearing the Liz Lange brand in the U.S.

Under the current terms of the restated Target agreement, the minimum annual guaranteed royalty for Target is $10.5 million and applies to all sales made by Target in the United States, other than sales of Cherokee branded products in the school uniforms category (which products are subject to a separate minimum annual guaranteed royalty of $0.8 million).

Royalty revenues from our Cherokee brand at Target U.S., which excludes sales of Cherokee branded products in Canada and Cherokee branded products sold in the school uniforms category were $3.6 million and $9.0 million in the Second Quarter and Six Months, which accounted for 43%, and 48%, respectively, of our consolidated revenues for such periods. Royalty revenues from our Cherokee brand at Target were $3.6 million and $9.1 million for the second quarter and six months of last year, which accounted for 41%, and 48%, respectively, of our consolidated revenues during such periods. On September 3, 2015, Target orally informed us that it would not renew the restated license agreement for the Cherokee brand in the U.S which expires at the end of its current term on January 31, 2017.  Target confirmed the non-renewal in writing on September 4, 2015.  The restated Target license agreement, including the existing royalty obligations, will remain in effect and continue to generate revenues to Cherokee in Fiscal 2016 and 2017 through its expiration.

Kohl’s

Kohl’s currently has approximately 1,200 stores in the United States. Retail sales of Hawk or Tony Hawk branded products at Kohl’s totaled $22.4 million and $41.2 million in the Second Quarter and Six Months, compared to $28.0 million and $53.8 million in the second quarter and six months of last year.

Because retails sales did not exceed the contractual minimum guarantees, royalty revenues from our Hawk brand at Kohl’s remained flat at $1.2 million and $2.4 million in the Second Quarter and Six Months, which accounted for 14% and 13% of our consolidated revenues for such periods.

United Kingdom and Europe

We terminated our license agreement with Tesco as of January 31, 2015 and entered into a new license agreement with Argos, a subsidiary of Home Retail Group plc, which launched a broad assortment of Cherokee lifestyle products online, in catalog and in more than 750 Argos stores across the United Kingdom and Ireland in late July 2015. We expect revenues from Argos licensees to begin during the third quarter of Fiscal 2016.

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Latin America, Asia and others

Other international royalty revenues in the Second Quarter decreased to $2.4 million from $2.7 million in the second quarter of Fiscal 2015, representing a 9.7% decrease. Other international royalty revenues in the Six Months decreased to $4.9 million from $5.1 million in the first six months of Fiscal 2015, representing a 3.1% decrease.  The decreases were principally due to the strengthening of the U.S. dollar. This total includes licensees for Japan, China, Mexico, South Africa, Peru, Israel, Chile, India, and other territories. In local currencies, the majority of these licensees had growth in retail sales for the Six Months.

The majority of our international licensees are required to pay the royalty revenues owed to us in U.S. dollars. As a consequence, any weakening of the U.S. dollar benefits us in that the total royalty revenues reported from our international licensees increases when the dollar weakens against such foreign currencies. Conversely, any strengthening of the U.S. dollar against an international licensee’s foreign currency results in lower royalty revenues from such licensee. As the U.S. dollar strengthened, the estimated cumulative effect on our revenues of changes to applicable foreign currency exchange rates during the Second Quarter and Six Months in comparison to the second quarter and six months of Fiscal 2015 was an approximate $0.2 million decrease and an approximate $0.4 million decrease, respectively.

Selling, General and Administrative

The following table sets forth additional detail information regarding the components for selling, general and administrative expenses for the three and six months ended August 1, 2015 and August 2, 2014.

Selling, general and administrative expenses, including amortization of trademarks, were $5.3 million and $9.8 million for the Second Quarter and Six Month period of Fiscal 2016, respectfully, compared to $5.1 million and $9.8 million for the second quarter and six month period of Fiscal 2015, representing an increase of $0.2 million for the quarter. The increase in selling, general, and administrative expenses for the quarter is due primarily to an increase in professional fees related to the protection of intellectual property, legal and due diligence costs related to potential acquisitions and stock based compensation. For the Six Month period, the increased professional fees and stock based compensation were offset by decreases in personnel expenses, with the result that total expenses remained relatively flat from the prior year.

Interest and Other Income

Our interest expense for the Second Quarter and Six Months was $0.2 million and $0.3 million compared to $0.2 million and $0.5 million for the second quarter and first six months of Fiscal 2015.

Tax Provision

During the Second Quarter and Six Months, we recorded a tax provision of $1.0 million and $3.1 million, which equates to an effective tax rate of 35.1% and 35.9%, as compared to a tax provision of $1.2 million and $2.6 million, and an effective tax rate of 35.7% and 30.7% recorded for the second quarter and first six months of last year. The effective tax rate for the Second Quarter differs from the statutory rate due to the effect of certain permanent nondeductible expenses, the apportionment of income among state jurisdictions, and the benefit of certain tax credits.

Net Income

During the Second Quarter and Six Months, our net income was $1.9 million and $5.5 million, or $0.22 and $0.62 per diluted share, respectively, compared to $2.3 million and $5.8 million, or $0.27 and $0.69 per diluted share, respectively, for the second quarter and first six months of last year.

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Liquidity and Capital Resources

Cash Flows.  On August 1, 2015, we had cash and cash equivalents of $9.8 million, which represented an increase of $2.2 million from January 31, 2015.

During the Six Months, cash provided by our operations was $5.4 million, compared to $4.3 million for the first six months of Fiscal 2015. The increase of $1.1 million during the Six Months was primarily due to the changes in:  (i) reversal of uncertain tax liabilities as there were none in the Six Months, as compared to an increase of $0.7 million in the first six months of Fiscal 2015 (ii) accounts receivable increased by $0.9 million in the Six Months, as compared to an increase of $2.1 million in the same period in the prior year, which was primarily due to the increase in royalty revenues from the Tony Hawk brand in Fiscal 2015; (iii) accrued compensation, which decreased by $1.1 million in the Six Months as compared to an increase of $0.3 million in the first six months of last year, which we attributed primarily to accruals for vesting of stock awards in the prior year as well as variances in bonus accruals.

Cash used by investing activities during the Six Months was $1.6 million, which consisted of capital expenditures of property and equipment and trademark registration and renewal costs, as well as a trademark acquisition.  In comparison, during the first six months of Fiscal 2015, cash used by investing activities was $0.4 million, which consisted of capital expenditures of property and equipment and trademark registration and renewal costs.

Cash used in financing activities was $1.6 million during the Six Months, which consisted of principal payments of $3.7 million on our term loan with JP Morgan, partially offset by proceeds from exercise of stock options of $1.9 million and excess tax benefit from share-based payment arrangements of $0.2 million.  In comparison, during the first six months of Fiscal 2015, cash used in financing activities was $3.5 million, which consisted of principal payments of $3.4 million for the term loan with JP Morgan and dividend payments of $0.4 million, partially offset by proceeds from exercise of stock options of $0.3 million.

Uses of Liquidity. Our cash requirements over the next twelve months are primarily to fund our operations and working capital, to make payments of principal and interest under our credit facility with JPMorgan, at our discretion and subject to the terms of the credit facility, to repurchase shares of our common stock or pay dividends as determined by our board of directors (the “Board of Directors”), and, to a lesser extent, to fund capital expenditures. The declaration and payment of any future dividends or repurchases of our common stock are subject to negative covenants contained in our credit facility and, assuming the satisfaction or waiver by JPMorgan of such covenants, would be made solely at the discretion of our Board of Directors and would be dependent upon our financial condition, results of operations, cash flows, capital expenditures, and other factors that may be deemed relevant by our Board of Directors. Additionally, should an established and marketable brand or similar equity property become available on favorable terms, we would consider using our liquidity to fund such an acquisition opportunity.

Sources of Liquidity.  We expect our primary sources of liquidity to be cash flow generated from operations, cash and cash equivalents currently on hand, and funds made available to us pursuant to the revolving line of credit issued by JPMorgan. We believe our cash flow from operations, together with our cash and cash equivalents currently on hand and access to funds pursuant to the revolving line of credit, will be sufficient to meet our working capital, capital expenditure and other commitments and otherwise support our operations for the next twelve months.

Target’s election not to renew the license agreement for the Cherokee brand in the U.S. triggered an event of default under our credit agreement with JPMorgan, but we and JPMorgan have entered into a Forbearance Agreement pursuant to which JPMorgan has agreed that it will not exercise any of its rights or remedies under the credit agreement solely with respect to such event of default through October 12, 2015.  We intend to seek a waiver of the event of default during the forbearance period, but no assurance can be given that such waiver will be issued, or if issued, that it will be on terms favorable to us.

In the event that we are not able to obtain a waiver, JP Morgan has rights under the credit agreement which include accelerating payment of the outstanding balance of the loan.  We currently do not have sufficient cash to repay the loan balance in full and would have to seek alternatives to repay the remaining loan balance which could include refinancing the balance with another lender, obtaining proceeds from the sale of our equity securities or the sale of assets.  No assurance can be given that we will be successful in repaying the bank loan should JP Morgan accelerate the facility.

We cannot predict our revenues and cash flow that will be generated from operations in future periods with certainty, and our revenues and cash flows could be materially lower than we expect. If our revenues and cash flows are lower than we anticipate, or if our expenses are higher than we anticipate, then we may not have sufficient cash available to fund our planned operations and we could fall out of compliance with the terms of our credit facility or our other contractual commitments. In that case, we may need to take steps to reduce expenditures by scaling back operations and reducing staff related to these activities. See “Risk Factors” in Item 1A of Part II of this quarterly report on Form 10-Q.

As of August 1, 2015, we were not the guarantor of any other material third-party obligations and did not have any irrevocable repurchase obligations.

Seasonality

We have agreed to certain contractual royalty rate reductions with our two most significant licensees, Target and Kohl’s, for sales of certain Cherokee branded products and Hawk and Tony Hawk branded products in various product categories in the U.S. in each fiscal year, which apply for future sales during the applicable fiscal year as certain sales volume thresholds are achieved. Historically, this has caused our first quarter to be our highest revenue and profitability quarter and our fourth quarter to be our lowest revenue and profitability quarter. However, such historical patterns and seasonal trends may vary significantly in future periods, depending upon retail sales volumes achieved in each quarter by Target and Kohl’s, the revenues we receive from Target and our other licensees that are not subject to reduced royalty rates based upon cumulative sales, and the terms of any new license agreements.

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Inflation and Changing Prices

The rate of inflation over the past several years has not had a material effect on our revenues and profits. Since most of our future revenues will be based upon a percentage of sales by our licensees of products bearing our owned or represented trademarks, we do not anticipate that short term future inflation will have a material impact, positive or negative, on future financial results.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Our market risk generally represents the risk that losses may occur in the values of financial instruments as a result of movements in interest rates and foreign currency exchange rates. We do not enter into derivatives or other financial instruments for trading or speculative purposes.

Interest

From time to time we invest our excess cash in interest bearing temporary investments of high quality issuers. Due to the short time the investments are outstanding and their general liquidity, these instruments are classified as cash equivalents in our consolidated balance sheet and do not represent a material interest rate risk to us. In relation to our credit facility with JPMorgan, a 100 basis point increase in the interest rate would have had an immaterial impact on interest expense for the period ended August 1, 2015.

Foreign Currency

We conduct business in various parts of the world. As most of our international licensees are required to pay the royalty revenues owed to us in U.S. dollars, we are exposed to fluctuations in the exchange rates of the foreign currencies in countries in which our licensees do business when they are converted to the U.S. dollar, and significant fluctuations in exchange rates could materially impact our results of operations and cash flow. For the Six Months, revenues from international licensing activities comprised 28% of our total revenues.  A hypothetical 10% strengthening of the U.S. dollar relative to the foreign currencies of countries where our licensees operate would have negatively affected our revenues by approximately $0.5 million for the Six Months, which represents 3% of the total revenues reported. As the U.S. dollar strengthened, the estimated cumulative effect on our revenues of changes to applicable foreign currency exchange rates during the Second Quarter in comparison to the second quarter of Fiscal 2015 was an approximate $0.4 million decrease. Such change is not considered to represent a material effect on our results of operations or cash flow.