10-Q 1 chke-20170429x10q.htm 10-Q chke_Current_Folio_10Q_Taxonomy2015

 

 

 

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 April 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)

 


 

 

 

 

Delaware

 

95-4182437

(State or other jurisdiction of Incorporation or organization)

 

(IRS employer identification number)

 

 

 

5990 Sepulveda Boulevard, Sherman Oaks, CA

 

91411

(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 ☒  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.

 

 

 

 

Large accelerated filer ☐

 

Accelerated filer ☒

 

 

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

Emerging growth company ☐

 

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.

 

 

 

 

Class

 

Outstanding at August 14, 2017

Common Stock, $.02 par value per share

 

13,002,150

 

 


 

CHEROKEE INC.

 

TABLE OF CONTENTS

 

 

 

PART I. FINANCIAL INFORMATION 

    

 

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets
April 29, 2017 and January 28, 2017
 

 

3

 

 

 

Consolidated Statements of Operations
Three month periods ended April 29, 2017 and April 30, 2016
 

 

4

 

 

 

Consolidated Statements of Comprehensive (Loss) Income
Three month periods ended April 29, 2017 and April 30, 2016
 

 

5

 

 

 

Consolidated Statement of Stockholders’ Equity
Three month period ended April 29, 2017
 

 

6

 

 

 

Consolidated Statements of Cash Flows
Three month periods ended April 29, 2017 and April 30, 2016
 

 

7

 

 

 

Notes to Consolidated Financial Statements 

 

8

 

 

 

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 

 

26

 

 

 

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 

 

37

 

 

 

ITEM 4. Controls and Procedures 

 

39

 

 

 

PART II. OTHER INFORMATION 

 

 

 

 

 

ITEM 1. Legal Proceedings 

 

40

 

 

 

ITEM 1A. Risk Factors 

 

41

 

 

 

ITEM 6. Exhibits 

 

56

 

 

 

Signatures 

 

57

 

 

 

 

 

 

 

 

2


 

PART 1. FINANCIAL INFORMATION

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

CHEROKEE INC.

CONSOLIDATED BALANCE SHEETS

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

 

 

 

 

 

 

 

 

 

 

 

April 29,

    

January 28,

 

 

 

2017

 

2017

 

 

 

(Unaudited)

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

5,700

 

$

8,378

 

Receivables

 

 

14,236

 

 

21,873

 

Other receivables

 

 

4,048

 

 

3,292

 

Income taxes receivable

 

 

2,213

 

 

1,020

 

Inventory, net

 

 

1,661

 

 

1,567

 

Prepaid expenses and other current assets

 

 

3,834

 

 

5,010

 

Total current assets

 

 

31,692

 

 

41,140

 

Intangible assets, net

 

 

105,917

 

 

106,193

 

Goodwill

 

 

15,735

 

 

15,794

 

Property and equipment, net

 

 

1,445

 

 

1,311

 

Other assets

 

 

1,438

 

 

1,578

 

Total assets

 

$

156,227

 

$

166,016

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable and other accrued payables

 

$

18,708

 

$

26,736

 

Current portion of long term debt

 

 

1,242

 

 

1,241

 

Related party Ravich loan

 

 

1,458

 

 

3,896

 

Deferred revenue—current

 

 

5,572

 

 

7,015

 

Accrued compensation payable

 

 

557

 

 

935

 

Income taxes payable—current

 

 

364

 

 

347

 

Total current liabilities

 

 

27,901

 

 

40,170

 

Long term liabilities:

 

 

 

 

 

 

 

Deferred tax liability

 

 

7,928

 

 

7,718

 

Income taxes payable—non-current

 

 

3,271

 

 

3,041

 

Long term debt

 

 

46,308

 

 

41,595

 

Other non-current

 

 

1,122

 

 

1,174

 

Total liabilities

 

 

86,530

 

 

93,698

 

Commitments and Contingencies (Note 9)

 

 

 

 

 

 

 

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, 12,953,783 shares issued and outstanding at April 29, 2017 and 12,951,284 issued and outstanding at January 28, 2017

 

 

259

 

 

259

 

Additional paid-in capital

 

 

67,161

 

 

66,612

 

Retained earnings

 

 

2,155

 

 

5,414

 

Accumulated other comprehensive income

 

 

122

 

 

33

 

Total stockholders’ equity

 

 

69,697

 

 

72,318

 

Total liabilities and stockholders’ equity

 

$

156,227

 

$

166,016

 

 

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

 

3


 

CHEROKEE INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(amounts in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

April 29,

 

April 30,

 

 

    

2017

    

2016

 

Royalty revenues

 

$

6,840

 

$

10,678

 

Indirect product sales

 

 

4,273

 

 

 —

 

Total revenues

 

 

11,113

 

 

10,678

 

Cost of goods sold

 

 

3,008

 

 

 —

 

Gross profit

 

 

8,105

 

 

10,678

 

Selling, general and administrative expenses

 

 

9,791

 

 

6,176

 

Amortization of intangible assets

 

 

266

 

 

226

 

Restructure charges

 

 

128

 

 

 —

 

Operating (loss) income

 

 

(2,080)

 

 

4,276

 

Other income (expense):

 

 

 

 

 

 

 

Interest expense

 

 

(1,498)

 

 

(197)

 

Other income (expense), net

 

 

(129)

 

 

 —

 

Total other expense, net

 

 

(1,627)

 

 

(197)

 

(Loss) income before income taxes

 

 

(3,707)

 

 

4,079

 

Income tax (benefit) provision

 

 

(448)

 

 

1,498

 

Net (loss) income

 

$

(3,259)

 

$

2,581

 

Net (loss) income per common share attributable to common stockholders:

 

 

 

 

 

 

 

Basic (loss) earnings per share

 

$

(0.25)

 

$

0.30

 

Diluted (loss) earnings per share

 

$

(0.25)

 

$

0.29

 

Weighted average common shares outstanding attributable to common stockholders:

 

 

 

 

 

 

 

Basic

 

 

12,953

 

 

8,720

 

Diluted

 

 

12,953

 

 

8,833

 

 

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

4


 

CHEROKEE INC.

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

Unaudited

(amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

April 29,

    

April 30,

 

 

    

2017

    

2016

 

Net (loss) income

 

$

(3,259)

 

$

2,581

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

89

 

 

 —

 

Other comprehensive (loss) income:

 

 

89

 

 

 —

 

Comprehensive (loss) income

 

$

(3,170)

 

$

2,581

 

 

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

5


 

CHEROKEE INC.

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

(amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Other

 

 

 

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Comprehensive

 

 

 

 

 

    

Shares

    

Par Value

    

Capital

    

Earnings

    

Income

    

Total

 

Balance at January 28, 2017

 

12,951

 

$

259

 

$

66,612

 

$

5,414

 

$

33

 

$

72,318

 

Stock-based compensation

 

 —

 

 

 —

 

 

536

 

 

 —

 

 

 —

 

 

536

 

Equity issuances, net of tax

 

 3

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Stock warrants

 

 —

 

 

 —

 

 

13

 

 

 —

 

 

 —

 

 

13

 

Foreign currency

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

89

 

 

89

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

(3,259)

 

 

 —

 

 

(3,259)

 

Balance at April 29, 2017

 

12,954

 

$

259

 

$

67,161

 

$

2,155

 

$

122

 

$

69,697

 

 

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

6


 

CHEROKEE INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

    

April 29, 2017

    

April 30, 2016

 

Operating activities:

 

 

 

 

 

 

 

Net (loss) income

 

$

(3,259)

 

$

2,581

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation

 

 

220

 

 

127

 

Bad debt expense

 

 

186

 

 

 

 

Amortization of intangible assets

 

 

266

 

 

226

 

Amortization of debt discounts/deferred financing fees

 

 

295

 

 

 3

 

Deferred income taxes

 

 

210

 

 

135

 

Stock-based compensation

 

 

536

 

 

636

 

Warrants

 

 

13

 

 

 —

 

Other, net

 

 

207

 

 

18

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Receivables

 

 

5,741

 

 

(3,527)

 

Other receivables

 

 

(756)

 

 

 —

 

Prepaids and other current assets

 

 

1,161

 

 

(35)

 

Income taxes receivable and payable, net

 

 

(945)

 

 

484

 

Inventories

 

 

(94)

 

 

 —

 

Accounts payable and other accrued payables

 

 

(6,291)

 

 

280

 

Deferred revenue

 

 

(1,625)

 

 

 3

 

Accrued compensation

 

 

(378)

 

 

(171)

 

Net cash (used in) provided by operating activities

 

 

(4,513)

 

 

760

 

Investing activities:

 

 

 

 

 

 

 

Purchases of trademarks, including registration and renewal cost

 

 

 —

 

 

(15)

 

Purchase of property and equipment

 

 

(354)

 

 

(44)

 

Net cash used in investing activities

 

 

(354)

 

 

(59)

 

Financing activities:

 

 

 

 

 

 

 

Proceeds from Cerberus loan

 

 

5,000

 

 

 —

 

Payments of Cerberus loan

 

 

(400)

 

 

 —

 

Payments of Ravich loan

 

 

(2,500)

 

 

 —

 

Payments of JPMorgan Term Notes

 

 

 —

 

 

(2,136)

 

Net cash provided by (used in) financing activities

 

 

2,100

 

 

(2,136)

 

Effect of exchange rate changes on cash

 

 

89

 

 

 —

 

(Decrease) in cash and cash equivalents

 

 

(2,678)

 

 

(1,435)

 

Cash and cash equivalents at beginning of period

 

 

8,378

 

 

6,534

 

Cash and cash equivalents at end of period

 

$

5,700

 

$

5,099

 

Cash paid during period for:

 

 

 

 

 

 

 

Income taxes

 

$

359

 

$

894

 

Interest

 

$

1,128

 

$

180

 

 

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

7


 

CHEROKEE INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

 

(1)   Basis of Presentation

 

The accompanying unaudited consolidated financial statements as of April 29, 2017 and for the three month periods ended April 29, 2017 and April 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) and have not been audited by independent registered public accountants, but include all adjustments, consisting of normal recurring accruals, which in the opinion of management of Cherokee Global Brands are necessary for a fair statement of the Company’s financial condition and the results of operations for the periods presented. All material intercompany accounts and transactions have been eliminated during the consolidation process. The accompanying consolidated balance sheet as of January 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 month period ended April 29, 2017 are not necessarily indicative of the financial condition or results to be expected for the fiscal year ending February 3, 2018 or any other 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, the term “First Quarter” refers to the three months ended April 29, 2017; the term “Fiscal 2019” refers to the fiscal year ending February 2, 2019; the term “Fiscal 2018” refers to the fiscal year ending February 3, 2018; the term “Fiscal 2017” refers to the fiscal year ended January 28, 2017; and the term “Fiscal 2016” refers to the fiscal year ended January 30, 2016.

 

(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

8


 

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 First Quarter. The impact of such adoption was as follows:

·

ASU 2016-09 requires companies to amend the presentation of employee shared-based payment-related items in the statement of cash flows as follows: (i) excess tax benefits are presented as an operating activity (such cash flows were previously included in cash flows from financing activities), and (ii) cash paid for employee taxes on withheld shares from equity awards is presented as a financing activity (such cash flows were previously included in cash flows from operating activities). These changes did not have an impact on the Company’s consolidated financial statements in the periods presented, as there were no excess tax benefits or shares withheld for tax purposes related to employee share-based payments during the three month periods ended April 29, 2017 or April 30, 2016.

 

·

ASU 2016-09 allows companies to make an entity-wide accounting policy election to either estimate and apply a forfeiture rate to reduce stock compensation expense during the vesting period or account for forfeitures as they occur. ASU 2016-09 requires that this change be adopted using the modified retrospective approach. The Company elected to continue to estimate the number of forfeitures related to share-based payments, rather than account for forfeitures as they occur, and as a result there was no impact on the Company’s consolidated financial statements.

 

·

ASU 2016-09 eliminates additional paid-in capital ("APIC") pools and requires excess tax benefits and tax deficiencies to be recorded in the statement of operations when awards vest or are settled. ASU 2016-09 requires that this change be adopted prospectively. This change did not have a material impact on the Company’s consolidated financial statements for the First Quarter, as awards vested or settled in the First Quarter were insignificant.

 

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

9


 

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.

Receivables

 

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

 

Allowance for Doubtful Accounts

 

The Company records an allowance for doubtful accounts based upon its assessment of various factors, such as: historical experience, age of accounts receivable balances, credit quality of the Company’s licensees, distributors or franchisees, current economic conditions, bankruptcy, and other factors that may affect the Company’s licensees’, distributors’ or franchisees’ ability to pay. The allowance for doubtful accounts was $667 and $481 as of April 29, 2017 and January 28, 2017, respectively.

   

Use of Estimates

 

The preparation of the accompanying 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.

10


 

Cash and Cash Equivalents

 

The Company considers all highly liquid debt instruments purchased and money market funds purchased with an original maturity date of three months or less to be cash equivalents, if applicable. At April 29, 2017 and January 28, 2017, the Company’s cash and cash equivalents exceeded Federal Deposit Insurance Corporation limits.

 

Revenue Recognition and Deferred Revenue

 

The Company recognizes revenue when persuasive evidence of a sale arrangement exists, delivery has occurred or services have been rendered, the buyer’s price is fixed or determinable and collection is reasonably assured. Revenues from royalty and brand representation agreements are recognized when earned by applying contractual royalty rates to quarterly point of sale data received from the Company’s licensees. The Company's royalty 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.  Revenue from the Company’s indirect product sales is recognized when products are shipped and the customer takes title and assumes risk of loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable.

Revenues from arrangements involving license fees, up-front payments and milestone payments, which are received or billable by the Company in connection with other rights and services that represent continuing obligations of the Company, are deferred and recognized in accordance with the license agreement. Deferred revenues also represent minimum licensee royalty revenues paid in advance of the culmination of the earnings process, the majority of which are non‑refundable to the licensee. Deferred revenues will be recognized as revenue in future periods in accordance with the license agreement.

Franchise revenues includes royalties and franchise fees. Royalties from franchisees are based on a percentage of net sales of the franchisee and are recognized as earned. Initial franchise fees are recorded as deferred revenue when received and are recognized as revenue when a franchised location commences operations, as all material services and conditions related to the initial franchise fee have been substantially performed upon the location opening. Renewal franchise fees are recognized as revenue when the franchise agreements are signed and the fee is paid, since there are no other material services and conditions related to these franchise fees.

In order to ensure that the Company’s licensees and franchisees are appropriately reporting and calculating royalties owed to the Company, all of the Company’s license and franchise agreements include audit rights to allow Cherokee Global Brands to validate the amount of the royalties paid. Differences between amounts initially recognized and amounts subsequently audited or reported as an adjustment to the amounts due from licensees or franchisees is recognized in the reporting period in which the differences become known and are determined to be collectible.

The Company is responsible for the enforcement of its intellectual property and for pursuing third parties that are utilizing its assets without a license. As a result of these activities, from time to time, the Company may recognize royalty revenues that relate to infringements that occurred in prior periods. These royalty recoveries may cause revenues to be higher than expected during a particular reporting period, which increases may not recur in subsequent periods.

Foreign Withholding Taxes

 

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

 

Deferred Financing Costs and Debt Discount

 

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

11


 

 

Property and Equipment

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

Intangible Assets

 

The Company holds various trademarks, including Cherokee®, Hi-Tec ®, Magnum ®, 50 Peaks®, Interceptor®, Hawk Signature®, Tony Hawk®, Liz Lange®, Completely Me by Liz Lange®, Flip Flop Shops®, Everyday California®, Carole Little®,  Sideout®, Sideout Sport®, Saint Tropez-West®, Chorus Line®, All That Jazz®, and others, in connection with numerous categories of apparel and other goods. These trademarks are registered with the United States Patent and Trademark Office and corresponding government agencies in a number of other countries. The Company also holds trademark applications for each of these brand names and others in numerous countries. The Company intends to renew these registrations, as appropriate, prior to expiration. The Company monitors on an ongoing basis unauthorized uses of the Company’s trademarks, and relies primarily upon a combination of trademarks, know-how, trade secrets, and contractual restrictions to protect the Company’s intellectual property rights domestically and internationally.

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

Franchise agreements have been treated as finite-lived and are amortized on a straight-line basis over the estimated useful lives of the agreements. Franchise agreements are evaluated for the possibility of impairment at least annually or when events or circumstances indicate a potential impairment.

Goodwill and Indefinite-Lived Assets

Goodwill and indefinite-lived assets are tested annually for impairment or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level which may be either an operating segment or one level below an operating segment if discrete financial information is available. Two or more reporting units within an operating segment may be aggregated for impairment testing if they have similar economic characteristics. In accordance with authoritative guidance, the Company may first assess qualitative factors relevant in determining whether it is more likely than not that the fair value of its reporting units are less than their carrying amounts. Based on this analysis, the Company may determine whether it is necessary to perform a quantitative impairment test. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the amount of any impairment loss to be recognized for that reporting unit is determined using two steps. First, the Company determines the fair value of the reporting unit using a discounted cash flow analysis, which requires unobservable inputs (Level 3) within the fair value hierarchy. These inputs include selection of an appropriate discount rate and the amount and timing of expected future cash flows. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill and other intangible assets over the implied fair value. The implied fair value is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with authoritative guidance.

Valuation of Assets and Liabilities in Connection with Business Combinations

The Company has acquired material intangible assets in connection with business combinations. These intangible assets consist primarily of trademarks, brand names and distributor, wholesaler and retailer relationships. 

12


 

Discounted cash flow models are typically used to determine the fair values of these intangible assets for purposes of allocating consideration paid to the net assets acquired in a business combination. These models require the use of significant estimates and assumptions, including, but not limited to, estimating the timing and amount of future net cash flows from intangible asset groupings and developing appropriate discount rates to calculate the present value of cash flows.

Significant estimates and assumptions are also required to determine the acquisition date fair values of certain tangible assets such as inventory.  The Company believes the fair values used to record intangible and tangible assets acquired in connection with business combinations are based upon reasonable estimates and assumptions given the facts and circumstances as of the related valuation dates.

Fair Value of Financial Instruments

 

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

 

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

 

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

 

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

 

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

 

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

Income Taxes

 

Income tax benefit of $448 was recognized for the First Quarter, resulting in an effective tax rate of (12.1)% in the First Quarter, compared to 36.7% in the first quarter of Fiscal 2017 and compared to (69.8)% for the full year of Fiscal 2017. The effective tax rate for the First 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 First 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.

 

13


 

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 First Quarter was $20 compared to $0 in the first quarter of Fiscal 2017. As of April 29, 2017 and January 28, 2017, the total amount of accrued interest and penalties included in the liability for unrecognized tax benefits was $187 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.

Marketing and Advertising

 

Generally, the Company’s licensees fund their own advertising programs. Cherokee Global Brands’ marketing, advertising and promotional costs were approximately $815 and $281 for the three month periods ended April 29, 2017 and April 30, 2016, respectively. These costs are expensed as incurred and were accounted for as selling, general and administrative expenses.

 

The Company provides marketing expense money to certain large licensees based upon sales criteria to help them build the Company’s licensed brands in their respective territories, thus providing an identifiable benefit to Cherokee Global Brands. The amounts paid for such marketing expenses during the three month periods ended April 29, 2017 and April 30, 2016 were approximately $152 and $157, respectively, and are included in the Company’s total marketing, advertising and promotional costs.

 

(Loss) Earnings Per Share Computation

 

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

Comprehensive (Loss) Income

 

Authoritative guidance establishes standards for reporting comprehensive (loss) income and its components in consolidated financial statements. Comprehensive (loss) income, as defined, includes all changes in equity (net assets) during a period. For the period ended April 29, 2017, the Company had a foreign currency translation adjustment of $89 included in comprehensive income.  For the period ended April 30, 2016, the Company had no comprehensive (loss) income components and accordingly, net (loss) income equals comprehensive (loss) income.

 

Foreign Currency Translation Adjustment

The local selling currency is typically the functional currency for all of the Company’s international operations, and in certain cases the U.S. dollar is the functional currency. In accordance with authoritative guidance, assets and liabilities of the Company’s foreign operations are translated from foreign currencies into U.S. dollars at period-end rates, while income and expenses are translated at the weighted average exchange rates for the period.

Foreign Currency Transaction Gains and Losses

Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in  currencies other than the Company’s functional currency, including gains and losses on foreign currency contracts, are included in the accompanying consolidated statements of operations. Gains or losses related to transactions where settlement is anticipated, or those that result from the remeasurement of receivables and payables denominated in currencies other than the Company’s functional currency, are included in other income (expense), net in the

14


 

accompanying consolidated statements of operations.  All long term assets are valued at their historical costs in U.S. dollars and therefore no gain or loss is recognized.  All intercompany transactions are recorded in U.S. dollars and therefore no gain or loss is recognized.

Treasury Stock

 

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

 

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

 

Additionally, if treasury stock is retired, the excess of the repurchase price for the shares over their par value is recorded as a decrease in retained earnings.

 

Deferred Rent and Lease Incentives

 

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

Stock-Based Compensation

The Company accounts for equity awards in accordance with authoritative guidance, which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values.

The fair value of stock options and other stock-based awards is estimated using option valuation models. These models require the input of subjective assumptions, including expected stock price volatility, risk free interest rate, dividend rate, estimated life and estimated forfeitures of each award. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service period in the consolidated statements of operations. The compensation expense recognized for all stock-based awards is net of estimated forfeitures over the award’s service period. The fair value of stock-based awards is amortized over the vesting period of the award, and the Company has elected to use the graded amortization method. The Company makes quarterly assessments of the adequacy of the tax credit pool to determine if there are any deficiencies which require recognition in the accompanying consolidated statements of operations.

Inventories

Inventories acquired through business combinations are recorded at fair value upon acquisition.  Purchased inventories are valued at the lower of cost or market using a standard cost method.  Standard cost consists of the direct purchase price of merchandise inventory, in-bound freight-related costs and customs or duties. Inventory is comprised of finished goods. Management regularly reviews inventories and records valuation reserves for damaged and defective merchandise, merchandise items with slow-moving or obsolescence exposure and merchandise that has a carrying value that exceeds net realizable value. There were no inventory reserve accounts as of April 29, 2017 and January 28, 2017.

15


 

Cost of Goods Sold

Cost of goods sold relates to payments remitted to manufacturers or distributors of purchased products that are sold to wholesalers and government entities through indirect product sales. The wholesalers and government entities that purchase products submit payments directly to us for their product orders, and we then remit a portion of these payments, representing the product cost, to the manufacturer or distributor of the purchased products.

Restructuring Charges

Restructuring charges consist 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 operating leases for their remaining terms without economic benefit to the Company, offset by any sublease income to be received thereafter. A liability for contract termination costs 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.

Warrants

The Company accounts for warrants under Accounting Standards Codification (“ASC”) 505-50 Equity-based payments to non-employees. Because the warrants are assessed to be equity in nature, they are measured at fair value at inception. The warrants are recognized in APIC and contra revenue over the period the related revenue from the license is expected to be recognized, in accordance with ASC 605-60-25 and ASC 505-50-S99-1.

 

(3)   Business Combinations

 

On December 7, 2016, the Company closed a Share Purchase Agreement (“Hi-Tec Acquisition” or “SPA”) with Hi-Tec International Holdings BV (“Hi-Tec”) 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 for $87,252 in cash, excluding non-interest bearing liabilities assumed and capitalized transaction costs. Cherokee Global Brands created a legal entity entitled Irene Acquisition Company B.V. (the “buyer”) to execute the transaction. 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restructuring Costs Accrued (amounts in thousands)

    

January 28, 2017

 

Q1 FY 2018
Payments

 

April 29, 2017

Contract termination costs

 

$

386

 

 

(84)

 

$

302

Leases, net of sublease

 

 

1,920

 

 

(291)

 

 

1,629

Severance costs

 

 

1,270

 

 

(482)

 

 

788

Service costs

 

 

206

 

 

(93)

 

 

113

Total Restructuring costs identified

 

$

3,782

 

 

(950)

 

$

2,832

 

 

 

 

 

 

 

 

 

 

16


 

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 First Quarter, the Company recorded a working capital adjustment to goodwill of $59.  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 consist of the following:

 

 

 

 

 

 

 

 

 

(amounts in thousands)

    

April 29, 2017

    

January 28, 2017

 

Computer Equipment

 

$

645

 

$

633

 

Software

 

 

295

 

 

156

 

Furniture and Fixtures

 

 

2,041

 

 

2,006

 

Leasehold Improvements

 

 

784

 

 

520

 

Work in Process

 

 

 —

 

 

128

 

Less: Accumulated depreciation

 

 

(2,320)

 

 

(2,132)

 

Property and Equipment, net

 

$

1,445

 

$

1,311

 

 

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 $220 for the three month period ended April 29, 2017 and $127 for the three month period ended April 30, 2016, respectively.

 

17


 

(5)   Intangible Assets

 

Intangible assets consist of the following:

 

 

 

 

 

 

 

 

 

(amounts in thousands)

    

April 29, 2017

    

January 28, 2017

 

Acquired Trademarks

 

$

114,694

 

$

114,694

 

Other Trademarks

 

 

8,777

 

 

8,787

 

Franchise Agreements

 

 

1,300

 

 

1,300

 

Goodwill

 

 

15,735

 

 

15,794

 

Total Intangible Assets, gross

 

 

140,506

 

 

140,575

 

Accumulated amortization

 

 

(18,854)

 

 

(18,588)

 

Total Intangible Assets, net

 

$

121,652

 

$

121,987

 

 

 

(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 month periods ended April 29, 2017 and April 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

    

April 29, 2017

    

April 30, 2016

 

Numerator:

 

 

 

 

 

 

 

Net income (loss)-numerator for net income (loss) per common share and net income (loss) per common share assuming dilution

 

$

(3,259)

 

$

2,581

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

Denominator for net income (loss) per common share — weighted average shares

 

 

12,953

 

 

8,720

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

 —

 

 

113

 

 

 

 

 

 

 

 

 

Denominator for net income (loss) per common share, assuming dilution:

 

 

 

 

 

 

 

Adjusted weighted average shares and assumed exercises

 

 

12,953

 

 

8,833

 

 

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 1,769 and 674 anti-dilutive shares for the three month periods ended April 29, 2017 and April 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) 136,484 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.

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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 was $229 and $295 for the First Quarter and the first quarter ended April 30, 2016, respectively.

 

The following table summarizes activity for the Company’s stock options in the First Quarter:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

 

 

 

Remaining

 

 

 

 

 

 

 

Weighted

 

Contractual

 

Aggregate

 

 

 

 

 

Average

 

Term

 

Intrinsic

 

 

    

Shares

    

Price

    

(in years)

    

Value

 

Outstanding, at January 28, 2017

 

1,092,502

 

$

16.59

 

3.66

 

 —

 

Granted

 

 —

 

$

 —

 

 

 

 

 

Exercised

 

 —

 

$

 —

 

 

 

 

 

Canceled/forfeited

 

(25,667)

 

$

 —

 

 

 

 

 

Outstanding, at April 29, 2017

 

1,066,835

 

$

16.57

 

3.33

 

 —

 

Vested and Exercisable at April 29, 2017

 

670,492

 

$

16.03

 

2.59

 

 —

 

 

As of April 29, 2017, total unrecognized stock-based compensation expense related to unvested stock options was approximately $1,184, which is expected to be recognized over a weighted average period of approximately 1.66 years. The total fair value of all stock options that vested during the First Quarter was $29.  

 

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, or 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 will 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-based equity awards 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.

 

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Stock-based compensation expense recognized in selling, general and administrative expenses for restricted stock units and performance stock units was $307 and $341 for the First Quarter and the first quarter ended April 30, 2016.

 

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

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

Number of

 

Grant-Date

 

 

    

Shares

    

Fair Value

 

Unvested stock at January 28, 2017

 

157,169

 

$

19.71

 

Granted

 

 —

 

 

 —

 

Vested

 

(2,500)

 

 

22.94

 

Forfeited

 

(7,500)

 

 

19.52

 

Unvested stock at April 29, 2017

 

147,169

 

$

19.66

 

 

As of April 29, 2017, total unrecognized stock-based compensation expense related to restricted stock units and performance stock units was approximately $1,507, which is expected to be recognized over a weighted average period of approximately 1.24 years.

 

Warrants

The Company issued warrants to purchase 120,000 shares of Cherokee Global Brands common stock in connection with a Hi-Tec customer license agreement.  The warrants vest in five tranches of 20,000 shares corresponding to the five year initial term of the license, plus a 6th tranche which 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 stock warrants to be $567.  During the three month period ended April 29, 2017, the Company recognized contra-revenue and additional paid in capital of $13, 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, and to repay all amounts owed under the prior JPMorgan Credit Agreement. The Company expects to use the remaining borrowings under the Cerberus Credit Facility for general working capital.  During the First Quarter, the Company drew down $5,000 under its revolving credit facility under the Cerberus Credit Facility. 

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

20


 

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 April 29, 2017, outstanding borrowings under the Cerberus Credit Facility were $49,200.  Outstanding borrowings are reflected on the accompanying condensed consolidated balance sheet net of unamortized deferred financing costs of $1,650, which will be amortized through the maturity date of the borrowings.  As of April 29, 2017, the Company was not in compliance with certain reporting requirements under the Cerberus Credit Facility as a result of its late filing of the quarterly report in which these consolidated financial statements are included, or with certain financial covenants set forth in the Cerberus Credit Facility.  However, following April 29, 2017, the Company obtained a waiver from Cerberus of these events of default and agreed with Cerberus to certain amendments to the terms of the Cerberus Credit Facility. See Note 11 for additional 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 our  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 (although such maturity date has been extended by the Company and the lender of the Ravich Loan subsequent to April 29, 2017, 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 April 29, 2017, outstanding borrowings under the Ravich Loan were approximately $1,500. The Company was in compliance with its covenants under the Ravich Loan as of April 29, 2017. 

 

(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.

 

21


 

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 April 29, 2017 or January 28, 2017 related to any of the Company’s legal proceedings.

 

 

(10)   Segment Reporting and Geographic Information

 

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

As a result of the Hi-Tec acquisition, the Company’s reportable segments beginning in Fiscal 2017 consist of Cherokee Global Brands and Hi-Tec, for which Cherokee Global Brand’s chief-operating decision maker internally evaluates operating performance and financial results. For the three month period ended April 30, 2016 the Company considered the business activities to constitute a single segment, the marketing and licensing of brand names and trademarks for apparel, footwear and accessories. Cherokee Global Brands’ marketing and licensing activities extend to brands which the Company owns and to brands owned by others. Cherokee Global Brands’ operating activities relating to owned and represented brands are identical and are performed by a single group of marketing professionals.

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

 

 

 

 

 

 

 

 

 

 

 

(amounts in thousands)

    

Cherokee Global Brands

 

Hi-Tec

 

Consolidated

 

Royalty revenues

 

$

5,180

 

$

1,660

 

$

6,840

 

Indirect product sales

 

 

 —

 

 

4,273

 

 

4,273

 

Amortization of intangible assets

 

 

224

 

 

42

 

 

266

 

Other (expense) income , net

 

 

(877)

 

 

(750)

 

 

(1,627)

 

Income tax provision

 

 

1,008

 

 

(560)

 

 

448

 

Net (loss) income

 

$

(1,287)

 

$

(1,972)

 

$

(3,259)

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

 

100

 

 

15,635

 

 

15,735

 

Total assets

 

$

65,871

 

$

90,356

 

$

156,227

 

22


 

 

Revenues by geographic area based upon the licensees’ country of domicile consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

(amounts in thousands)

    

April 29, 2017

 

April 30, 2016

    

 

 

 

U.S. and Canada

 

$

3,189

 

$

8,121

 

 

 

 

Asia

 

 

1,105

 

 

1,102

 

 

 

 

Latin America

 

 

568

 

 

554

 

 

 

 

Africa

 

 

467

 

 

260

 

 

 

 

United Kingdom and Europe

 

 

1,116

 

 

155

 

 

 

 

All Others

 

 

395

 

 

486

 

 

 

 

Total

 

$

6,840

 

$

10,678

 

 

 

 

 

Long-lived tangible assets were located in the U.S., United Kingdom and Europe, Mexico and Asia with net values of approximately $702,  $558,  $176 and $9, respectively, as of April 29, 2017 and with net values of approximately $750,  $349,  $196 and $16, respectively, as of January 28, 2017.

 

(11)   Subsequent Events

 

Cerberus Credit Facility – Forbearance, Waiver and Amendment

 

On June 27, 2017, the Company obtained a forbearance from Cerberus regarding (i) the Company’s failure to comply with certain reporting covenants under the Cerberus Credit Facility as a result of the Company’s late filing of the quarterly report in which these consolidated financial statements are included, and (ii) the Company’s failure to meet certain financial covenants set forth in the Cerberus Credit Facility, namely the required leverage ratio (as defined and calculated in the Cerberus Credit Facility) of 3.00 to 1.00 and the required fixed charge ratio (as defined and calculated in the Cerberus Credit Facility) of 1.50 to 1.00. Pursuant to the forbearance, Cerberus agreed that it would not exercise its rights or remedies under the Cerberus Credit Facility solely with respect to these events of default through July 7, 2017, which was subsequently extended on multiple occasions through August 11, 2017.

 

On August 11, 2017, the Company entered into an amendment (the “Cerberus Amendment”) to the Cerberus Credit Facility. The Cerberus Amendment includes a waiver of all events of default under the Cerberus Credit Facility described above and amends certain other terms thereof, as follows:  (i) the required leverage ratio (as defined and calculated in the Cerberus Credit Facility) has been amended to 16.00 to 1.00 through July 31, 2017, 10.50 to 1.00 through October 31, 2017, and decreasing ratios at the end of each of the Company’s fiscal quarters thereafter as set forth therein; (ii) the required fixed charge coverage ratio (as defined and calculated in the Cerberus Credit Facility) has been amended to 0.25 to 1.00 through July 31, 2017, 0.35 to 1.00 through October 31, 2017, and increasing ratios at the end of each of the Company’s fiscal quarters thereafter as set forth therein; (iii) the Company has agreed to a new liquidity covenant that requires the Company to maintain an amount of unrestricted cash on-hand, together with the availability under the revolving credit facility of the Cerberus Credit Facility, of no less than $3,000, and (iv) the parties have agreed to certain additional administrative amendments. The Cerberus Amendment also provides that, if at any time the new liquidity covenant is not satisfied and Cerberus submits a written capital demand, the Company would be required to complete an equity financing resulting in net cash proceeds to the Company of the amount requested by Cerberus in such demand, subject to an aggregate maximum of approximately $5,500 and certain additional conditions (such financings, the “Committed Financings”). The Company anticipates that it will be able to satisfy the amended covenants described above for at least the next twelve months.

 

As a condition to effectiveness of the Cerberus Amendment, the Company is required to: (i) complete the Concurrent Financing, as defined and described below, and (ii) obtain a firm commitment from one or more investors to fund one or more Committed Financings if required on or before March 5, 2018, which is also described below.

 

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Concurrent Financing and Committed Financing

 

On August 11, 2017, the Company and several investors, including certain of the Company’s directors, officers and large stockholders, entered into common stock purchase agreements (the “Purchase Agreements”) to effect the Concurrent Financing and agree to the Committed Financing as required by the Cerberus Amendment. Pursuant to the terms of the Purchase Agreements, the investors have agreed to purchase, and the Company has agreed to issue and sell, an aggregate of 947,870 shares of the Company’s common stock in a private placement financing at a per share purchase price of $4.22 for net cash proceeds to the Company of approximately $4,000 (the “Concurrent Financing”). The Concurrent Financing closed on August 17, 2017.

 

In addition, pursuant to the terms of the Purchase Agreements, certain investors have agreed to participate in the Committed Financings, such that, if the Company notifies any such investor on or before March 5, 2018 of a failure to meet the new liquidity covenant set forth in the Cerberus Amendment, then such investor will be obligated to purchase in a private placement financing additional shares of the Company’s common stock as requested at a per share purchase price equal to the lower of $4.22,  90% of the average closing price of the Company’s common stock for the 20 days prior to the date of the Company’s notification, or the closing price of the Company’s common stock on the day prior to the Company’s notification, subject to certain other conditions and caps, including that the aggregate number of shares issuable in the Concurrent Financing and the Committed Financings will not exceed 19.9% of the total number of shares of the Company’s common stock outstanding as of August 11, 2017. The maximum aggregate value of the commitments from all investors for the Committed Financings is approximately $5,500. In addition, pursuant to the terms of the Purchase Agreements, in consideration for the agreement of certain investors to participate in the Committed Financings, the Company has issued to such investors warrants to purchase up to an aggregate of 326,695 shares of the Company’s common stock at an exercise price of $4.22. The warrants are exercisable at any time from March 5, 2018 until the seven-year anniversary of the initial issuance date, may be exercised in cash or on a “cashless” basis, and are subject to customary adjustments in the event of stock dividends or other distributions, stock splits, or mergers, reclassifications or similar transactions.

 

Certain terms of the Concurrent Financing and the Committed Financing with respect to each of the Company’s directors, officers and large stockholders participating therein are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Name of Investor,
Relationship with the Company

 

No. of Shares Purchased in Concurrent Financing

 

No. of Shares Subject to Warrant Issued in Concurrent Financing

 

Aggregate Purchase Price of Shares Purchased in Concurrent Financing

 

Aggregate Purchase Price of Shares That May Be Purchased in Committed Financings

 

Aggregate Purchase Price of all Shares(1)

Jess Ravich,
Director

 

473,934

 

237,834

 

$

2,000

 

$

4,015

 

$

6,015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Robert Galvin,
Chairman of the Board

 

23,697

 

5,924

 

$

100

 

$

100

 

$

200

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Howard Siegel,
President, Chief Operating Officer

 

23,697

 

 

$

100

 

$

 

$

100

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cove Street Capital, LLC
Significant Stockholder

 

236,967

 

59,241

 

$

1,000

 

$

1,000

 

$

2,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Investors

 

189,575

 

23,696

 

$

800

 

$

400

 

$

1,200

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)   Assumes the purchase by each investor of its maximum commitment in the Committed Financings.

 

24


 

Ravich Loan

 

As of June 5, 2017, the Company and the lender of the Ravich Loan mutually agreed to extend the maturity date of the amounts owed thereunder to July 31, 2017, and as of August 11, 2017, the Company and the lender of the Ravich Loan mutually agreed to further extend the maturity date of the amounts owed thereunder to February 28, 2018. As a result, borrowings under the Ravich Loan were $1,500 as of April 29, 2017 and as of the date hereof. 

 

25


 

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

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (this “MD&A”) should be read together with the unaudited consolidated financial statements and the related notes included in this report. For additional context with which to understand our financial condition and results of operations, refer to the MD& contained in our 2017 Annual Report on Form 10-K, for the fiscal year ended January 28, 2017,  which was filed with the Securities and Exchange Commission (“SEC”) on May 16, 2017, as well as the consolidated financial statements and notes contained therein (collectively, our “Annual Report”).  In preparing this MD&A, we presume that readers have access to and have read the MD&A in our Annual Report pursuant to Instruction 2 to paragraph (b) of Item 303 of Regulation S-K.

 

In addition to historical information, the following discussion and analysis contains forward‑looking statements. Forward-looking statements are statements other than historical facts that relate to future events or circumstances or our future performance. Forward-looking statements are based on our current views, expectations and assumptions that may cause actual results, performance, achievements or stock prices to be materially different from any future results, performance, achievements or stock prices expressed or implied by the forward‑looking statements. Such risks and uncertainties include, among others, the risks described in Part II, Item 1A, “Risk Factors” and elsewhere in this report. You should not place undue reliance on the forward‑looking statements we make because some or all of them may turn out to be wrong.

 

As used in this MD&A, “Cherokee Global Brands”, the “Company”, “we”, “us” and “our” refer to Cherokee Inc. and its consolidated subsidiaries, unless the context indicates or requires otherwise. Additionally, as used herein, the term “First Quarter” refers to the three months ended April 29, 2017; the term “Fiscal 2018” refers to the fiscal year ending February 3, 2018; the term “Fiscal 2017” refers to the fiscal year ended January 28, 2017; the term “Fiscal 2016” refers to the fiscal year ended January 30, 2016; and the term “Fiscal 2015” refers to fiscal year ended January 31, 2015.

 

We have a 52‑ or 53‑week fiscal year ending on the Saturday nearest to January 31, which aligns with our retail licensees who generally also operate and plan using such a fiscal year. This results in a 53‑week fiscal year approximately every four or five years. Each of Fiscal 2017, Fiscal 2016 and Fiscal 2015 was a 52‑week fiscal year, and Fiscal 2018 will be a 53-week fiscal year. Certain of our international licensees report royalties to us for quarterly and annual periods that may differ from ours.  We do not believe that the varying quarterly or annual period ending dates from our international licensees have a material impact upon our reported financial results, as these international licensees maintain comparable annual periods in which they report retail sales and royalties to us on a year‑to‑year basis.

We own the registered trademarks or trademark applications for Cherokee®, Hi-Tec®, Magnum®, 50 Peaks®, Interceptor®, Hawk Signature®, Tony Hawk®, Liz Lange®, Completely Me by Liz Lange®, Flip Flop Shops®, Everyday California®, Carole Little®, Sideout®, Sideout Sport®, Saint Tropez-West®, Chorus Line®, All That Jazz®, and others. All other trademarks, trade names and service marks included in this report are the property of their respective owners.

 

Overview

Cherokee Global Brands is a global marketer and manager of a portfolio of fashion and lifestyle brands it owns or represents, licensing the Cherokee, Hi-Tec, Magnum, 50 Peaks, Interceptor, Hawk Signature, Tony Hawk, Liz Lange, Completely Me by Liz Lange, Flip Flop Shops, Everyday California, Carole Little, Sideout, and other brands and related trademarks in multiple consumer product categories and sectors. As part of our business strategy, we also regularly evaluate other brands and trademarks for acquisition into our portfolio. We believe the strength of our brand portfolio and platform of design, product sourcing and marketing capabilities has made us one of the leading global licensors of style focused lifestyle brands for apparel, footwear, home products and accessories.

26


 

We have entered into license agreements with recognizable retail partners in their respective global locations to provide them the rights to design, manufacture and sell products bearing our brands and to provide them access to our proprietary 360-degree platform. We refer to this strategy as our “Direct to Retail” or “DTR” licensing model. We have also entered into wholesale arrangements for the manufacture and sale of products bearing certain of our brands. We refer to this strategy as our “Wholesale” licensing model. Further, we have franchise relationships for the Flip Flop Shops trademark and related assets with franchisees that operate Flip Flop Shops retail stores located worldwide. In addition, beginning in December 2016 when we acquired our Hi-Tec and Magnum brands through our acquisition of Hi-Tec International Holdings BV (“Hi-Tec”), which we refer to as the “Hi-Tec Acquisition,” we conduct indirect product sales to certain select distributors and government entities for these brands. We operate in two reportable segments, consisting of the Hi-Tec segment, which includes our operations associated with our Hi-Tec, Magnum, 50 Peaks, Interceptor and other footwear brands acquired in the Hi-Tec Acquisition, and the Cherokee Global Brands segment, consisting of our operations associated with all of our other owned and represented brands.

 

We believe our retail responsiveness process and 360-degree unique value proposition have allowed Cherokee Global Brands to address the growing power of the consumer and the present and future needs of the wholesalers, distributors and retailers that are selling our portfolio of lifestyle brands. Based on consumer research, retail insights and brand insights that we continually measure, evaluate and incorporate into our 360-degree platform, we believe Cherokee Global Brands has become a key strategic partner to our licensees. As of April 29, 2017, we had 130 continuing license agreements, 25 of which pertained to the Cherokee brand and 81 of which pertain to the Hi-Tec and Magnum brands.

We are guided by three value pillars that speak to our diverse global partners, Vision, Agility, Scale:

Vision—Brand vision that will drive differentiation and a fresh point of view to engage customers across every touch point and in multiple categories.

Agility—The agility of our unique 360-degree platform to quickly seize opportunity and swiftly introduce our branded products.

Scale—The ability to fully leverage our brands’ physical and digital spaces with multi-category relevancy and with globally recognized brands that drive a seamless customer experience.

We derive revenues primarily from licensing our trademarks to retailers and wholesalers all over the world. Our current licensee relationships cover over 110 countries and over 12,000 retail stores and Ecommerce businesses that includes relationships with Walmart, Target Corporation (“Target”), Kohl’s Illinois, Inc. (“Kohl’s”), Soriana, Comercial Mexicana, TJ Maxx, Tottus, Pick N Pay, Nishimatsuya Walmart, Big 5, Academy, JD Sports, Black’s, and REI. Our two most significant licensees in Fiscal 2017, Fiscal 2016, and Fiscal 2015 were Target and Kohl’s.

Recent Developments

 

Cerberus Credit Facility – Forbearance, Waiver and Amendment

 

On December 7, 2016, we entered into a senior secured credit facility with Cerberus Business Finance, LLC (“Cerberus”), pursuant to which we have borrowed $45.0 million under a term loan facility, which we drew down in December 2016, and $5.0 million under a revolving credit facility, which we drew down in the First Quarter. As of the end of the First Quarter, we were not in compliance with certain financial and reporting covenants under the Cerberus credit facility, and from June 27, 2017 through August 11, 2017, Cerberus agreed to forbear from exercising its rights or remedies under the credit facility solely with respect to these events of default.

 

On August 11, 2017, we entered into an amendment (the “Cerberus Amendment”) to the Cerberus credit facility, which includes a waiver of all existing events of default under the credit facility and amends certain other terms thereof, as follows:  (i) the required leverage ratio (as defined and calculated in the credit facility) has been amended to 16.00 to 1.00 through July 31, 2017, 10.50 to 1.00 through October 31, 2017, and decreasing ratios at the end of each of our fiscal quarters thereafter as set forth therein; (ii) the required fixed charge coverage ratio (as defined and calculated in the credit facility) has been amended to 0.25 to 1.00 through July 31, 2017, 0.35 to 1.00 through October 31, 2017,

27


 

and increasing ratios at the end of each of our fiscal quarters thereafter as set forth therein; (iii) we have agreed to a new liquidity covenant that requires us to maintain an amount of unrestricted cash on-hand, together with the availability under the revolving credit facility of the Cerberus credit facility, of no less than $3.0 million, and (iv) the parties have agreed to certain additional administrative amendments. The Cerberus Amendment also provides that, if at any time the new liquidity covenant is not satisfied and Cerberus submits a written capital demand, we would be required to complete an equity financing resulting in net cash proceeds to us of the amount requested by Cerberus in such demand, subject to an aggregate maximum of approximately $5.5 million and certain additional conditions (such financings, the “Committed Financings”).

 

As a condition to effectiveness of the Cerberus Amendment, we are required to: (i) complete the Concurrent Financing, as defined and described below, and (ii) obtain a firm commitment from one or more investors to fund one or more Committed Financings if required on or before March 5, 2018, which is also described below.

 

Concurrent Financing and Committed Financing

 

On August 11, 2017, we entered into common stock purchase agreements (the “Purchase Agreements”) with several investors to effect the Concurrent Financing and agree to the Committed Financing as required by the Cerberus Amendment. Pursuant to the terms of the Purchase Agreements, the investors have agreed to purchase, and we have agreed to issue and sell, an aggregate of 947,870 shares of our common stock in a private placement financing at a per share purchase price of $4.22 for net cash proceeds to us of approximately $4.0 million (the “Concurrent Financing”). The Concurrent Financing closed on August 17, 2017.

 

In addition, pursuant to the terms of the Purchase Agreements, certain investors have agreed to participate in the Committed Financings, such that, if we notify any such investor on or before March 5, 2018 of a failure to meet the new liquidity covenant set forth in the Cerberus Amendment, then such investor will be obligated to, subject to certain conditions and caps, purchase in a private placement financing additional shares of our common stock as requested at a per share purchase price equal to the lower of $4.22, 90% of the average closing price of our common stock for the 20 days prior to the date of our notification, or the closing price of our common stock on the day prior to our notification. The maximum aggregate value of the commitments from all investors for the Committed Financings is approximately $5.5 million. In addition, pursuant to the terms of the Purchase Agreements, in consideration for the agreement of certain investors to participate in the Committed Financings, we have issued to such investors warrants to purchase up to an aggregate of 326,695 shares of our common stock at an exercise price of $4.22. The warrants are exercisable at any time from March 5, 2018 until the seven-year anniversary of the initial issuance date, may be exercised in cash or on a “cashless” basis, and are subject to customary adjustments in the event of stock dividends or other distributions, stock splits, or mergers, reclassifications or similar transactions.

 

The investors participating in the Concurrent Financing and the Committed Financing include certain of our directors, officers and large stockholders, as follows: (i) Jess Ravich, one of our directors, who has agreed to purchase $2.0 million of shares in the Concurrent Financing and approximately $4.0 million of shares in the Committed Financings and has been issued a warrant to purchase up to 237,834 shares; (ii) Robert Galvin, our Chairman of the Board, who has agreed to purchase $100,000 of shares in the Concurrent Financing and $100,000 of shares in the Committed Financings and has been issued a warrant to purchase up to 5,924 shares; (iii) Howard Siegel, our President and Chief Operating Officer, who has agreed to purchase $100,000 of shares in the Concurrent Financing; and (iv) Cove Street Capital, LLC, one of our large stockholders, which has agreed to purchase $1.0 million of shares in the Concurrent Financing and $1.0 million of shares in the Committed Financings and has been issued a warrant to purchase up to 59,241 shares.

 

Ravich Loan

 

On December 7, 2016, we obtained a receivables funding loan for $5.0 million from Mr. Ravich. As of June 5, 2017, we and Mr. Ravich mutually agreed to extend the maturity date of the amounts owed under the loan to July 31, 2017, and as of August 11, 2017, we and Mr. Ravich mutually agreed to further extend the maturity date of the amounts owed under the loan to February 28, 2018. As a result, borrowings under the loan were $1.5 million as of the end of the First Quarter and as of the date of this report.

28


 

 

Critical Accounting Policies and Estimates

 

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

 

This MD&A is based upon our consolidated financial statements, included in this report, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires management to make estimates and 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.

 

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

 

·

Allowance for doubtful accounts;

 

·

Revenue recognition and deferred revenue;

 

·

Provision for income taxes and deferred taxes;

 

·

Valuation and impairment of long-lived assets;

 

·

Valuation and impairment of goodwill and indefinite-lived assets;

 

·

Valuation of assets and liabilities in connection with business combinations

 

·

Contingencies and litigation; and

 

·

Accounting for stock-based compensation.

 

Refer to our Annual Report and Note 2 to the consolidated financial statements included in this report for a discussion of our critical accounting policies and recent accounting pronouncements.

 

29


 

Results of Operations

 

The table below sets forth certain of our consolidated financial data for the periods indicated. Historical results are not necessarily indicative of results to be expected in the current period or in future periods.

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

    

Three Months Ended

 

 

 

April 29,

 

April 30,

 

(amounts in thousands)

 

2017

 

2016

 

Revenues:

 

 

 

 

 

 

 

Royalty revenues

 

$

6,840

 

$

10,678

 

Indirect product sales

 

 

4,273

 

 

 —

 

Total revenues

 

 

11,113

 

 

10,678

 

Costs of goods sold

 

 

3,008

 

 

 —

 

Gross profit

 

 

8,105

 

 

10,678

 

Selling, general and, administrative expenses and amortization of intangible assets

 

 

10,057

 

 

6,402

 

Restructure charges

 

 

128

 

 

 —

 

Operating (loss) income

 

 

(2,080)

 

 

4,276

 

Interest expense and other expense, net

 

 

(1,627)

 

 

(197)

 

Income tax (benefit) provision

 

 

(448)

 

 

1,498

 

Net (loss) income

 

$

(3,259)

 

$

2,581

 

 

Revenues

 

Our revenues totaled $11.1 million and $10.7 million in the three month periods ended April 29, 2017 and April 30, 2016, respectively.  Revenues during the three month period ended April 29, 2017 were comprised of royalty revenues and indirect product sales.  We began recording revenues from indirect product sales in December 2016 when we acquired the Hi-Tec and Magnum brands.

 

Royalty revenues for all periods were primarily generated from licensing our trademarks to retailers and to wholesalers, our share of licensing revenues from brand representation licensing agreements with other brand owners, franchise fees and royalty revenues received from franchisees of our Flip Flop Shops brand, and beginning in the fourth quarter of Fiscal 2017, revenues from royalties on wholesale sales of products bearing our Hi-Tec and Magnum brands throughout the world.   

 

Since the Hi-Tec Acquisition, we have been indirectly selling products bearing the Hi-Tec and Magnum brands to certain select wholesalers and government entities. In these arrangements, the purchasers of the products place their product orders directly with us, which we then forward to a manufacturer or distributor for the manufacture and delivery of the products directly to the original purchaser. The wholesalers and government entities that purchase products under these arrangements submit payments directly to us for their product orders, and we then remit a portion of these payments representing the product cost to the manufacturer or distributor of the purchased products. We maintain these indirect product sale relationships with a minimal portion of the customers of the Hi-Tec and Magnum brands. As we transition these wholesalers into new licensing agreements, these indirect product sales and corresponding cost of goods sold may vary significantly, however we expect gross profit to remain consistent. The indirect product sale arrangements subject us to certain risks, see item 1A, “Risk Factors,” for additional information. 

 

The decrease in royalty revenues between periods was primarily due to a decrease in United States royalties of $5.2 million, as we transition to our new wholesale licensing partners for sales of Cherokee branded products at many new retailers in the United States. The decrease is partially offset by an increase in royalties from the Hi-Tec and Mangum brands of $1.7 million.

 

Pursuant