SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
x
Quarterly Report Pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934
For
the quarterly period ended July 31, 2010.
¨
Transition Report Pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934
For the Transition Period
From to .
Commission
file number 0-18640
CHEROKEE
INC.
(Exact
name of registrant as specified in its charter)
Delaware
|
|
95-4182437
|
(State or other jurisdiction of Incorporation or organization)
|
|
(IRS employer identification number)
|
|
|
6835 Valjean Avenue, Van Nuys, CA
|
|
91406
|
(Address of principal executive offices)
|
|
Zip Code
|
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
o 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.
Large
accelerated filer o Accelerated
filer x Non-accelerated
filer o Smaller
reporting company o
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.
Class
|
|
Outstanding at September 8, 2010
|
|
|
|
Common Stock, $.02 par value per share
|
|
8,896,154
|
CHEROKEE
INC.
INDEX
PART I. FINANCIAL
INFORMATION
|
|
|
|
ITEM
1. Consolidated Financial Statements
(unaudited):
|
|
|
|
Consolidated
Balance Sheets July
31, 2010 and January 30, 2010
|
3
|
|
|
Consolidated
Statements of Operations Three
and Six Month periods ended July 31, 2010 and August 1,
2009
|
4
|
|
|
Condensed
Consolidated Statement of Stockholders’ Equity Six
Month period ended July 31, 2010
|
5
|
|
|
Consolidated
Statements of Cash Flows Six
Month periods ended July 31, 2010 and August 1, 2009
|
6
|
|
|
Notes
to Consolidated Financial Statements
|
7
|
|
|
ITEM 2. Management’s Discussion
and Analysis of Financial Condition and Results of
Operations
|
16
|
|
|
ITEM 3. Quantitative and
Qualitative Disclosure about Market Risk
|
22
|
|
|
ITEM 4. Controls and
Procedures
|
23
|
|
|
PART II. OTHER
INFORMATION
|
|
|
|
ITEM 1. Legal
Proceedings
|
24
|
|
|
ITEM 1A. Risk
Factors
|
24
|
|
|
ITEM 2. Unregistered
Sales of Equity Securities and Use of Proceeds
|
27
|
|
|
ITEM 4. (Removed and
Reserved)
|
27
|
|
|
ITEM 5. Other
Information
|
27
|
|
|
ITEM 6.
Exhibits
|
27
|
Signatures
|
28
|
|
|
Certifications
|
|
Part
1. Financial Information
ITEM
1. CONSOLIDATED FINANCIAL STATEMENTS
CHEROKEE
INC.
CONSOLIDATED
BALANCE SHEETS
Unaudited
|
July 31, 2010
|
|
January 30, 2010
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
7,292,000 |
|
|
$ |
9,419,000 |
|
Receivables,
net
|
|
|
6,694,000 |
|
|
|
6,939,000 |
|
Prepaid
expenses and other current assets
|
|
|
148,000 |
|
|
|
101,000 |
|
Income
taxes receivable
|
|
|
1,273,000 |
|
|
|
1,271,000 |
|
Deferred
tax asset
|
|
|
567,000 |
|
|
|
740,000 |
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
15,974,000 |
|
|
|
18,470,000 |
|
|
|
|
|
|
Deferred
tax asset
|
|
|
667,000 |
|
|
|
630,000 |
|
Property
and equipment, net
|
|
|
164,000 |
|
|
|
185,000 |
|
Trademarks,
net
|
|
|
7,299,000 |
|
|
|
7,866,000 |
|
Other
assets
|
|
|
14,000 |
|
|
|
14,000 |
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$ |
24,118,000 |
|
|
$ |
27,165,000 |
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
1,306,000 |
|
|
$ |
967,000 |
|
Accrued
compensation payable
|
|
|
1,008,000 |
|
|
|
2,536,000 |
|
Income
taxes payable
|
|
|
437,000 |
|
|
|
1,260,000 |
|
Dividends
payable
|
|
|
3,349,000 |
|
|
|
3,349,000 |
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
6,100,000 |
|
|
|
8,112,000 |
|
|
|
|
|
|
|
|
|
|
Commitments
and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
Equity:
|
|
|
|
|
|
|
|
|
Preferred
stock, $.02 par value, 1,000,000 shares authorized, none issued and
outstanding
|
|
|
— |
|
|
|
— |
|
Common
stock, $.02 par value, 20,000,000 shares authorized, 8,814,187 shares
issued and outstanding at July 31, 2010 and at January 30,
2010
|
|
|
176,000 |
|
|
|
176,000 |
|
Additional
paid-in capital
|
|
|
15,456,000 |
|
|
|
15,187,000 |
|
Retained
earnings
|
|
|
2,386,000 |
|
|
|
3,690,000 |
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity
|
|
|
18,018,000 |
|
|
|
19,053,000 |
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders’ equity
|
|
$ |
24,118,000 |
|
|
$ |
27,165,000 |
|
See the
accompanying notes which are an integral part of these consolidated financial
statements.
CHEROKEE
INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
Unaudited
|
|
Three months ended
|
|
|
Six months ended
|
|
|
|
July 31, 2010
|
|
|
August 1, 2009
|
|
|
July 31, 2010
|
|
|
August 1, 2009
|
|
Royalty
revenues
|
|
$ |
7,496,000 |
|
|
$ |
8,091,000 |
|
|
$ |
15,735,000 |
|
|
$ |
16,974,000 |
|
Selling,
general and administrative expenses
|
|
|
3,363,000 |
|
|
|
3,346,000 |
|
|
|
6,731,000 |
|
|
|
6,460,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
4,133,000 |
|
|
|
4,745,000 |
|
|
|
9,004,000 |
|
|
|
10,514,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income
|
|
|
3,000 |
|
|
|
6,000 |
|
|
|
7,000 |
|
|
|
13,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
other income
|
|
|
3,000 |
|
|
|
6,000 |
|
|
|
7,000 |
|
|
|
13,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
|
4,136,000 |
|
|
|
4,751,000 |
|
|
|
9,011,000 |
|
|
|
10,527,000 |
|
Income
tax provision
|
|
|
1,655,000 |
|
|
|
1,888,000 |
|
|
|
3,617,000 |
|
|
|
3,837,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
2,481,000 |
|
|
$ |
2,863,000 |
|
|
$ |
5,394,000 |
|
|
$ |
6,690,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share
|
|
$ |
0.28 |
|
|
$ |
0.32 |
|
|
$ |
0.61 |
|
|
$ |
0.76 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
earnings per share
|
|
$ |
0.28 |
|
|
$ |
0.32 |
|
|
$ |
0.61 |
|
|
$ |
0.76 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
8,814,187 |
|
|
|
8,814,187 |
|
|
|
8,814,187 |
|
|
|
8,814,187 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
8,855,957 |
|
|
|
8,814,187 |
|
|
|
8,848,696 |
|
|
|
8,814,187 |
|
See the
accompanying notes which are an integral part of these consolidated financial
statements.
CHEROKEE
INC.
CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
Unaudited
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Retained
|
|
|
|
|
|
|
Shares
|
|
|
Par Value
|
|
|
Capital
|
|
|
Earnings
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at January 30, 2010
|
|
|
8,814,187 |
|
|
$ |
176,000 |
|
|
$ |
15,187,000 |
|
|
$ |
3,690,000 |
|
|
$ |
19,053,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based
compensation
|
|
|
|
|
|
|
|
|
|
|
269,000 |
|
|
|
|
|
|
|
269,000 |
|
Accrued
dividends
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,698,000 |
) |
|
|
(6,698,000 |
) |
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,394,000 |
|
|
|
5,394,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at July 31, 2010
|
|
|
8,814,187 |
|
|
$ |
176,000 |
|
|
$ |
15,456,000 |
|
|
$ |
2,386,000 |
|
|
$ |
18,018,000 |
|
See the
accompanying notes which are an integral part of these consolidated financial
statements.
CHEROKEE
INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Unaudited
|
|
Six months ended
|
|
|
|
July 31, 2010
|
|
|
August 1, 2009
|
|
Operating activities
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
5,394,000
|
|
|
$
|
6,690,000
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
38,000
|
|
|
|
38,000
|
|
Amortization
of trademarks
|
|
|
738,000
|
|
|
|
721,000
|
|
Deferred
income taxes
|
|
|
136,000
|
|
|
|
218,000
|
|
Stock-based
compensation
|
|
|
269,000
|
|
|
|
317,000
|
|
Changes
in current assets and liabilities:
|
|
|
|
|
|
|
|
|
Decrease
(increase) in accounts receivable
|
|
|
245,000
|
|
|
|
(1,965,000
|
)
|
Increase
in prepaid expenses and other assets
|
|
|
(47,000
|
)
|
|
|
(99,000
|
)
|
Decrease
(increase) in income taxes receivable
|
|
|
(2,000
|
)
|
|
|
(252,000
|
)
|
Increase
(decrease) in accounts payable
|
|
|
339,000
|
|
|
|
25,000
|
|
Decrease
in accrued compensation
|
|
|
(1,528,000
|
)
|
|
|
(1,608,000
|
)
|
Increase
(decrease) in income taxes payable and other accrued
liabilities
|
|
|
(823,000
|
)
|
|
|
144,000
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
|
4,759,000
|
|
|
|
4,229,000
|
|
|
|
|
|
|
|
|
|
|
Investing activities
|
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(17,000
|
)
|
|
|
(10,000
|
)
|
Purchase
of trademarks, registration and renewal costs
|
|
|
(171,000
|
)
|
|
|
(117,000
|
)
|
|
|
|
|
|
|
|
|
|
Net
cash used in investing activities
|
|
|
(188,000
|
)
|
|
|
(127,000
|
)
|
|
|
|
|
|
|
|
|
|
Financing activities
|
|
|
|
|
|
|
|
|
Dividends
|
|
|
(6,698,000
|
)
|
|
|
(8,814,000
|
)
|
|
|
|
|
|
|
|
|
|
Net
cash used in financing activities
|
|
|
(6,698,000
|
)
|
|
|
(8,814,000
|
)
|
|
|
|
|
|
|
|
|
|
Decrease
in cash and cash equivalents
|
|
|
(2,127,000
|
)
|
|
|
(4,712,000
|
)
|
Cash
and cash equivalents at beginning of period
|
|
|
9,419,000
|
|
|
|
13,652,000
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end of period
|
|
$
|
7,292,000
|
|
|
$
|
8,940,000
|
|
|
|
|
|
|
|
|
|
|
Cash
paid during period for:
|
|
|
|
|
|
|
|
|
Income
taxes
|
|
$
|
3,965,000
|
|
|
$
|
3,461,000
|
|
|
|
|
|
|
|
|
|
|
Declaration
of dividends
|
|
$
|
3,349,000
|
|
|
$
|
4,407,000
|
|
See the
accompanying notes which are an integral part of these consolidated financial
statements.
CHEROKEE
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(1)
Basis of
Presentation
The
accompanying unaudited condensed consolidated financial statements as of July
31, 2010 and for the three and six month periods ended July 31, 2010 and August
1, 2009 have been prepared in accordance with U.S. generally accepted accounting
principles (“GAAP”). These consolidated financial statements 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 Inc. (“Cherokee” or the “Company”) are necessary for a
fair statement of the financial position and the results of operations for the
periods presented. Certain previously reported amounts have been reclassified to
conform to current year presentation. The accompanying consolidated balance
sheet as of January 30, 2010 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 period ended July 31, 2010 are
not necessarily indicative of the results to be expected for the fiscal year
ending January 29, 2011. 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 30, 2010.
The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of sales and expenses during
the reporting period. Actual results could differ from those
estimates.
As used
herein, the term “First Quarter” refers to the three months ended May 1, 2010;
the term “Second Quarter” refers to the three months ended July 31, 2010; the
term “Six Months” refers to the six months ended July 31, 2010; the term “Fiscal
2011” refers to our fiscal year ending January 29, 2011; the term “Fiscal 2010”
refers to our most recent past fiscal year ended January 30, 2010; the term
“Fiscal 2009” refers to our fiscal year ended January 31, 2009; and the term
“Fiscal 2008” refers to our fiscal year ended February 2, 2008.
(2)
Summary of
Significant Accounting Policies
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiary, SPELL C. LLC, a Delaware limited liability
corporation. All significant intercompany accounts and transactions
have been eliminated in consolidation.
Revenue
Recognition
Revenues
from royalty and brand representation agreements are recognized when earned by
applying contractual royalty rates to quarterly point of sale data received from
our licensees. Our royalty recognition policy provides for recognition of
royalties in the quarter earned, although a large portion of such royalty
payments are actually received during the month following the end of a quarter.
Revenues are not recognized unless collectability is reasonably assured. Certain
royalty agreements that account for the majority of our historical revenues are
structured to provide royalty rate reductions once certain cumulative levels of
sales are achieved by our licensees. Revenue is recognized by applying the
reduced contractual royalty rates prospectively to point of sale data as
required sales thresholds are exceeded. The royalty rate reductions do not apply
retroactively to sales since the beginning of the fiscal year, and as a
consequence such royalty rate reductions do not impact previously recognized
royalty revenue.
As a
result, our royalty revenues from certain licensees’ retail sales of branded
products are typically highest at the beginning of each fiscal year and may
decrease in each fiscal quarter as licensees reach certain retail sales
thresholds contained in their respective license
agreements. Therefore, the amount of royalty revenue we recognize in
any quarter is dependent on the retail sales of branded products in such quarter
and the royalty rate in effect after considering the cumulative level of retail
sales. Historically, this has usually caused our first quarter to be
our highest revenue and profitability quarter; our second quarter to be our next
highest quarter, and our third and fourth quarters to be our lowest
quarters. However, such historical patterns may vary in the future,
depending upon the product mix and retail sales volumes achieved in each quarter
with our licensees. The amount of the royalty rate reductions and the
level of retail sales at which they are achieved vary in each licensing
agreement.
Earnings
Per Share Computation
The
following table provides a reconciliation of the numerator and denominator of
the basic and diluted per-share computations for the three and six month periods
ended July 31, 2010 and August 1, 2009:
|
|
July 31, 2010
|
|
|
August 1, 2009
|
|
|
|
3 Months
|
|
|
6 Months
|
|
|
3 Months
|
|
|
6 Months
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income-numerator for net income per common share and net income per common
share assuming dilution
|
|
$ |
2,481,000 |
|
|
$ |
5,394,000 |
|
|
$ |
2,863,000 |
|
|
$ |
6,690,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for net income per common share-weighted average shares
|
|
|
8,814,187 |
|
|
|
8,814,187 |
|
|
|
8,814,187 |
|
|
|
8,814,187 |
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options
|
|
|
41,770 |
|
|
|
34,509 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for net income per common share, assuming dilution: Adjusted weighted
average shares and assumed exercises
|
|
|
8,855,957 |
|
|
|
8,848,696 |
|
|
|
8,814,187 |
|
|
|
8,814,187 |
|
The
diluted weighted average number of shares for the three month periods ended July
31, 2010 and August 1, 2009, respectively, excludes 160,778 and 354,723 shares,
respectively, of common stock issuable on the exercise of stock options that
have an exercise price above the average market price for the period because
such stock options outstanding were anti-dilutive. The diluted weighted average
number of shares for the six month periods ended July 31, 2010 and August 1,
2009, respectively, excludes 199,649 and 354,723 shares, respectively, of common
stock issuable on the exercise of stock options because such options were
anti-dilutive.
Significant
Contracts
Our two
most significant contracts are our retail direct licensing agreements with
Target Stores, a subsidiary of Target Corp. (“Target”) for the Cherokee brand in
the United States, and with Great Britain’s Tesco Stores Limited (“Tesco”) for
the Cherokee brand in the United Kingdom, and certain countries in Central
Europe, as further described below.
We first
entered into a licensing agreement with Target in 1995 for the exclusive use of
our Cherokee brand in the United States across certain product categories. The
current terms of our agreement with Target are set forth in a restated license
agreement with Target, which was entered into effective as of February 1, 2008
(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. The term of the Restated Target
Agreement continues through January 31, 2012. However, the Restated Target
Agreement provides that if Target remains current in its payments of the minimum
guaranteed royalty of $9.0 million for the preceding fiscal year, then the term
of the Restated Target Agreement will continue to automatically renew for
successive fiscal year terms provided that Target does not give notice of its
intention to terminate the agreement during February of the calendar year prior
to termination. 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 ended January 31st, which
percentage varies according to the volume of sales of
merchandise.
On August
1, 2001, we entered into an exclusive international retail direct licensing
agreement for the Cherokee brand with Tesco (the “Tesco Agreement”). Tesco was
granted the exclusive right to manufacture, promote, sell and distribute a wide
range of products bearing our Cherokee brand in the United Kingdom and Ireland
and is obligated to pay us a royalty based upon a percentage of its net sales of
Cherokee branded products in those countries. In January 2004, we expanded the
Tesco Agreement to include South Korea, Malaysia, Thailand, Slovakia, and
Hungary, and in 2005, we expanded the Tesco Agreement to include Poland and the
Czech Republic. In March 2006, Tesco began to sell Cherokee branded products in
the Czech Republic, Poland, and Slovakia, and, in July 2006, Tesco began to sell
Cherokee branded products in Hungary. In February 2007, we added the territory
of China to the Tesco Agreement and Turkey was added shortly thereafter. During
Fiscal 2010, Tesco’s rights to expand its license to include all Asian
territories, including Malaysia, South Korea, Thailand and China, were
re-claimed from Tesco as the designated time frame to expand the Cherokee brand
into these territories had elapsed. The term of the Tesco Agreement was renewed
in February 2010 and now expires on January 31, 2014. Tesco has several options
to extend this term.
We also
have other licensing agreements regarding our brands, including
with: (i) Zellers for our Cherokee brand in Canada; (ii) TJX
Companies for our Carole Little and St. Tropez-West brands in the U.S. and other
select countries; and (iii) a number of other international license agreements
for our Cherokee brand. For a more complete description of our
license agreements and other commercial agreements, please see our Annual Report
on Form 10-K for Fiscal 2010.
Stock-Based
Compensation
We
currently maintain three equity-based compensation plans: (i) the
Cherokee 1995 Incentive Stock Option Plan (the “1995 Plan”); (ii) the 2003
Incentive Award Plan as amended in 2006 with the adoption of the 2006 Incentive
Award Plan (the “2003 Plan”); and (iii) the 2006 Incentive Award Plan (the “2006
Plan”). Each of these equity based compensation plans provide for the
issuance of equity-based awards to officers and other employees and directors,
and they have previously been approved by our stockholders. 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. We issue new shares of common stock upon
exercise of stock options.
The 1995
Plan was approved at the October 30, 1995 Annual Meeting of Stockholders.
The options granted under the 1995 Plan vest in equal installments over a
three-year period starting at the grant date and have a term of ten
years. The 1995 Plan expired on July 24,
2005. However, options previously granted under the 1995 Plan will
remain outstanding until the earlier of expiration or exercise. In
the event that any outstanding option under the 1995 Plan expires or is
terminated, the shares of common stock allocable to the unexercised portion of
the option shall no longer be available for grant.
The 2003
Plan was approved at the June 9, 2003 Annual Meeting of Stockholders, and
amended at the June 13, 2006 Annual Meeting of Stockholders. The principal
purposes of the 2003 Plan are to provide an additional incentive for our
directors, employees and consultants to further our growth, development and
financial success and to enable us to obtain and retain their services. The
Compensation Committee of the Board of Directors or another committee thereof
(the “Committee”) administers the 2003 Plan with respect to grants to our
employees or consultants and the full Board of Directors (the “Board”)
administers the 2003 Plan with respect to grants to independent directors.
Awards under the 2003 Plan may be granted to individuals who are then officers
or other employees of Cherokee or any of our present or future subsidiaries.
Such awards also may be granted to our consultants selected by the Committee for
participation in the 2003 Plan. The 2003 Plan provides that the Committee may
grant or issue stock options and restricted stock awards, or any combination
thereof. Two types of stock options may be granted under the plan: incentive and
non-qualified stock options. In addition, restricted stock may be sold to
participants at various prices (but not below par value) and made subject to
such restrictions as may be determined by the Board or Committee. The maximum
number of shares authorized for the grant of awards under the 2003 Plan is
250,000. Furthermore, the maximum number of shares which may be subject to
awards granted under the 2003 Plan to any individual in any calendar year cannot
exceed 100,000. The vesting period and term for options granted under the 2003
Plan shall be set by the Committee, with the term being no greater than 10
years, and the options generally will vest over a specific time period as
designated by the Committee upon the awarding of such options. During the First
Quarter, we granted to non-employee directors and certain employees stock
options with a five-year term to purchase 113,666 shares of our common stock at
an exercise price of $16.08 per share (the closing price on the date of grant)
pursuant to the 2003 Plan. We did not make any grants during the Second Quarter
under the 2003 Plan. As of July 31, 2010, there were 625 shares available for
grant under the 2003 Plan. In the event that any outstanding option under the
2003 Plan expires or is terminated, the shares of common stock allocable to the
unexercised portion of the option shall then become available for grant in the
future, until the 2003 Plan expires on April 28, 2016.
The 2006
Plan was approved at the June 13, 2006 Annual Meeting of Stockholders and
amended at the June 4, 2010 Annual Meeting of Stockholders. The principal
purposes of the 2006 Plan are to provide an additional incentive for our
directors, employees and consultants to further our growth, development and
financial success and to enable us to obtain and retain their services. The 2006
Plan provides for the grant of options and restricted stock awards. The 2006
Plan is administered by the Committee with respect to grants to our employees or
consultants and the full Board administers the 2006 Plan with respect to grants
to independent directors. Awards under the 2006 Plan may be granted to
individuals who are then officers or other employees of Cherokee or any of our
present or future subsidiaries. Such awards also may be granted to our
consultants selected by the Committee for participation in the 2006 Plan. The
2006 Plan provides that the Committee may grant or issue stock options and
restricted stock awards, or any combination thereof. Two types of stock options
may be granted under the 2006 Plan: incentive and non-qualified stock options.
In addition, restricted stock may be sold to participants at various prices (but
not below par value) and made subject to such restrictions as may be determined
by the Board or Committee. The maximum number of shares authorized for the grant
of awards under the 2006 Plan is 750,000. Furthermore, the maximum number of
shares which may be subject to awards granted under the 2006 Plan to any
individual in any calendar year cannot exceed 100,000. The vesting period and
term for options granted under the 2006 Plan shall be set by the Committee, with
the term being no greater than 10 years, and the options generally vesting over
a specific time period as designated by the Committee upon the awarding of such
options. During the First Quarter, we granted to certain employees stock options
with a five-year term to purchase 153,334 shares of our common stock at an
exercise price of $16.08 per share (the closing price on the date of grant)
pursuant to the 2006 Plan. We did not make any grants during the Second Quarter
under the 2006 Plan. As of July 31, 2010, there were 501,666 shares available
for grant under the 2006 Plan. In the event that any outstanding option granted
under the 2006 Plan expires or is terminated, the shares of common stock
allocable to the unexercised portion of the option shall then become available
for grant in the future, until the 2006 Plan expires on April 28, 2016.
On June
4, 2010, our Executive Chairman, Robert Margolis, was awarded a non-qualified,
non-plan option to purchase 100,000 shares of Cherokee’s common stock at an
exercise price of $18.49 per share (the closing price of Cherokee’s common stock
on June 4, 2010), which vests in two equal installments on January 31, 2011 and
January 31, 2012 and which shall become fully vested in the event of a change in
control of Cherokee, and which expires on June 4, 2015.
On August
26, 2010, our Chief Executive Officer, Henry Stupp, was awarded a non-qualified,
non-plan option to purchase up to 300,000 shares of Cherokee’s common stock as
an inducement grant outside of the 2006 Plan at an exercise price of $18.30 per
share (the closing price of Cherokee’s common stock on the date of grant) which
vests in five equal annual installments beginning on January 31, 2012 and has a
term of six years. In addition, in the event of a change in control of Cherokee,
an additional twenty percent of the shares subject to the option shall
vest.
Stock-based
compensation expense recognized for the Six Months was $269,000, as compared to
$317,000 for the comparable period in the prior year.
The
estimated fair value of options granted during the Six Months (there were no
grants in Fiscal 2010) was estimated using the Black-Scholes option-pricing
model with the following weighted average assumptions:
|
|
Fiscal 2011
|
|
|
|
First Quarter
|
|
|
Six Months
|
|
Grant
Date
|
|
February
1, 2010
|
|
|
June
4, 2010
|
|
#
of Options Granted
|
|
|
267,000 |
|
|
|
100,000 |
|
Expected
Dividend Yield
|
|
|
9.4 |
% |
|
|
8.2 |
% |
Expected
Volatility
|
|
|
58.13 |
% |
|
|
58.76 |
% |
Avg.
Risk-Free Rate
|
|
|
2.13 |
% |
|
|
1.17 |
% |
Expected
Life (in years)
|
|
|
4.5 |
|
|
|
4.5 |
|
The
expected term of the options represents the estimated period of time until
exercise and is based on historical experience of similar options, giving
consideration to the contractual terms, vesting schedules and expectations of
future employee behavior. The expected stock price volatility is based on the
historical volatility of our stock price. The risk-free interest rate is based
on the U.S. Treasury yield in effect at the time of grant with an equivalent
remaining term. The dividend yield is based on the past dividends paid and the
current dividend yield at the time of grant.
A summary
of activity for the Company’s stock options for the Six Months is as
follows:
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Contractual
|
|
|
Aggregate
|
|
|
|
|
|
|
Average
|
|
|
Term
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
(in years)
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
at January 30, 2010
|
|
|
162,444 |
|
|
$ |
24.63 |
|
|
|
|
|
|
|
Granted
|
|
|
367,000 |
|
|
$ |
16.74 |
|
|
|
|
|
|
|
Exercised
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
Canceled/forfeited
|
|
|
(1,666 |
) |
|
$ |
22.70 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
at July 31, 2010
|
|
|
527,778 |
|
|
$ |
19.15 |
|
|
|
4.14 |
|
|
$ |
1,164,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested
and Exercisable at July 31, 2010
|
|
|
97,440 |
|
|
$ |
25.91 |
|
|
|
2.58 |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-vested
and not exercisable at July 31, 2010
|
|
|
430,338 |
|
|
$ |
17.61 |
|
|
|
4.66 |
|
|
$ |
1,164,000 |
|
As of
July 31, 2010, total unrecognized stock-based compensation expense related to
non-vested stock options was approximately $1,505,000, which is expected to be
recognized over a weighted average period of approximately 2.0
years. The total fair value of all options which vested during the
Six Months was $0.
Trademarks
During
the Second Quarter and Six Months, the Company did not acquire any trademarks,
nor were there any trademark acquisitions during the comparable periods last
year. Trademark registration and renewal fees which were capitalized during the
Second Quarter and Six Months totaled $47,000 and $171,000, respectively. In
comparison, for the second quarter and six months of last year, the total
trademark registration and renewal fees capitalized totaled $52,000 and
$117,000, respectively.
Income
Taxes
Income
tax expense of $1.7 million was recognized for the Second Quarter,
resulting in an effective tax rate of 40.0%, as compared to 39.7% in the second
quarter of last year and compared to 38.3% for the full year of Fiscal
2010.
The
Company files U.S. federal and state income tax returns. For our federal income
tax returns, the Company is generally no longer subject to tax examinations for
fiscal years prior to 2009. We are currently subject to a federal tax
examination for Fiscal 2009. With limited exception, our significant state tax
jurisdictions are no longer subject to examinations by the various tax
authorities for fiscal years prior to 2004. Although the outcome of tax audits
is always uncertain, we believe that adequate amounts of tax, interest and
penalties, if any, have been provided for in our income tax reserve for any
adjustments that may result from future tax audits. We recognize interest and
penalties, if any, related to unrecognized tax benefits within the provision for
income taxes in our consolidated statement of income. As of January 30, 2010 and
July 31, 2010, respectively, accrued interest on a gross basis was $66,000 and
$84,000.
As of
January 30, 2010 and July 31, 2010, respectively, the total amount of gross
unrecognized tax benefits was approximately $0.8 and $0.7 million, of which
approximately $0.8 and $0.7 million represents the amount of unrecognized tax
benefits that, if recognized, would affect the effective tax rate. It
is reasonably possible that $0.6 million of unrecognized tax benefits may
decrease within the next 12 months as a result of settling certain positions.
The expected net impact of the changes would not have a significant impact on
the results of operations or the financial position of the Company.
Recent
Accounting Pronouncements
In the
third quarter of 2009, the Company adopted the Financial Accounting Standards
Board (“FASB”) Accounting Standards Codification (“ASC” and collectively, the
“Codification”), which establishes the Codification as the source of
authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
conformity with GAAP. The historical GAAP hierarchy was eliminated and the
Codification became the only level of authoritative GAAP, other than guidance
issued by the SEC. The FASB will not issue new standards in the form of
Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts.
Instead, it will issue Accounting Standard Updates (“ASUs”). ASUs will serve to
update the Codification, provide background information about the guidance and
provide the bases for conclusions on change(s) in the Codification. The
Codification is effective for all financial statements issued for interim and
annual periods ending after September 15, 2009. The adoption of the Codification
did not have an impact on our consolidated financial statements. However,
references to specific accounting standards in the notes to our condensed
consolidated financial statements have been changed to refer to the appropriate
section of the Codification.
(3) Dividends
On
January 27, 2010, our Board of Directors approved a dividend of $3.3 million, or
$0.38 per share, which was paid on March 17, 2010. On April 28, 2010,
we declared a dividend of $3.3 million, or $0.38 per share, which was paid on
June 16, 2010. On July 26, 2010, we declared a dividend of $3.3
million, or $0.38 per share, which is to be paid on September 15, 2010 to
stockholders of record as of September 1, 2010.
(4) Related Party
Transactions
The
services of Mr. Robert Margolis as our Executive Chairman are provided to us
pursuant to a management agreement, as amended (the “Management
Agreement”). On April 23, 2010, the Company and Mr. Margolis entered
into an amendment to the Management Agreement, which was approved by the
Company’s stockholders at the Company’s annual meeting of stockholders on June
4, 2010 (the “Amendment”). On August 26, 2010, Mr. Margolis was
appointed as our Executive Chairman. Prior to such appointment, Mr.
Margolis served as our Chief Executive Officer.
The term
of the Management Agreement expires on February 1, 2012, whether or not the
performance measures required to extend this expiration date for another year
without giving effect to the Amendment are achieved during Fiscal 2011.
Thereafter, the term of the Management Agreement may be extended by one or more
additional fiscal years, as described below. Pursuant to the Management
Agreement, Mr. Margolis shall serve as Executive Chairman of Cherokee’s Board of
Directors until January 31, 2012 (or such earlier date as Mr. Margolis
voluntarily resigns or becomes unable to serve due to his death or disability)
(the “Initial Chair Service Period”). In January 2012, and in January of any
Subsequent Chair Service Period (as defined below), the Company’s Nominating
Committee, which shall then be comprised of all the independent directors (as
that term is defined under the rules of the Nasdaq Stock Market) then serving on
the Company’s Board of Directors, shall meet and determine in its sole
discretion whether to elect (by majority approval) to extend Mr. Margolis’
service as Executive Chairman for the following fiscal year. Any such period
following the Initial Chair Service Period during which the Nominating Committee
has elected to extend Mr. Margolis’ services as Executive Chairman is referred
to herein as a “Subsequent Chair Service Period”. During the Initial Chair
Service Period and in any Subsequent Chair Service Period, Mr. Margolis shall
remain an employee of Cherokee and shall perform such services and have such
executive powers as are reasonable and necessary to carry out the
responsibilities assigned to him by the Board of Directors.
Pursuant
to the Management Agreement, Mr. Margolis’ base salary is fixed at $804,000 for
Fiscal 2011 and for each fiscal year thereafter until the termination of the
Management Agreement. For Fiscal 2011, Mr. Margolis is entitled to receive a
performance bonus calculated in accordance with the following formula: if our
EBITDA for Fiscal 2011 is no less than $5.0 million, then Mr. Margolis will
receive a performance bonus equal to 10% of our EBITDA for such fiscal year in
excess of $2.5 million up to $10.0 million, plus 15% of our EBITDA for such
fiscal year in excess of $10.0 million. For the Six Months, the Company accrued
$1.0 million, the majority of which pertains to Mr. Margolis’ performance bonus
for this period. As of July 31, 2010 and January 31, 2010, the Company accrued
bonus compensation payable pertaining to Mr. Margolis’ performance bonus of
approximately $0.8 million and $2.3 million, respectively. If our EBITDA in
Fiscal 2011 continues to increase, the bonus payable to Mr. Margolis under the
Management Agreement for Fiscal 2011 will also increase.
After
Fiscal 2011, the performance bonus compensation due to Mr. Margolis shall
continue to be calculated pursuant to the foregoing formula; however, the total
base salary and performance bonus compensation for Mr. Margolis for the Initial
Chair Service Period shall not exceed $2.24 million, and in any Subsequent Chair
Service Period is not to exceed $2.02 million. Following Mr. Margolis’ service
as Executive Chairman pursuant to the Management Agreement, and for so long as
Mr. Margolis continues to serve as a member of the Company’s Board of Directors,
Mr. Margolis will be entitled to participate in Board compensation programs
consistent with other members of the Board.
The
Management Agreement may be terminated at any time without cause or in the event
of certain circumstances, as defined in the Management Agreement. If, during
Fiscal 2011, we terminate the Management Agreement without cause or Mr. Margolis
terminates the Management Agreement if we materially breach the terms and
conditions of the Management Agreement or fail to perform any material
obligation there under, or in the event of a change in control of Cherokee, Mr.
Margolis is entitled to receive within 60 days of termination or the
consummation of such change in control, a lump sum cash payment equal to three
times the sum of his annual base compensation and the previous year’s
performance bonus, plus the pro rata earned performance bonus during such fiscal
year up to the date of termination (the “Fiscal 2011 Termination Payoff”). In
the event the Management Agreement, as amended, was terminated as described
above, the Fiscal 2011 Termination Payoff for Mr. Margolis as of July 31, 2010
would be approximately $10.8 million.
If,
during the Initial Chair Service Period, the Management Agreement is terminated
by Cherokee without cause or by Mr. Margolis as a result of Cherokee’s breach of
the Management Agreement, or in the event of a change in control of Cherokee
that occurs during the Initial Chair Service Period or following the Initial
Chair Service Period pursuant to definitive agreement executed by Cherokee
during the Initial Chair Service Period (each of such events, an “Initial Chair
Service Early Termination Event”), then Mr. Margolis shall be entitled to
receive a lump sum payment of $6.0 million in full satisfaction of all payments
that might otherwise be due to Mr. Margolis pursuant to the Management Agreement
(such lump sum payment, the “Initial Chair Service Termination Payment”). The
Initial Chair Service Termination Payment shall not be payable as a result of an
Initial Chair Service Early Termination Event that occurs in any Subsequent
Chair Service Period (other than the case in which a change in control of
Cherokee is consummated in a Subsequent Chair Service Period as a result of a
definitive agreement executed during the Initial Chair Service
Period).
Pursuant
to the Management Agreement, on June 4, 2010, Mr. Margolis was awarded a
non-qualified, non-plan option to purchase 100,000 shares of Cherokee’s common
stock at an exercise price of $18.49 per share (the closing price of
Cherokee’s common stock on June 4, 2010), which vests in two equal installments
on January 31, 2011 and January 31, 2012 and which shall become fully vested in
the event of a change in control of Cherokee, and which expires on June 4,
2015.
On August
26, 2010, Henry Stupp was appointed as our Chief Executive Officer and was also
appointed to serve as a member of our Board of Directors. In connection with
such appointment, we entered into an Employment Agreement with Mr. Stupp, dated
as of August 26, 2010 (the “Employment Agreement”). Pursuant to the terms of the
Employment Agreement, Mr. Stupp is to receive a base salary equal to $350,000
per year. In addition, beginning for Cherokee’s fiscal year ending January 31,
2012 (“Fiscal 2012”), and for each subsequent fiscal year during the term of the
Employment Agreement, Mr. Stupp shall be entitled to receive a performance bonus
(the “Performance Bonus”) equal to five percent of Cherokee’s pre-tax income
during such fiscal year in excess of a threshold amount of $20,000,000, subject
to a maximum of $650,000 per fiscal year. Mr. Stupp’s services as our Chief
Executive Officer are at will. The Employment Agreement expires as of January
31, 2014, unless earlier terminated by Cherokee or by Mr. Stupp or extended by
mutual agreement. Pursuant to the Employment Agreement, Cherokee has agreed to
certain indemnification obligations to Mr. Stupp related to his service to
Cherokee in his capacity as an officer or director of Cherokee.
Pursuant
to the Employment Agreement, in the event that Mr. Stupp’s employment is
terminated by Cherokee without cause during the first twelve months of his
service as our Chief Executive Officer, Mr. Stupp will be paid an amount equal
to $175,000. The Employment Agreement also provides that Mr. Stupp will be paid
an amount equal to $300,000 in the event that Cherokee terminates Mr. Stupp’s
employment without cause within three months prior to or twelve months following
a change in control of Cherokee which occurs on or before August 26, 2011.
Pursuant to the Employment Agreement, if Mr. Stupp’s employment is terminated by
Cherokee without cause at any time after the first twelve months of his service
as our Chief Executive Officer, then he shall be paid an amount equal to twelve
months of his then-current base salary, which currently equals
$350,000.
Pursuant
to the Employment Agreement, on August 26, 2010, Mr. Stupp purchased 81,967
shares of Cherokee’s common stock (the “Initial Shares”) at a per share price of
$18.30 (which was equal to the closing price of Cherokee’s common stock on such
date), for aggregate proceeds of $1,500,000. Pursuant to the Employment
Agreement, Mr. Stupp agreed to purchase, and Cherokee agreed to sell, on or
before January 31, 2011, that number of shares of Cherokee’s common stock equal
to $1,000,000, divided by the closing sale price of Cherokee’s common stock on
the date of such purchase and sale (the “Subsequent Shares” and, together with
the Initial Shares, the “Shares”). Mr. Stupp has agreed to certain “lock up”
restrictions regarding his ability to resell or otherwise dispose of any of the
Shares as set forth in the Employment Agreement. Pursuant to the Employment
Agreement, Cherokee has agreed to file with the SEC a registration statement, or
registration statements if necessary, on an appropriate form(s) to effect the
registration for resale of both the Shares and the shares of Common Stock that
may be acquired upon exercise of the Option (as defined below).
In
addition, in connection with the appointment of Mr. Stupp as our Chief Executive
Officer, Cherokee has granted to Mr. Stupp an option to purchase up to 300,000
shares (the “Option”) of Cherokee’s common stock as an inducement grant outside
of the 2006 Plan. This grant of stock options was entered into as an inducement
material for Mr. Stupp to enter into employment with Cherokee. While the grant
of the Option was made outside of the 2006 Plan, the grant is consistent with
applicable terms of the 2006 Plan. The Option has an exercise price of $18.30
per share, which is equal to the closing price of Cherokee’s common stock on the
date of grant. The Option vests in five equal annual installments beginning on
January 31, 2012, and vesting in four additional increments on each yearly
anniversary thereafter. In addition, in the event of a change in control of
Cherokee, an additional twenty percent of the shares subject to the Option shall
vest. The Option has a term of six years and will be forfeited if not exercised
before the expiration of the term. In addition, in the event that Mr. Stupp does
not comply with his obligation under his employment agreement to purchase the
Subsequent Shares, then 150,000 of the shares subject to the Option will be
immediately forfeited and not exercisable, and the vesting schedule will be
proportionally adjusted. If Mr. Stupp’s service to Cherokee is terminated for
any reason, the Option shall cease vesting upon such termination.
On October 8, 2007, the Company entered
into a contingent Finders Fee Agreement (the “Contingent Finders Fee Agreement”)
with a director pertaining to his services as a director of the Company in
introducing the Company to its licensee for the Cherokee brand in India. The
Contingent Finders Fee Agreement provides for the director to receive 5% of all
royalty revenues received by the Company in years 6 through 10 (and possibly
years 11 through 15) only if the licensee decides to renew the licensing
agreement beyond the original five year term to a second five year term (years 6
through 10), and again if another five year term is renewed (years 11 through
15). The Contingent Finders Fee Agreement
expires at the earlier of (i) the termination of the licensing agreement with
the subject licensee for India, or (ii) ten years of payments (through year 15).
On November 17, 2009, the Company and its licensee for the Cherokee brand in
India entered into an amended agreement extending the first renewal term to ten
(10) years. As the licensing agreement with the licensee has been renewed to a
ten-year term, there will be future payments made to the director under the
Contingent Finders Fee Agreement if royalties are actually received by the
Company in years 6 through 10. The director has not earned or received any
payments or other compensation and will not receive any payments under the
Contingent Finders Fee Agreement during the first five years of the
agreement.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Cautionary
note regarding forward looking statements
This
quarterly report on Form 10-Q and other filings which we make with the
Securities and Exchange Commission, as well as press releases and other written
or oral statements we may make may contain “forward-looking statements” within
the meaning of the Private Securities Litigation Reform Act of 1995. When used,
the words “anticipates”, “believes”, “estimates”, “objectives”, “goals”, “aims”,
“hopes”, “may”, “likely”, “should” and similar expressions are intended to
identify such forward-looking statements. In particular, the forward-looking
statements in this Form 10-Q include, among others, statements regarding our
goals or expectations regarding our future revenues and earnings, the likelihood
of increased retail sales by our current and future licensees, such as Target
and Tesco, the likelihood that our licensees will achieve royalty rate
reductions, our prospects for obtaining new licensees and our prospects for
obtaining new brands to acquire or represent. Forward-looking statements involve
known and unknown risks and uncertainties that may cause our actual results,
performance, achievements or share price to be materially different from any
future results, performance, achievements or share price expressed or implied by
any forward-looking statements. Such risks and uncertainties include, but are
not limited to, the financial condition of the apparel industry and the retail
industry, the overall level of consumer spending, the effect of intense
competition from other apparel lines both within and outside of Target and
Tesco, adverse changes in licensee or consumer acceptance of products bearing
the Cherokee or our other brands as a result of fashion trends or otherwise, the
ability and/or commitment of our licensees to design, manufacture and market
Cherokee or our other branded products, our dependence on two licensees for a
substantial portion of our revenues, our dependence on our key management
personnel, any adverse determination of claims, liabilities or litigation, and
the effect of a breach or termination by us of the Management Agreement with our
Executive Chairman. Several of these risks and uncertainties are discussed in
more detail under “Item 1A. Risk Factors” in this Report on Form 10-Q or in the
discussion and analysis below. You should, however, understand that it is not
possible to predict or identify all risks and uncertainties and you should not
consider the risks and uncertainties identified by us to be a complete set of
all potential risks or uncertainties that could materially affect us. You should
not place undue reliance on the forward-looking statements we make herein
because some or all of them may turn out to be wrong. We undertake no obligation
to update any of the forward-looking statements contained herein to reflect
future events and developments.
The
following discussion should be read in conjunction with our consolidated
financial statements and related notes included elsewhere in this Report on Form
10-Q. See “Item 1. Consolidated Financial Statements” and our Form
10-K for our fiscal year ended January 30, 2010 (“Fiscal 2010”).
Cherokee
Inc. (which may be referred to as we, us, our or the Company) is in the business
of marketing and licensing the Cherokee, Sideout and Carole Little brands and
related trademarks and other brands we own or represent. We are one of the
leading licensors of brand names and trademarks for apparel, footwear and
accessories in the world.
We own
several trademarks, including Cherokee®, Sideout®, Sideout Sport®, Carole
Little®, CLII®, Saint Tropez-West®, Chorus Line®, All That Jazz®, Molly Malloy®
and others. As of July 31, 2010, we had twenty-seven continuing
license agreements covering both domestic and international
markets. As part of our business strategy, we frequently evaluate
other brands and trademarks for acquisition into our portfolio.
In
addition to licensing our own brands, we also assist other brand-owners,
companies, wholesalers and retailers in identifying licensees or licensors for
their brands or stores.
We
operate on a 52 or 53 week fiscal year ending on the Saturday nearest to
January 31 in order to better align us with our licensees who generally
also operate and plan using such a fiscal year. This results in a 53
week fiscal year approximately every four or five years. We do not
believe that the extra week in the occasionally reported 53 week fiscal year
results in any material impact on our financial results.
On July
22, 1999, our Board of Directors authorized the repurchase of up to one million
shares of our then outstanding common stock. Pursuant to this directive, and
including certain repurchases of our common stock that were effected during
Fiscal 2009 and are described below, we have used cash of $7.5 million to
repurchase and retire a total of 717,516 shares of our common stock since the
stock repurchases were authorized. Our Board of Directors subsequently
authorized and approved the extension of the expiration date of our stock
repurchase program to January 31, 2012 and has established the number of
remaining shares which could currently be repurchased from time to time in the
open market at prevailing market prices or in privately negotiated transactions
to a total of 800,000 shares of our common stock. During Fiscal 2008 and Fiscal
2007, we did not repurchase any shares of our common stock. During Fiscal 2009, we
purchased and retired a total of 109,716 shares of our common stock at an
average price of $17.99. We did not repurchase any shares of our common stock
during Fiscal 2010, nor during the six months ended July 31, 2010 (the “Six
Months”). Continued repurchases of our stock, if any, will be made from time to
time in the open market at prevailing market prices or in privately negotiated
transactions.
Critical
Accounting Policies and Estimates
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.
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 on-going 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 differ from these
estimates.
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:
|
·
|
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 on Form 10-K for Fiscal 2010, 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.
Recent
Accounting Pronouncements
We
describe recent accounting pronouncements in Item 1 — “Consolidated Financial
Statements — Notes to Consolidated Financial Statements.”
Results
of Operations
Retail
Sales
During
the Second Quarter, total U.S. dollar based retail sales of merchandise bearing
the Cherokee brand in all licensed territories were 16.6% below the second
quarter of last year, totaling $305.7 million in the Second Quarter versus
$366.3 million in the second quarter of last year. During the Six Months, the
total U.S. dollar based retail sales of merchandise bearing the Cherokee brand
in all licensed territories were 13.1% below the comparable six months period of
last year, totaling $650.4 million in the Six Months as compared to $748.9
million in the comparable period of last year. Much of this decline during the
Second Quarter and Six Months was due to the following two factors: (i) a
difficult retailing environment worldwide, which contributed to a decrease in
available inventory levels for Cherokee branded products at certain licensees’
stores during the Second Quarter; and (ii) the generally stronger U.S. dollar
during the Second Quarter as compared to the second quarter of last year, which
resulted in lower comparative U.S. dollar-based retail sales from many of our
international licensees, and ultimately lower U.S. dollar-based
royalties.
Pursuant
to our typical arrangements with our licensees, we receive quarterly royalty
statements and periodic retail sales information for Cherokee branded products
and other product brands that we own or represent. However, our licensees are
generally not required to provide, and typically do not provide, information
that would enable us to determine the specific reasons for period-to-period
fluctuations in retail sales of our branded products by our licensees in the
specific territories in which they operate. Fluctuations in retail sales of
Cherokee branded products or other product brands that we own or represent may
be the result of a variety of factors, including, without limitation: (i)
changes in the number of product categories for which a licensee chooses to use
our brands from period-to-period, which generally results in changes in the
amount of inventory (utilizing our brands) available for sale from
period-to-period; (ii) the number of geographical markets/territories or number
of stores in which our licensees are currently selling Cherokee or our other
branded products from period-to-period; or (iii) our licensees experiencing
changes in retail sales levels as a result of a variety of factors, including
fashion-related and general retail sales trends (See Item IA “Risk
Factors”).
During
the Second Quarter, retail sales of Cherokee branded products by Target Stores
totaled approximately $143.6 million compared to approximately $149.4 million
for the second quarter of last year, or a decline of 3.9% (which is less than
the 9.8% decline experienced in our First Quarter). This Second Quarter decline
was due to both a difficult retailing environment, and also less Cherokee
branded inventory being available in the Second Quarter, as compared to the
prior year. Target’s sales of Cherokee branded products for the Six Months
totaled $333.0 million, as compared to $359.3 million for the comparable period
last year. Given that the Cherokee brand is primarily being utilized for kids
apparel at Target during Fiscal 2011, and that the typical seasonal demand for
kids apparel is highest in the latter two quarters, we expect the retail sales
of Cherokee branded products in the upcoming third and fourth quarters may
surpass that of our Second Quarter.
Tesco’s
U.S. dollar based retail sales of merchandise bearing the Cherokee brand, which
included the U.K., Ireland, the Czech Republic, Slovakia, Poland, Hungary and
Turkey, were $113.1 million in our Second Quarter compared to $182.3 million in
the second quarter of last year, representing a total decline of 37.9%.
Approximately $33.0 million of the total $69.2 million decline was from Tesco’s
Central European territories, with the UK accounting for a $35.1 million
decline, representing nearly all of the remainder. The primary reason for the
current retail sales declines at Tesco is the reduction in inventory levels of
Cherokee branded goods. In addition, there was a strengthening of the U.S.
dollar in nearly all of the Tesco territories, ranging from 3% to 12.5% in the
Second Quarter as compared to the comparable period last year. Retail sales in
the United Kingdom, as measured in British Pounds Sterling, were down 26.2% in
the Second Quarter as compared to the comparable period in the prior year.
Hence, retail sales in U.S. dollars for the United Kingdom totaled $76.4 million
in the Second Quarter, as compared to $111.5 million in the second quarter of
last year. The decline in retail sales in the Tesco Central European countries
of the Czech Republic, Slovakia, Poland and Hungary, as measured in their
respective local currencies, ranged from 44% to 54%. Additionally, currency rate
fluctuations in the Central European countries, which reflected the stronger
U.S. dollar in the Second Quarter, exhibited unfavorable changes ranging from 3%
to 12.5%, and as a consequence the collective U.S. dollar based retail sales
from Tesco Central Europe for the Second Quarter were $28.4 million, as compared
to $61.5 million in the second quarter of last year.
Zeller’s
retail sales in Canada of merchandise bearing the Cherokee brand, in U.S.
dollars, were approximately $19.0 million during the Second Quarter compared to
$13.9 million for the second quarter of last year, representing a 36.3%
increase. This increase was primarily attributable to an increase in product
categories for the Cherokee brand in the Second Quarter and Six Months, as
compared to the comparable periods last year. Zeller’s sales of Cherokee
merchandise for the Six Months totaled $38.3 million as compared to $26.7
million in the comparable period last year, representing an increase of
43.4%.
Despite
the difficult global retail environment and generally a stronger U.S. dollar in
the First Quarter and Second Quarter (as compared to the comparable periods last
year), on a U.S. dollar basis we experienced retail sales increases with several
other of our foreign licensees, including the countries of Mexico, South Africa,
Brazil, Israel and India. We expect that several of our newer foreign
territories may continue to show growth throughout Fiscal 2011.
During
the Second Quarter, retail sales of Carole Little and St. Tropez-West branded
products by TJX increased 84% to total $24.2 million, as compared to $13.1
million for the second quarter of last year. For the Six Months, retail sales of
Carole Little and St. Tropez-West branded products by TJX totaled $53.3 million,
as compared to $49.9 million for the comparable period last year, representing
an increase of 6.8% over last year.
Royalty
Revenues and Expenses
Royalty
revenues were $7.5 million and $15.7 million during the Second Quarter and the
Six Months, respectively, compared to $8.1 million and $17.0 million during the
comparable periods last year, a decrease of 7.4% and 7.3%, respectively. Royalty
revenues from the Cherokee brand were $6.6 million and $13.8 million during the
Second Quarter and Six Months, respectively, compared to $7.4 million and $15.4
million for the comparable periods last year. During the Second Quarter and Six
Months, revenues of $2.7 million and $6.5 million, respectively, were recognized
from Target Stores compared to $2.7 million and $6.9 million for the comparable
periods last year, which accounted for 36% and 42% of our total revenues, in the
Second Quarter and the Six Months, respectively, versus 34% and 41% last year.
The decrease in royalty revenues from Target Stores for the Six Months compared
to the comparable prior year period was attributable to a difficult retail
environment and also lower inventory levels of Cherokee branded products during
the Six Months, as compared to the comparable period of last year. During the
Second Quarter, the retail sales of Cherokee product declined 3.9%, but due to a
slightly higher average royalty rate, the royalties from Target for the Second
Quarter were the same as the prior year period.
Revenues
from all of the Tesco countries were $2.6 million and $4.9 million during the
Second Quarter and Six Months, respectively, compared to $3.7 million and $6.7
million for the comparable periods last year. Revenues from Tesco U.K. totaled
$1.7 million and $3.3 million during the Second Quarter and Six Months,
respectively, compared to $2.2 million and $4.1 million for the comparable
periods last year. The decline in royalties from Cherokee branded products in
all other non-U.K. Tesco countries (primarily Central Europe) was 49.7% and
46.7% for the Second Quarter and Six Months, respectively, which was
significantly more than the decline in the U.K. The decrease in royalties from
Tesco is primarily due to a reduction in the number of product categories
utilizing the Cherokee brand throughout Tesco’s larger territories (U.K.,
Central Europe).
Revenues
from Zellers were $381,000 and $774,000 during the Second Quarter and Six
Months, respectively, compared to $280,000 and $534,000 for the comparable
periods last year, due primarily to higher sales volumes and the utilization of
the Cherokee brand on a greater number of kids product categories. Royalty
revenues from our retail direct licensee in Mexico, Comercial Mexicana, totaled
$175,000 and $333,000 during the Second Quarter and Six Months, respectively, as
compared to $152,000 and $302,000 in royalty revenues for the comparable periods
last year. The increase in royalties from Comercial Mexicana for the Second
Quarter and Six Months was due to greater retail sales and slightly favorable
exchange rate differential, as compared to the comparable periods last
year.
Royalty
revenues from the retail sales of products bearing our Sideout brand were
$53,000 and $115,000, respectively, during the Second Quarter and Six Months
compared to $46,000 and $94,000 for the comparable periods last year. We have
recently signed several new U.S. licensees for our Sideout brand, and expect
royalties to increase in the future.
Revenues
from international licensees of both Cherokee and Sideout brands, such as Tesco,
Zellers, Comercial Mexicana and others were collectively $3.9 million and $7.4
million during the Second Quarter and Six Months, respectively, compared to $4.7
million and $8.5 million for the comparable periods last year. This decline
primarily reflects a decrease in royalties from the Tesco territories, which was
countered somewhat by growth from other international licensees from the
countries of Canada, South Africa, Israel and India.
Our
Second Quarter and Six Months revenues also included $315,000 and $688,000,
respectively, from the Carole Little brands, as compared to the $179,000 and
$649,000 for the comparable periods last year from these brands.
Royalty
revenues during the Second Quarter benefited from higher royalty rates applied
under our contracts with Tesco and Target because (i) in the case of Target, the
cumulative retail sales achieved the applicable threshold for reduced royalty
rates later in the Second Quarter, and (ii) in the case of Tesco, the cumulative
retail sales did not achieve the applicable threshold for reduced royalty rates
in the Second Quarter, in each case as compared to the comparable period in the
prior fiscal year. As a result of our achieving the applicable threshold for
reduced royalty rates under our contract with Target during the Second Quarter,
royalty revenues from Target at times during the Second Quarter may be lower
than that of the previous quarter. These lower contractual royalty rates were
applied due to the attainment by Target of contractually specified cumulative
levels of retail sales during the current fiscal year. In the event that
cumulative retail sales in future quarters in Fiscal 2011 do exceed the
applicable thresholds for reduced royalty rates under our contracts with Tesco
or Target, we will then be entitled to smaller royalty rates on incremental
retail sales by Target and Tesco that are in excess of such
thresholds.
We
believe that our future revenues from Target, for the remaining six months of
Fiscal 2011, will likely be flat or slightly higher when compared to the
revenues from Fiscal 2010, partially due to the expected modest volume increases
in our upcoming third and fourth fiscal quarters in kids apparel categories at
Target. We believe that our future revenues from Zellers for Fiscal 2011 will
continue to be up due to higher inventory levels as compared to Fiscal 2010.
Based on Tesco’s sales of Cherokee branded products in Fiscal 2010 and through
the Six Months, and the lower inventory levels for the Cherokee Brand, we
believe that our future revenues from Tesco will be down when compared to the
revenues from Fiscal 2010. Based upon the royalties received for the Six Months
from TJX, we estimate that our future royalty revenues from TJX may be up or
flat when compared to the revenues from Fiscal 2010, but will depend upon the
future condition of the U.S. retail market, which is currently difficult and
uncertain. Furthermore, although the U.S. dollar has generally strengthened
somewhat when comparing the Second Quarter to the First Quarter, it varies when
compared to the various exchange rates used in determining royalties from our
licensees for the second quarter of last year. Should the U.S. dollar strengthen
in the future against such foreign currencies, our future royalties from our
international licensees will be negatively affected throughout the rest of
Fiscal 2011.
We
recognize royalty revenues in the quarter earned. A large portion of such
royalty revenues recognized as earned are collected from licensees during the
month following the end of a quarter. Our trade receivables balance of $7.0
million as of the end of the Second Quarter included accrual for revenues earned
from Target Stores, Zeller’s, Tesco, TJX and other licensees that are expected
to be received in the month or 45 days following the end of the subject fiscal
quarter.
Selling,
general and administrative expenses for the Second Quarter and Six Months were
$3.36 million and $6.73 million, respectively, or 44.9% and 42.8%, of revenues,
in comparison to selling, general and administrative expenses of $3.35 million
and $6.5 million, respectively, or 41.3% and 38.1% of revenues during the
comparable periods last year. Our selling, general and administrative expenses
of $3.36 million in our Second Quarter were approximately $17,000 greater than
last year, and exhibited the following positive and negative variances: (i)
lower travel expenses as compared to the second quarter of last year; (ii) lower
bonus accrual expense of $0.6 million as compared to $1.8 million in the second
quarter of last year; (iii) higher payroll and related expenses (due to a higher
headcount); and (iv) higher marketing, advertising and related expenses, as
compared to last year. The increase in our selling, general and administrative
expenses of $0.3 million during the Six Months was primarily attributable to the
following positive and negative variances: (i) higher marketing, advertising and
related expenses as compared to the comparable period last year; (ii) lower
bonus accrual expense of $1.0 million as compared to $1.3 million last year;
(iii) higher salary and payroll related expenses as compared to the first six
months of last year (due to a higher headcount); and (iv) higher legal expenses
versus the comparable period last year.
We
reported zero interest expense during the Second Quarter and Six Months and
during the comparable periods last year. During the Second Quarter and Six
Months our interest and other income was $3,000 and $6,000, respectively,
compared to $6,000 and $13,000 for the comparable periods last year. The
decrease in interest income is primarily due to lower cash balances and lower
interest rates during the Second Quarter and Six Months, as compared to the
comparable periods in the prior year.
During
the Second Quarter and Six Months we recorded a tax provision of $1.7 million
and $3.6 million, respectively, which equates to an effective tax rate of 40.0%
and 40.1% for such periods, compared to $1.9 million and $3.8 million and an
effective tax rate of 39.7% and 36.5% recorded for the same periods last year.
We are making quarterly estimated tax payments for our federal and state income
tax liabilities. During the Second Quarter and Six Months our net income was
$2.5 million and $5.4 million, or $0.28 and $0.61 per diluted share,
respectively, compared to $2.9 million and $6.7 million or $0.32 and $0.76 per
diluted share for the comparable periods last year.
Liquidity
and Capital Resources
Cash Flows. On July 31, 2010,
we had cash and cash equivalents of $7.3 million. On January 30, 2010, we had
cash and cash equivalents of $9.4 million. The $2.1 million decrease in cash and
cash equivalents during the Six Months is primarily attributable to the payment
of $6.6 million in dividends, and the payment of our previously accrued bonus
for our Executive Chairman of $2.5 million during the First Quarter. These were
offset by various other items detailed below.
During
the Six Months, cash provided by our operations was $4.8 million, compared to
$4.2 million for the comparable period last year. The cash provided by
operations of $4.8 million during the Six Months was primarily due to net income
of $5.4 million offset by the changes in: (i) accounts receivable, which
decreased by $245,000 in the Six Months, as compared to an increase of $2.0
million in the comparable period last year; (ii) accounts payable, which
increased by $339,000 in the Six Months, as compared to an increase of $25,000
in the comparable period last year, (iii) accrued compensation, which decreased
by $1.5 million in the Six Months, as compared to a decrease of $1.6 million in
the comparable period last year; (iv) a decrease of income taxes payable of $0.8
million, as compared to an increase of $0.1 million in the comparable period
last year; and (v) a slight increase in income taxes receivable for the Six
Months, as compared to an increase of $0.3 million in the comparable period last
year. In addition, our cash from operations includes non-cash stock-based
compensation expense of $269,000 pursuant to SFAS 123 (R) as compared to
$317,000 in the comparable period last year, and our deferred tax assets
decreased by $136,000, as compared to a decrease of $218,000 in the comparable
period last year.
Cash used
by investing activities during the Six Months was $188,000, which was comprised
of $17,000 of capital expenditures of office equipment, and $171,000 in
trademark registration and renewal fees for the Cherokee, Sideout and Carole
Little brands. In comparison, during the comparable period last year, cash used
by investing activities was $127,000, which was comprised of $10,000 of capital
expenditures of office equipment, and $117,000 in trademark registration and
renewal fees for the Cherokee, Sideout and Carole Little brands.
Cash used
in financing activities was $6.7 million during the Six Months, which included
the payment of two dividends during this period. In comparison, during the
comparable period last year, cash used in financing activities was $8.8 million
during the Six Months, which also represented the payment of two dividends
totaling $8.8 million during that period.
Uses of Liquidity. We
anticipate that our cash requirements through the end of Fiscal 2011 are
primarily to fund operations, trademark registration expenses, capital
expenditures, selectively expand our brand portfolio and, if adequate, and, at
the discretion of our Board, to pay dividends and/or potentially repurchase
shares of our common stock. Our Board may reduce or discontinue payment of
dividends at any time for any reason it deems relevant. Our dividend payments in
certain past quarters have exceeded our cash flow from operations, and our
dividends may not continue at current levels in future periods unless cash flow
from operations increases. The declaration and payment of any future dividends
or repurchase of shares of our common stock will be at the discretion of our
Board and will be dependent upon our financial condition, results of operations,
cash flow, capital expenditures and other factors deemed relevant by our
Board.
We are
frequently approached by parties seeking to sell their brands and related
trademarks. Should an established marketable brand or equity become available on
favorable terms, we would be interested in pursuing such an acquisition and may
elect to fund such acquisition, in whole or in part, using our then-available
cash.
Sources of Liquidity. Our
primary source of liquidity is expected to be cash flow generated from
operations, and cash and cash equivalents currently on hand. We believe our cash
flow from operations, together with our cash and cash equivalents currently on
hand, will be sufficient to meet our working capital, capital expenditure and
other commitments through July 2011; provided that, if our Management Agreement
with our Executive Chairman is terminated, we may not have sufficient cash to
make the lump sum payment due to Mr. Margolis. We cannot predict our revenues
and cash flow generated from operations. Some of the factors that could cause
our revenues and cash flows to be materially lower are described under the
caption titled “Risk Factors” in Item 1A of this Report on Form
10-Q.
As of
July 31, 2010, we did not have any credit facilities or lines of credit, and we
are not the guarantor of any debt or any other material third-party obligations.
As of July 31, 2010, we did not have any standby letters of credit nor any
standby repurchase obligations.
If our
revenues and cash flows during Fiscal 2011 are lower than Fiscal 2010, which we
expect may occur, we would have less cash available to pay dividends, repurchase
shares of our common stock or to explore or consummate the acquisition of other
brands. In addition, if our revenues and cash flows during Fiscal 2011 are
materially lower than Fiscal 2010, we may need to take steps to reduce
expenditures by scaling back operations and reducing staff. However, any
reduction of revenues would be partially offset by reductions in the amounts we
would be required to pay under the Management Agreement, employee bonuses and
any other agreements. We believe that we will have sufficient cash generated
from our business activities to support our operations for the next twelve
months.
Inflation
and Changing Prices
Inflation,
traditionally, has not had a significant effect on our operations. Since most of
our future revenues are based upon a percentage of sales of the licensed
products by our licensees, we do not anticipate that inflation will have a
material negative impact on future operations.
Seasonality
Given our
contractual royalty rate reductions with our licensees, as certain sales volume
thresholds are achieved by our licensees in any given fiscal year, historically
this has usually caused our first quarter to be our highest revenue and
profitability quarter; our second quarter to be our next highest quarter, and
our third and fourth quarters to be our lowest quarters. However, such
historical patterns may vary in the future, depending upon the product mix and
retail sales volumes achieved in each quarter with our licensees.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market
risk generally represents the risk that losses may occur in the values of
financial instruments as a result of movements in interest rates, foreign
currency exchange rates and commodity prices. We do not enter into derivatives
or other financial instruments for trading or speculative
purposes.
Interest:
From time to time we invest our excess cash in interest-bearing temporary
investments of high-quality issuers. Due to the short time the investments are
outstanding and their general liquidity, these instruments are classified as
cash equivalents in our consolidated balance sheet and do not represent a
material interest rate risk to us. As of July 31, 2010, we had no long term debt
obligations.
Foreign
Currency: We conduct business in various parts of the world. We are exposed to
fluctuations in exchange rates to the extent that the foreign currency exchange
rate fluctuates in countries where our licensees do business, and significant
fluctuations in exchange rates could result in a material affect on our results
of operations or cash flow. For Fiscal 2010, revenues from international
licensing comprised 50.7% of our consolidated revenues. For the Six Months,
international licensing royalties comprised 47.1% of our total revenues. A
hypothetical 10% strengthening of the U.S. dollar relative to the foreign
currencies of countries where we operate would have negatively affected our Six
Months revenues by approximately $0.7 million, which represents 4.7% of the
total revenues reported for the Six Months.
Most of
our international licensees are required to pay the royalty revenues owed to us
in U.S. dollars. As a consequence, in past years the weakening of the U.S.
dollar has benefited us in that the total royalty revenues reported from our
international licensees such as Tesco and Zellers increases when the dollar
weakens against such foreign currencies (the British Pound, the Canadian Dollar,
and the Euro). During the First Quarter the U.S. dollar fluctuated across
countries and was stronger in some countries and weaker in other countries based
on the prior quarter last year. For example, the royalty revenues from Tesco
U.K. in our First Quarter reflect a 6.2% favorable change in the exchange rate
as compared to the exchange rate used in the first quarter of last year, while
royalty revenues from Tesco Slovakia in our First Quarter reflect a -1.2%
unfavorable change in the exchange rate as compared to the exchange rate used in
the first quarter of last year. Similarly, during the Second Quarter, the U.S.
dollar fluctuated across countries and was stronger in some countries and weaker
in other countries based on the prior quarter last year. For example, the
royalty revenues from Tesco U.K. in our Second Quarter reflect a 7.1%
unfavorable change in the exchange rate as compared to the exchange rate used in
the second quarter of last year, while royalty revenues from the Tesco Central
European countries in our Second Quarter reflect a range of 3.3% to 12.5% in
unfavorable changes in the exchange rates as compared to the exchange rates used
in the second quarter of last year. However, other exchange rate comparisons
exhibited a favorable change (i.e., relative weaker dollar) for the Second
Quarter. In the future, should the dollar strengthen further against such
foreign currencies, the total royalty revenues reported by us from such
licensees would reflect such changes in the currency exchange rates.
Accordingly, a strengthening dollar, compared to current exchange rates, would
likely result in lower reported royalty revenues than otherwise would be
reported as a result of such unfavorable exchange rate movements.
ITEM
4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls
and procedures. Cherokee maintains “disclosure controls and procedures,”
as such term is defined under Exchange Act Rule 13a-15 (e) that are designed to
ensure that information required to be disclosed in Cherokee’s Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms and that such information is accumulated
and communicated to Cherokee’s management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.
Cherokee
has carried out an evaluation under the supervision and with the participation
of Cherokee’s management, including Cherokee’s Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Cherokee’s disclosure controls and procedures. Based upon their evaluation and
subject to the foregoing, the Chief Executive Officer and Chief Financial
Officer concluded that Cherokee’s disclosure controls and procedures were
effective as of July 31, 2010.
(b) Changes in internal controls.
Management determined that as of July 31, 2010, there have been no changes in
Cherokee’s internal controls over financial reporting that occurred during the
quarter covered by this report that have materially affected, or are reasonably
likely to materially affect, the Company’s internal control over financial
reporting.
PART
II—OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS
In the
ordinary course of business, from time to time we become involved in legal
claims and litigation. In the opinion of management, based on consultations with
legal counsel, the disposition of litigation currently pending against us is
unlikely to have, individually or in the aggregate, a materially adverse effect
on our business, financial position or results of operations.
In
addition to the other information contained herein or incorporated herein by
reference, the risks and uncertainties and other factors described below could
have a material adverse effect on our business, financial condition, results of
operations and share price and could also cause our future business, financial
condition and results of operations to differ materially from the results
contemplated by any forward-looking statement we may make herein, in any other
document we file with the Securities and Exchange Commission, or in any press
release or other written or oral statement we may make. Please also see “Item 2.
Management’s Discussion and Analysis of Financial Condition And Results of
Operations—Cautionary Note Regarding Forward-Looking Statements” for additional
risks and uncertainties applicable to us.
Our
business is subject to intense competition.
Royalties
paid to us under our licensing agreements are generally based on a percentage of
our licensee’s net sales of licensed products. Cherokee, Carole Little and
Sideout brand footwear, apparel, and accessories, which are manufactured and
sold by both domestic and international wholesalers and retail licensees, are
subject to extensive competition by numerous domestic and foreign companies.
Such competitors with respect to the Cherokee brand include independent brands
such as Levi Strauss & Co., The Gap, Old Navy, Martha Stewart Living
Omnimedia Inc., Liz Claiborne, Iconix Brand Group, and VF Corp., and private
label brands developed by retailers such as Faded Glory, Arizona, and Route 66.
Competitors with respect to the Sideout brand include Quiksilver, Nike and other
active wear companies. Factors which shape the competitive environment include
quality of garment construction and design, brand name, style and color
selection, price and the manufacturer’s ability to respond quickly to the
retailer on a national basis. In recognition of the increasing trend towards
consolidation of retailers and greater emphasis by retailers on the manufacture
of private label merchandise, in the United States our business plan focuses on
creating strategic alliances with major retailers for their sale of products
bearing our brands through the licensing of our trademarks directly to
retailers. Therefore, our degree of success is dependent on the strength of our
brands, consumer acceptance of and desire for our brands, our licensees’ ability
to design, manufacture and sell products bearing our brands and to respond to
ever-changing consumer demands, and any significant failure by our licensees to
do so could have a material adverse effect on our business prospects, financial
condition, results of operations and liquidity. We cannot control the level of
resources that our licensees commit to supporting our brands, and our licensees
may choose to support other brands to the detriment of ours.
Further,
there are numerous risk factors that apply to the businesses of retailers that
can affect their level of sales of products that carry our brands. Any decline
in sales by our licensees can adversely affect our revenues. Factors that may
adversely affect retailers include the following: weather; changes in the
availability or cost of capital; shifts in the seasonality of
shopping patterns; labor strikes or other work interruptions including work
interruptions that impact supply chains and transport vendors; the impact of excess retail
capacity; changes in
the cost of accepting various payment methods and changes in the rate of
utilization of these payment methods; material acquisitions or
dispositions;
investments in new business strategies; the success or failure of
significant new business ventures or technologies; actions taken or omitted to
be taken by legislative, regulatory, judicial and other governmental authorities
and officials; and natural disasters, the outbreak of war, acts of terrorism or
other significant national or international events. The risks associated with
our business are more acute during periods of economic slowdown or recession. In
addition to other consequences, these periods may be accompanied by decreased
consumer spending generally, as well as decreased demand for, or additional
downward pricing pressure on, the products carrying our brands. Accordingly, any
prolonged economic slowdown or a lengthy or severe recession with respect to
either the U.S. or the global economy is likely to have a material adverse
effect on our results of operations, financial condition and business prospects.
As a result, given the deteriorating position of the U.S. and global economy, as
well as the decreasing purchasing power of consumers, we expect that our
business will continue to suffer for so long as, and to the extent that, such
adverse economic conditions exist.
In
addition, other companies owning established trademarks could also enter into
similar arrangements with retailers.
Our
business is largely dependent on royalties from two licensees, Target Stores and
Tesco, which each accounted for 40.6% and 36.9%, respectively, of our
consolidated licensing revenues in Fiscal 2010, and accounted for 41.5% and
31.3%, respectively, of our Six Months licensing revenues.
During
Fiscal 2010, 40.6% of our licensing revenues were generated from Target and
36.9% of our licensing revenues were generated from Tesco. For the Six Months,
41.5% and 31.3%, respectively, of our licensing revenues were generated from
Target Stores and Tesco. We could suffer substantially decreased royalty
revenues and cash flow under the Restated Target Agreement if Target were to
reduce its sales of Cherokee branded products while continuing to pay the
minimum royalties of $9.0 million per fiscal year required under such agreement.
The termination of either the Restated Target Agreement or the Tesco Agreement
would have a material adverse effect upon our revenues and cash flow if we were
unable to replace these royalty streams in a timely manner. We are unsure
whether we would be able to replace the royalty payments received from Target
and Tesco. Together, these two licensees accounted for 77.5% of our consolidated
licensing revenues in Fiscal 2010 and accounted for 72.8% of our consolidated
licensing revenues in our Six Months.
We
are dependent on our intellectual property and we cannot assure you that we will
be able to successfully protect our rights.
We hold
various trademarks including Cherokee, Sideout, Carole Little and others in
connection with apparel, footwear and accessories. These trademarks are vital to
the success and future growth of our business. These trademarks are registered
with the United States Patent and Trademark Office and in numerous other
countries. We also hold several trademark applications for Cherokee and Sideout
in several countries. There can be no assurance that the actions taken by us to
establish and protect our trademarks and other proprietary rights will prevent
imitation of our products or infringement of our intellectual property rights by
others, or prevent the loss of licensing revenue or other damages caused
thereby. In addition, the laws of several countries in which we have licensed
our intellectual property may not protect our intellectual property rights to
the same extent as the laws of the United States. Despite our efforts to protect
our intellectual property rights, unauthorized parties may attempt to copy
aspects of our intellectual property, which could have a material adverse effect
on our business prospects, financial condition, results of operations and
liquidity. In the future we may be required to assert infringement claims
against third parties, and there can be no assurance that one or more parties
will not assert infringement claims against us. Any resulting litigation could
result in significant expense and divert the efforts of our management personnel
whether or not such litigation is determined in our favor.
We
are dependent on our key management personnel and we recently appointed a new
Chief Executive Officer.
Our
success is highly dependent upon the continued services of our key executives,
including Robert Margolis, our Executive Chairman, Henry Stupp, our Chief
Executive Officer, Howard Siegel, our Chief Operating Officer; and Russell J.
Riopelle, our Chief Financial Officer. We have a limited number of employees and
Mr. Margolis’, Mr. Stupp’s and our other executives’ leadership and experience
in the apparel licensing industry is important to the successful implementation
of our business and marketing strategy. We do not carry key person life
insurance covering any of our executives. The loss of the services of Mr.
Margolis, Mr. Stupp or our other key executives could have a material adverse
effect on our business prospects, financial condition, results of operations and
liquidity. In addition, on August 26, 2010, we experienced a transition in our
executive management team, in connection with the appointment of Henry Stupp as
our Chief Executive Officer and the appointment of our former Chief Executive
Officer, Robert Margolis, as our Executive Chairman. Mr. Stupp has not worked
with our existing executive management team prior to his appointment as our
Chief Executive Officer, and we cannot assure you that this management
transition will not result in some disruption of our business. If our new Chief
Executive Officer is unable work with our existing management team to implement
our strategies, manage our operations and accomplish our objectives, our
business, operations and financial results could be impaired.
The
Management Agreement with our Executive Chairman contains provisions that
provide for a substantial cash payment to our Executive Chairman upon our breach
or termination of the Management Agreement.
Mr. Margolis’ services as our Executive Chairman are
provided to us pursuant to a management agreement, as amended (the “Management
Agreement”). The current term of the Management Agreement ends on February 1,
2012; however, the term may be extended indefinitely for additional one year
terms by the mutual consent of our Nominating Committee and Mr. Margolis. If,
during Fiscal 2011, we terminate the Management Agreement without cause or Mr.
Margolis terminates the Management Agreement after we materially breach any of
the terms and conditions thereof, or in the event of a change in control of
Cherokee, we would be obligated to pay Mr. Margolis, within sixty days after the
date of termination or such change in control, a lump sum in cash equal to three
times the sum of the annual base compensation under the Management Agreement at
the rate in effect at the time of the termination plus the amount of the
previous year’s performance bonus under the Management Agreement. Mr. Margolis’
annual base compensation for Fiscal 2011 is $804,000 and his performance bonus
for Fiscal 2010 was approximately $2.5 million. Based on Mr.
Margolis’ salary for Fiscal 2010 and his bonus paid for Fiscal 2010, the lump
sum payment owed upon such a termination would be approximately $10.0 million, plus his
pro rata earned performance bonus during Fiscal 2011 up to the date of
termination. If, during Fiscal 2012, we terminate the Management
Agreement without cause or Mr. Margolis terminates the Management Agreement
after we materially breach any of the terms and conditions thereof, or in the
event of a change in control of Cherokee that occurs during Fiscal 2012 or
pursuant to an agreement that is entered into during Fiscal 2012, we would be
obligated to pay Mr. Margolis, within sixty days after the date of termination
or such change in control, a lump sum in cash equal to $6.0 million.
At the time such payment is due, we may not have
sufficient cash to make the lump sum payment to Mr. Margolis, and becoming
obligated to make such payment would have a material adverse effect on our
business prospects, financial condition, results of operations and liquidity. In
addition, the obligation to make such lump sum payment to Mr. Margolis would be
triggered if a third party were to acquire us during Fiscal 2011, Fiscal 2012 or
pursuant to an agreement that is entered into during Fiscal 2012, which would
increase such third party’s acquisition costs, but would also each year
thereafter reduce our annual operating expenses due to the elimination of annual
bonus payments to Mr. Margolis pursuant to the Management
Agreement.
We
may not pay dividends regularly or at all in the future.
Although
we have paid dividends during each quarter since December 2003, and including
during the First and Second Quarters, our Board of Directors may reduce or
discontinue dividends at any time for any reason it deems relevant and there can
be no assurances that we will continue to generate excess cash to pay dividends,
or that we will continue to pay dividends with such excess cash if other, more
compelling business opportunities are available, as determined by our Board of
Directors. Our ability to generate excess cash from our operations in the future
is dependent upon a variety of factors, including Cherokee’s financial
condition, results of operations, cash flow, capital requirements and other
factors. In Fiscal 2010, we paid a total of $17.6 million in dividends, which
was materially greater than our net income of $12.6 million for Fiscal 2010. In
recognition of the fact that our payment of dividends could not continue at
historical levels beyond Fiscal 2010 unless cash flow from operations increases
substantially, on January 26, 2010, we announced that we reduced our future
quarterly dividend payment from $0.50 per share to $0.38 per share, which more
closely aligned our dividend payments with our expected cash flow from
operations. Should our future dividend payments exceed our cash from operations,
we will reduce the excess cash on our balance sheet and our Board of Directors
may elect to further reduce or eliminate future dividend payments. Furthermore,
should the dividend tax laws change such that taxes on dividends become higher
than they currently are, or should we decide to use our excess cash to make
acquisitions of complimentary business or brands or for other reasons, we may
further reduce or eliminate the dividends we pay to our stockholders in favor of
other ways to increase value for our stockholders.
The
trading price of our stock may be volatile.
The
trading price of our common stock is likely to be subject to fluctuations as a
result of various factors impacting our business, including (i) our financial
results, (ii) announcements of us, our retail partners or by our competitors, as
applicable, regarding or affecting the retail environment either domestically or
internationally, our existing license agreements, our existing brand
representations, new license agreements, new brand representations or strategic
alliances or other agreements, (iii) recruitment or departure of key personnel,
(iv) changes in the estimates of our financial results or changes in the
recommendations of any securities analysts that elect to follow our common
stock, and (v) market conditions in the retail industry and the economy as a
whole.
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM
4. (REMOVED AND RESERVED)
ITEM
5. OTHER INFORMATION
None.
ITEM 6.
EXHIBITS
Exhibit
Number
|
|
Description of Exhibit
|
10.1
|
|
Amendment No 1 to The 2006 Incentive Award Plan
(incorporated by reference from Exhibit 10.1 to Cherokee’s Report on Form
10-Q, filed with the Commission on June 9, 2010)
|
10.2
|
|
Amendment No 1 to The 2003 Incentive Award Plan
(incorporated by reference from Exhibit 10.2 to Cherokee’s Report on Form
10-Q, filed with the Commission on June 9, 2010)
|
10.3
|
|
Stock Option Agreement, dated as of June 4, 2010,
by and between the Company and Robert Margolis (incorporated by reference
from Exhibit 10.3 to Cherokee’s Report on Form 10-Q, filed with the
Commission on June 9, 2010)
|
10.4
|
|
Second Amendment to the Second Revised and
Restated Management Agreement, dated as of April 23, 2010, between
Cherokee and The Newstar Group d/b/a The Wilstar Group dated as of
November 29, 1999 and amended as of August 28, 2007 (incorporated by
reference from Exhibit 10.3 to Cherokee’s Report on Form 8-K, dated April
23, 2010)
|
31.1*
|
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
31.2*
|
|
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
32.1*
|
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
32.2*
|
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
* Filed
herewith.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: September
8, 2010
CHEROKEE
INC.
|
|
|
By:
|
|
/s/ Henry
Stupp
|
|
|
|
|
|
Henry
Stupp
|
|
|
Chief
Executive Officer
|
|
|
(Principal
Executive Officer)
|
|
|
By:
|
|
/s/ Russell
J. Riopelle
|
|
|
|
|
|
Russell
J. Riopelle
|
|
|
Chief
Financial Officer
|
|
|
(Principal
Financial Officer and Principal
Accounting
Officer)
|