SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

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

 

For the quarterly period ended July 29, 2017.

 

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

 

For the Transition Period From            to            .

 

Commission file number 0-18640

 

 

CHEROKEE INC.

(Exact name of registrant as specified in its charter)

 

 

 

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

 

 

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

 

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 ☒  No ☐

 

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

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

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

 

 

 

CHEROKEE INC.

 

TABLE OF CONTENTS

 

 

 

PART 1. FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

CHEROKEE INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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

 

 

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

 

CHEROKEE INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(amounts in thousands, except per share amounts)

 

 

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

CHEROKEE INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

Unaudited

(amounts in thousands)

 

 

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

CHEROKEE INC.

 

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

(amounts in thousands)

 

 

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

CHEROKEE INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(amounts in thousands)

 

 

 

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

CHEROKEE INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

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

 

(1)   Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements as of July 29, 2017 and for the three and six month periods ended July 29, 2017 and July 30, 2016 have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and Article 10 of Regulation S-X. The accompanying consolidated financial statements include the accounts of Cherokee Inc. and its consolidated subsidiaries (referred to collectively as “Cherokee Global Brands” or the “Company” unless the context indicates or requires otherwise) include all adjustments, consisting of normal recurring accruals, which in the opinion of management of Cherokee Global Brands are necessary for a fair statement of the Company’s financial condition and the results of operations for the periods presented. All intercompany accounts and transactions have been eliminated during the consolidation process. The accompanying consolidated balance sheet as of January 28, 2017 has been derived from audited consolidated financial statements, but does not include all disclosures required by GAAP for an audited balance sheet. The Company’s financial condition and results of operations as of or for the three and six month periods ended July 29, 2017 are not necessarily indicative of the financial condition or results to be expected as of or for the fiscal year ending February 3, 2018 or any other date period. 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 28, 2017 (“Annual Report”).

 

As used herein, “Second Quarter” refers to the three month ended July 29, 2017; “Six Months” refers to the six month ended July 29, 2017; “Fiscal 2019” refers to the fiscal year ending February 2, 2019; “Fiscal 2018” refers to the fiscal year ending February 3, 2018; “Fiscal 2017” refers to the fiscal year ended January 28, 2017; and “Fiscal 2016” refers to the fiscal year ended January 30, 2016.

 

         Liquidity and Going Concern

 

The accompanying condensed consolidated financial statements have been prepared on the going concern basis of accounting, which assumes that the Company will continue to operate as a going concern and which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. As described in Note 8, the Company has entered into the Cerberus Credit Facility with Cerberus (each as defined below), pursuant to which the Company has borrowed  $45,000 under a term loan facility, which the Company drew down in December 2016, and $5,000 under a revolving credit facility, which the Company drew down in the First Quarter. As of July 29, 2017, the Company had $48,800 in principal amount of outstanding indebtedness owed under the Cerberus Credit Facility. Additionally, as of July 29, the Company was not in compliance with certain of its financial covenants set forth in the Cerberus Credit Facility (see Note 8). The Company is working with Cerberus to obtain a waiver of the events of default and/or amend certain terms of the Cerberus Credit Facility, but such a waiver or amendment may not be obtained, or if obtained, may not be obtained in a timely manner, or on terms favorable to the Company. Any failure to obtain such a waiver or amendment would subject the Company to significant risks. These risks include Cerberus’s right to terminate its obligations under the Cerberus Credit Facility, declare all or any portion of the borrowed amounts then outstanding to be accelerated and due and payable, and/or exercise any other rights or remedies it may have under applicable law, including foreclosing on the Company’s and/or its subsidiaries assets that serve as collateral for the borrowed amounts. If Cerberus elects to exercise any of these rights, the Company’s financial condition and ability to continue operations could be materially jeopardized. As a result of these risks, there is substantial doubt about the Company’s ability to continue as a going concern.

 

(2)   Summary of Significant Accounting Policies

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued a comprehensive new revenue recognition standard which will supersede previous existing revenue recognition guidance. The standard creates a five-step model for revenue recognition that requires companies to exercise judgment when considering contract terms and relevant facts and circumstances. The five-step model includes (1) identifying the contract, (2) identifying the separate performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to the separate performance obligations and (5) recognizing revenue when each performance obligation has been satisfied. The standard also requires expanded disclosures surrounding revenue recognition. During Fiscal 2017, the FASB issued additional clarification guidance on the new revenue recognition standard which also included certain scope improvements and practical expedients. The standard (including clarification guidance issued) is effective for fiscal periods beginning after December 15, 2017 and allows for either full retrospective or modified retrospective adoption. Early adoption is permitted for fiscal periods beginning after December 15, 2016. The Company is primarily engaged in the business of marketing and licensing the brands it owns or represents, as well as marketing and franchising the Flip Flop Shops brand.  These royalty revenues are recognized when earned. To date, the Company has performed a preliminary detailed review of key contracts and compared historical accounting policies and practices to the new standard. The Company plans to adopt this guidance using the modified retrospective method beginning in the first quarter of Fiscal 2019 and is continuing to evaluate the impact of the adoption of this standard on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued authoritative guidance which modifies existing guidance for off-balance sheet treatment of a lessees’ operating leases. The standard requires a lessee to recognize assets and liabilities related to long-term leases that were classified as operating leases under previous guidance in its balance sheet. An asset would be recognized related to the right to use the underlying asset and a liability would be recognized related to the obligation to make lease payments over the term of the lease. The standard also requires expanded disclosures surrounding leases. This guidance is effective for fiscal periods beginning after January 1, 2019. The anticipated impact of the adoption of this guidance on the Company’s consolidated financial statements is still being evaluated, but the Company expects there will be a significant increase in its long-term assets and liabilities resulting from the adoption.

In March 2016, the FASB issued authoritative guidance to simplify the accounting for certain aspects of share-based compensation, Accounting Standards Update No, 2016-09 (“ASU 2016-09”). This guidance addresses the accounting for income tax effects at award settlement, the use of an expected forfeiture rate to estimate award cancellations prior to the vesting date and the presentation of excess tax benefits and shares surrendered for tax withholdings on the statement of cash flows. This guidance requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled.  This is a change from the current guidance that requires such activity to be recorded in paid-in capital within stockholder’s equity. This guidance will be applied prospectively and may create volatility in the Company’s effective tax rate depending largely on future events and other factors which may include the Company’s stock price, timing of stock option exercises, the value realized upon vesting or exercise of shares compared to the grant date fair value of those shares and any employee terminations. This guidance also eliminates the requirement to estimate forfeitures, but rather provides for an election that would allow entities to account for forfeitures as they occur. This guidance is effective for fiscal periods beginning after December 15, 2016 and was adopted by the Company in the Six Months. The impact of such adoption was as follows:

 

 

 

In August 2016, the FASB issued authoritative guidance that reduces the diversity in practice of the classification of certain cash receipts and cash payments within the statement of cash flows.  This guidance is effective for fiscal periods beginning after December 15, 2017 and allows for early adoption.  The anticipated impact of the adoption of this guidance on the Company’s consolidated financial statements is still being evaluated.

In October 2016, the FASB issued authoritative guidance which amends the accounting for income taxes on intra-entity transfers of assets other than inventory. This guidance requires that entities recognize the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. The income tax consequences on intra-entity transfers of inventory will continue to be deferred until the inventory has been sold to a third party. This guidance is effective for fiscal years beginning after December 15, 2017, and requires a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. Early adoption is permitted at the beginning of a fiscal year. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements or related disclosures.

On November 17, 2016, the FASB issued authoritative guidance to require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance is effective for fiscal periods beginning after December 15, 2017 and allows for early adoption.  The anticipated impact of the adoption of this guidance on the Company’s consolidated financial statements is still being evaluated.

In January 2017, the FASB issued authoritative guidance to simplify the testing for goodwill impairment by removing step two from the goodwill testing. Under current guidance, if the fair value of a reporting unit is lower than its carrying amount (step one), an entity would calculate an impairment charge by comparing the implied fair value of goodwill with its carrying amount (step two). The implied fair value of goodwill was calculated by deducting the fair value of the assets and liabilities of the respective reporting unit from the reporting unit’s fair value as determined under step one. This guidance instead provides that an impairment charge should be recognized based on the difference between a reporting unit’s fair value and its carrying value. This guidance also does not require a qualitative test to be performed on reporting units with zero or negative carrying amounts. However, entities need to disclose any reporting units with zero or negative carrying amounts that have goodwill and the amount of goodwill allocated to each. This guidance is effective for fiscal years beginning after December 15, 2019, with early adoption permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements or related disclosures.

In May 2017, the FASB issued authoritative guidance to provide clarity and reduce diversity in practice as well as cost and complexity when applying the guidance in Accounting Standards Codification (“ASC”) Topic 718,

Compensation-Stock Compensation, in the event of a change to the terms or conditions of a share-based payment award. Under the new guidance, an entity should account for the effects of a modification unless all of the following are met:

The new guidance does not change the current disclosure requirements. The guidance is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted and should be applied prospectively to awards modified after the adoption date. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements or related disclosures.    

Use of Estimates

 

The preparation of the accompanying condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates and assumptions, including those related to allowance for doubtful accounts, revenue recognition, deferred revenue, income taxes, valuation of intangible assets, impairment of long-lived assets, contingencies and litigation and stock-based compensation. Management bases its estimates on historical and anticipated results, trends and various other assumptions that it believes are reasonable under the circumstances, including expectations about future events. These estimates form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results could differ materially from these estimates.

Income Taxes

 

Income tax provision of $2,002 was recognized for the Second Quarter, resulting in an effective tax rate of 76.4% in the Second Quarter, compared to 37.9% in the second quarter of Fiscal 2017 and compared to (69.8)% for the full year of Fiscal 2017. The effective tax rate for the Second Quarter differs from the statutory rate due to the effect of certain permanent nondeductible expenses, the change in valuation allowance recorded against certain foreign deferred tax assets, unrecognized tax benefits, amortization of tax deductible goodwill acquired in the Hi-Tec Acquisition that is not an available source of income to realize deferred tax assets, foreign tax rate differential, the apportionment of income among state jurisdictions, and the benefit of certain tax credits. The difference in the effective tax rate for the Second Quarter in comparison to Fiscal 2017 was primarily due to nondeductible transaction costs related to the Hi-Tec Acquisition.  Since the transaction costs exceeded the Fiscal 2017 pretax book loss, the result was a significant fluctuation in the Fiscal 2017 effective tax rate.

 

In accordance with authoritative guidance, interest and penalties related to unrecognized tax benefits are included within the provision for taxes in the consolidated statements of operations. The total amount of interest and penalties recognized in the consolidated statements of operations for the Second Quarter was $44 compared to $0 in the second quarter of Fiscal 2017. As of July 29, 2017 and January 28, 2017, the total amount of accrued interest and penalties included in the liability for unrecognized tax benefits was $247 and $167, respectively.

 

The Company files income tax returns in the U.S. federal, California and certain other state jurisdictions, as well as in the Netherlands and other foreign jurisdictions. For federal and Netherlands income tax purposes, the fiscal year ended February 1, 2014 and later tax years remain open for examination by the tax authorities under the normal

three-year statute of limitations. For state tax purposes, the fiscal year ended February 2, 2013 and later tax years remain open for examination by the tax authorities under a four-year statute of limitations.

 

(3)   Business Combinations

 

On December 7, 2016, the Company closed under a Share Purchase Agreement (“SPA”) with Hi-Tec International Holdings BV (“Hi-Tec holdings”) and simultaneous Asset Purchase Agreements (“APAs”) with various third parties, pursuant to which Cherokee Global Brands acquired all of the issued and outstanding equity interests of Hi-Tec Holdings for $87,252 in cash, excluding non-interest bearing liabilities assumed and capitalized transaction costs (the “Hi-tec Acquisition”). The Company has accounted for this transaction under Accounting Standards Update 2017-01.

For the year ended January 28, 2017, the Company also incurred restructuring charges of $3,782 related to the Hi-Tec Acquisition. Restructuring charges consisted of severance, contract termination and other restructuring-related costs. A liability for severance costs is typically recognized when the plan of termination has been communicated to the affected employees and is measured at its fair value at the communication date. Contract termination costs consist primarily of costs that will continue to be incurred under the contract for their remaining terms without economic benefit to the Company. A liability for lease obligations is recognized at the date the Company ceases using the rights conveyed by the lease contract and is measured at its fair value, which is determined based on the remaining contractual lease rentals reduced by estimated sublease rentals. A liability for other restructuring-related costs is measured at its fair value in the period in which the liability is incurred.

 

The assets and liabilities recorded in the preliminary purchase price allocation are provisional, as the Company has not yet obtained all available information necessary to finalize the measurement of such assets and liabilities.  During the six month period ended July, 29, 2017, the Company recorded a working capital adjustment to goodwill of $149.  The measurement of acquired deferred income taxes has not been finalized as the Company is currently in the process of obtaining the necessary information to complete the analysis related to acquired net operating loss carryforwards, including the finalization of the assessment of available tax planning strategies.  In addition, the Company is also waiting on information related to certain pre-acquisition income tax filing positions of Hi-Tec in various taxing jurisdictions that will assist the Company in finalizing the amounts to record for the acquired deferred income taxes. The Company is also waiting on information to assist the Company in finalizing the recording of any assumed uncertain income tax positions. The Company is also finalizing the required working capital true-up in accordance with the SPA, and finalizing the settlement statements in relation to the APA’s. The final allocation of the purchase price is expected to be completed as soon as practicable, but no later than one year from the date of acquisition.  

In connection with the Hi-Tec acquisition, Cherokee Global Brands sold inventory to a third party in the First Quarter. In accordance with ASC 820-10-20, the price received for sale of the inventory represents the approximate fair value of that inventory held for sale as of the December 7, 2016 acquisition date.

(4)   Property and Equipment

 

Property and equipment consisted of the following:

 

 

Computers and related equipment and software are depreciated over three years. Furniture and store fixtures are depreciated over the shorter of five to seven years, or the remaining term of the corresponding license agreement. Leasehold improvements are depreciated over the shorter of five years, or the remaining life of the applicable lease term. Depreciation expense was $185 and $403 for the three and six month periods ended July 29, 2017, respectively,  and $129 and $256 for the three and six month period ended July 30, 2016, respectively.

 

(5)   Intangible Assets

 

Intangible assets consisted of the following:

 

 

 

(6)   (Loss) Earnings Per Share

 

The following table provides a reconciliation of the numerator and denominator of the basic and diluted (loss) earnings per share (“EPS”) computations for the three and six month periods ended July 29, 2017 and July 30, 2016:

 

 

The computation for the diluted number of shares excludes unvested restricted stock units, unexercised stock options and unexercised warrants that are anti-dilutive. There were 1,890 and 1,824 anti-dilutive shares for the three and six month periods ended July 29, 2017, respectively, and 1,014 and 702 anti-dilutive shares for the three and six month periods ended July 30, 2016, respectively.

 

(7)   Capitalization

 

Stock-Based Compensation

 

Effective July 16, 2013, the Company’s stockholders approved the 2013 Stock Incentive Plan and effective June 6, 2016, the Company’s stockholders approved the amendment and restatement of such plan (as amended and restated, the “2013 Plan”). The 2013 Plan serves as the successor to the 2006 Incentive Award Plan (which includes the 2003 Incentive Award Plan as amended by the adoption of the 2006 Incentive Award Plan) (the “2006 Plan”). The 2013 Plan authorizes to be issued (i) 1,200,000 additional shares of common stock, and (ii) 155,486 shares of common stock previously reserved but unissued under the 2006 Plan. No future grants will be awarded under the 2006 Plan, but outstanding awards previously granted under the 2006 Plan continue to be governed by its terms. Any shares of common stock that are subject to outstanding awards under the 2006 Plan which are forfeited, terminate or expire unexercised and would otherwise have been returned to the share reserve under the 2006 Plan will be available for issuance as common stock under the 2013 Plan. The 2013 Plan provides for the issuance of equity‑based awards to officers, other employees and directors.

Stock Options

 

Stock options issued to employees are granted at the market price on the date of grant, generally vest over a three-year period, and generally expire seven to ten years from the date of grant. The Company issues new shares of common stock upon exercise of stock options. The Company has also granted non-plan stock options to certain executives as a material inducement for employment. The Company estimates the fair value of stock-based payment awards on the date of grant using an option-pricing model.

 

Stock-based compensation expense recognized in selling, general and administrative expenses for stock options for the Second Quarter and Six Months was $237 and  $466, respectively, compared to $254 and $550 for the second quarter and six months ended July 30, 2016, respectively.

 

The following table summarizes activity for the Company’s stock options in the Six Months:

 

 

As of July 29, 2017, total unrecognized stock-based compensation expense related to unvested stock options was approximately $1,041, which is expected to be recognized over a weighted average period of approximately 1.52 years. The total fair value of all stock options that vested during the Six Months was $870.

 

Performance Stock Units and Restricted Stock Units

 

In April 2016, the compensation committee of the Company’s board of directors granted certain performance-based equity awards (“performance stock units”) to executives under the 2013 Plan.

 

The performance metric applicable to such awards is compound stock price growth, using the closing price of the Company’s common stock on April 5, 2016, or $16.89, as the benchmark. The target growth rate is 10% annually, which results in an average share price target of (i) $18.58 for Fiscal 2017, (ii) $20.44 for Fiscal 2018 and (iii) $22.48 for Fiscal 2019. The average share price is to be calculated as the average of all market closing prices during the January preceding the applicable fiscal year end. If a target is met at the end of a fiscal year, one third of the shares subject to the award will vest. If the stock price target is not met at the end of a fiscal year, the relevant portion of the shares subject to the award will not vest but will roll over to the following fiscal year. The executive must continue to be employed by the Company through the relevant vesting dates to be eligible for vesting. The target average share price was not achieved for Fiscal 2017.

 

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

 

Stock-based compensation expense recognized in selling, general and administrative expenses for restricted stock units and performance stock units for the Second Quarter and Six Months was $321 and $628, respectively, compared to $363 and $703 for the second quarter and six months ended July 30, 2016.

 

The following table summarizes activity for the Company’s restricted stock units and performance stock units in the Six Months:

 

 

As of July 29, 2017, total unrecognized stock-based compensation expense related to restricted stock units and performance stock units was approximately $1,188, which is expected to be recognized over a weighted average period of approximately 1.01 years.

 

Warrants

As of July 29, 2017, the Company had outstanding a warrant to purchase up to 120,000 shares of Cherokee Global Brands common stock, which was issued in connection with a customer license agreement for the Hi-Tec brand.  The shares subject to the warrant vest in five tranches of 20,000 shares corresponding to the five -year initial term of the related license agreement, plus a 6th tranche that vests only if the license is renewed for a subsequent five year period. The 6th tranche is assigned no value until such time as the related contingency is resolved.

 

For the year ended January 28, 2017, the Company determined the fair value of the outstanding warrants to be $567.  During the three and six month periods ended July 29, 2017, the Company recognized contra-revenue and additional paid in capital of $13 and $26, respectively, related to the amortization of the deferred warrant expense.

 

(8)   Debt

 

Cerberus Credit Facility

On December 7, 2016, in connection with the closing of the Hi-Tec Acquisition, the Company entered into a senior secured credit facility with Cerberus Business Finance, LLC (“Cerberus”), as administrative agent and collateral agent for the lenders from time to time party thereto (such credit facility, the “Cerberus Credit Facility”), pursuant to which the Company is permitted to borrow (i) up to $5,000 under a revolving credit facility, and (ii) up to $45,000 under a term loan facility. Also on December 7, 2016 and in connection with the closing of the Hi-Tec Acquisition, the Company drew down a $45,000 term loan under the Cerberus Credit Facility and used a portion of these borrowings to fund the Hi-Tec Acquisition, including the repayment of substantially all of the outstanding indebtedness of Hi-Tec Holdings, and to repay all amounts owed under the Company’s former credit facility with JPMorgan Chase, N.A. (“JPMorgan”). The Company used the remaining borrowings under the Cerberus Credit Facility for general working capital.  During the Six Months, the Company drew down $5,000 under its revolving credit facility under the Cerberus Credit Facility, none of which was drawn during the Second Quarter.

The Cerberus Credit Facility is secured by a first priority lien on, and security in, substantially all of the assets of the Company and its subsidiaries, is guaranteed by the Company’s subsidiaries, and has a five-year term. The Cerberus Credit Facility bears interest at a rate per annum equal to either the rate of interest publicly announced from time to time by JPMorgan in New York, New York as its reference rate, base rate or prime rate or LIBOR plus, in each case, the applicable margin and subject to the applicable rate floor. Borrowings under the Cerberus Credit Facility are subject to certain maintenance and other fees as set forth therein. The terms of the Cerberus Credit Facility include financial covenants that set financial standards the Company is required to maintain and operating covenants that impose various restrictions and obligations regarding the operation of the Company’s business, including covenants that require the Company to obtain Cerberus’s consent before the Company can take certain specified actions. Events of default

under the Cerberus Credit Facility include, among others, the following: any failure to make payments thereunder when due; the occurrence of certain bankruptcy events; any failure by the Company to meet certain revenue standards after the expiration or termination of any material contracts; the Company or any of its subsidiaries ceases to conduct any material part of their respective businesses; the imposition of penalties, remedies or liabilities on the Company or its subsidiaries in connection with certain criminal or regulatory actions or proceedings; and the occurrence of a change of control of the Company. If an event of default under the Cerberus Credit Facility occurs, subject to certain cure periods for certain events of default, Cerberus would have the right to terminate its obligations thereunder, declare all or any portion of the borrowed amounts then outstanding to be accelerated and due and payable, and/or exercise any other rights or remedies it may have under applicable law, including foreclosing on the Company’s and/or its subsidiaries assets that serve as collateral for the borrowed amounts.

As of July 29, 2017, outstanding borrowings under the Cerberus Credit Facility were $48,800.  Outstanding borrowings are reflected on the accompanying consolidated balance sheet net of unamortized deferred financing costs of $3,256, which will be amortized through the maturity date of the borrowings. In addition, all outstanding borrowings under the Cerberus Credit Facility are reflected as current liabilities on the accompanying consolidated balance sheet because, as of July 29, 2017, as the Company was not in compliance with certain financial covenants set forth in the Cerberus Credit Facility, namely (i) the leverage ratio (as defined and calculated in the Cerberus Credit Facility), which was required to be 16.00 to 1.00, and (ii) the fixed charge coverage ratio (as defined and calculated in the Cerberus Credit Facility), which was required to be 0.25 to 1.00.  The Company does not currently have the cash on hand to repay all of the Cerberus Credit Facility borrowings. See Note 11 for more information.

On August 11, 2017, the Company entered into an amendment (the “Cerberus Amendment”) to the Cerberus Credit Facility to cure the noncompliance with certain financial covenants as of April 29, 2017. See Note 11 for more information.

Related Party Ravich Loan

On December 7, 2016, in connection with the closing of the Hi-Tec Acquisition, the Company obtained an unsecured receivables funding loan for $5,000 from Jess Ravich, one of the Company’s directors (such loan, the “Ravich Loan”). The Ravich Loan bears interest at a rate of 9.5% per annum and is subject to a fee equal to 2.5% of the principal amount of the loan, or $125, which was paid upon the funding of the Ravich Loan. The outstanding principal and accrued interest under the Ravich Loan was due and payable 180 days after the closing of the Hi-Tec Acquisition, or on June 5, 2017, which the Company and the lender of the Ravich Loan agreed on June 5, 2017 to extend to July 31, 2017, and subsequently agreed on August 11, 2017 to further extend to February 28, 2018 (see Note 11). Events of default under the Ravich Loan include, among others, any failure to make payments thereunder when due; any failure to make payments under certain of the Company’s other indebtedness when due; and the occurrence of certain bankruptcy events. If an event of default under the Ravich Loan occurs, subject to certain cure periods for certain events of default, Mr. Ravich would have the right to terminate his obligations thereunder, declare all or any portion of the borrowed amounts then outstanding to be accelerated and due and payable, and/or exercise any other rights or remedies he may have under applicable law. The proceeds of the Ravich Loan were used to fund a portion of the purchase price for the Hi-Tec Acquisition. The Company expects that certain accounts receivable assets that are expected to be collected in the ordinary course of business will be used to repay the Ravich Loan. As of July 29, 2017, outstanding borrowings under the Ravich Loan were approximately $1,500.

 

(9)   Commitments and Contingencies

 

Trademark Indemnities

 

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

Litigation Reserves

 

From time to time, the Company may become involved in various legal proceedings and other similar matters incidental to the Company’s business, the resolution of which is not presently expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity. Estimated reserves for contingent liabilities, including threatened or pending litigation, are recorded as liabilities in the accompanying consolidated balance sheets when the outcome of these matters is deemed probable and the liability is reasonably estimable.

The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the expected probable favorable or unfavorable outcome of each claim. As additional information becomes available, the Company assesses the potential liability related to new claims and existing claims and revises estimates as appropriate. As new claims arise or existing claims evolve, such revisions in estimates of the potential liability could materially impact the Company's results of operations and financial condition. No material amounts were accrued as of July 29, 2017 or January 28, 2017 related to any of the Company’s legal proceedings.

 

 

(10)   Segment Reporting and Geographic Information

 

The following table reconciles the segment activity to the consolidated statement of operations for the three and six months ended July 29, 2017 and the consolidated balance sheet as of July 29, 2017: